Roth 401k vs Roth IRA

Roth 401k vs Roth IRA: Should I Roll it Over?

When choosing between a Roth 401k vs Roth IRA, there are a few similarities and differences you need to be aware of.

It’s customary to roll Roth 401ks into Roth IRAs at retirement for better options and more control. However, Roth 401k withdrawal rules differ from the rules for Roth IRA withdrawals in several ways. Understanding these differences can help you plan your distribution strategy as well as decide if a Roth 401k to Roth IRA rollover is in your best interest.


Although the differences are mainly with withdrawal rules, we first need to understand how contributions are treated.

With a Roth IRA, all of the money goes into the account as after-tax Roth dollars. Not so with the Roth 401k. Your own contributions through salary deferral are Roth contributions, but the employer match goes into a separate account that is tax-deferred. That means your Roth 401k has both Roth money and traditional, tax-deferred money.

That matters because each will be treated differently on withdrawal. Just like you are accustomed to, the Roth account is withdrawn tax-free while the employer contributions are taxable when you withdraw them. If you decide to roll your Roth 401k into a Roth IRA make sure you roll the employer matching contributions into a traditional IRA.

That fact by itself doesn’t really present you with anything to say a Roth IRA or Roth 401k is better. It’s just something you need to be aware of. Although your employers match on a Roth 401k goes into a tax-deferred account, it’s still money you otherwise would not have received. If you are still saving and have the option of a Roth 401k, it’s probably your better option. The main thing that would make the Roth IRA better is if your Roth 401k has very poor and expensive investment options.

The distribution rules are where the differences can really be a big deal and give you some planning elements to consider.

10% Early Withdrawal Penalty

If you think you’ll retire earlier than 59.5, leaving your money in the Roth 401k makes it easier to avoid the 10% penalty.

You’re probably aware of the 10% early withdrawal penalty. For IRAs, both Roth and Traditional, the 10% penalty applies to withdrawals taken before you turn 59.5. (You can withdraw your contributions to your Roth IRA any time, just not the earnings.) There are a few exceptions, but the rule applies under normal circumstances.

Roth 401k rules allow you to take distributions when you turn 55 and retire without incurring a 10% penalty. Your employers plan has to allow it, and you have to be retired, but as long as you are 55 then you won’t owe the 10% penalty.

Where this rule helps is the years between 55 and 59.5. If you are retired and taking distributions during that period, rolling your Roth 401k into your Roth IRA could expose you to the 10% penalty. Once you turn 59.5 you are no longer subject to the 10% penalty in either plan.

If you plan to retire BEFORE you turn 55, it may make sense to go ahead and convert some of your 401k into a Roth account using a Roth conversion ladder strategy. Suppose you plan to retire at 50. You could build the Roth conversion ladder to get you from 50-55, then when you turn 55 you can start taking distributions from your Roth 401k.

Required Minimum Distributions

You are required to withdraw specified minimum amounts from most retirement plans once you reach 70 & 1/2 and are no longer working. You may be withdrawing more than that minimum anyway, but if you aren’t you’ll have to start taking at least the minimum amount. Failure to take the RMD results in a tax penalty of 50% of the amount you should have withdrawn.

RMDs can be a sticking point for retirees who either don’t need to take distributions or would like to take smaller distributions and leave a larger inheritance. Depending on your withdrawal rate, RMDs could force you to change your distributions strategy mid-stream. Unwanted RMDs may also leave you with the problem of needing to figure out how to reinvest them.

You may want to structure your savings in a way that minimizes RMDs impact.

One way to do that is to avoid them altogether. You don’t have RMDs with your Roth IRA. Your heirs will have to adhere to a different set of distribution rules, but you won’t have to take an RMD during your lifetime.

Roth 401ks are not exempt from the RMD rules. Even though it is a Roth account you have to take RMDs from your Roth 401k.

To avoid RMDs on your Roth 401k, simply roll your Roth 401k into a Roth IRA. If you do that make sure you account for the five year rules of Roth IRAs. If you don’t already have a Roth IRA and think you may need to consider one in the future, go ahead and start one now. Your Roth IRA clock starts from the time you first open any Roth IRA.

You can roll money from a traditional IRA or 401k into a Roth IRA as well, but you’ll owe taxes on the amount you convert.

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