Business Development Officer, T.D. McNeil Insurance Services, Fresno, California
The similarity between a Roth IRA and a 401(k) plan is that they are both qualified retirement plans. The Internal Revenue Service has issued regulations on both and they appear in the Code. The number 401(k) is the code section that permits that specific type of retirement program. In both programs the income tax on earnings from money held in the program is tax-deferred, meaning that there isn’t any income tax on the earnings in the current year.
A Roth IRA is an individual plan. You own the plan. The money that you put into the plan is made with money that has already been taxed. You don’t need to be the employee of a particular company to have a Roth IRA. There isn’t any tax current tax deduction for the deposit. You can have a Roth IRA even if you have a retirement plan elsewhere. As a plan owner you select where the funds are to be invested, within limits. There are adjusted gross income limits to participation so check with your advisor if you have relatively high income. A non-working spouse can have a Roth IRA.
A 401(k) is an employer sponsored plan. Your employer sets up the plan and either administers the plan directly or uses a third party administrator to maintain the plan. Under most circumstances the employer states clearly who can participate in the plan. The money contributed to the plan is normally deducted from your paycheck before income tax is withheld. That is because that money is tax-deferred. There won’t be any current income tax on that money.
Sometimes employers will match some of the money contributed as an incentive. Particularly when the employer contributes to the plan there will probably be a vesting schedule. That means that the money contributed by the employer isn’t really yours until you meet a certain criteria for service or participation in the plan. The plan will also stipulate whether “in-service” withdrawals can be made, and the conditions under which they can be made.
During the “accumulation phase” withdrawals from a 401(k) plan can trigger a “taxable event.” However, with a Roth IRA if the program has been in place for more than five years and you are older than 59.5, or have become disabled or need the money for a first-time home purchase, there isn’t a penalty tax of 10%. You can also use the money for higher education costs. Withdrawals for education prior to your reaching age 59.5 will be subject to income tax even though they are not subject to the additional 10% penalty tax. You can withdraw up to the total of your payments without income tax or the additional 10% penalty tax.
Treatment can be different under a 401(k.) The plan itself might not allow in-service withdrawals and income tax and penalty could also be charged. During the accumulation phase the 401(k) plan will offer a limited number of investment options, often including an option to purchase company stock. Those are the only investment options available. However, a Roth IRA can be funded with a variety of investments and changed whenever it is deemed best by you.
When you retire with a 401(k) the IRS will require that starting after you reach 70.5 you must make withdrawals every year. These are scheduled in the code. With a 401(k) these withdrawals are treated as ordinary income and are fully taxed. This is not a requirement of your Roth IRA. Withdrawals are not required and when you decide to take them, they are free of income tax if you are over 59.5 years old.
You can name a beneficiary with both types of plans; however with the Roth IRA if the plan has been held for more than five years, the funds can pass to an heir tax-free.
The key issue is that deposits in a 401(k) are currently not included in your income tax and may be matched by your employer. The contributions to a Roth IRA are made with after-tax dollars. When you retire all of the money in your 401(k) plan will be taxed as withdrawn as ordinary income, however, none of the money from a Roth IRA will be taxed.
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A Roth IRA is an individual plan. You own the plan. The money that you put into the plan is made with money that has already been taxed. You don’t need to be the employee of a particular company to have a Roth IRA. There isn’t any tax current tax deduction for the deposit. You can have a Roth IRA even if you have a retirement plan elsewhere. As a plan owner you select where the funds are to be invested, within limits. There are adjusted gross income limits to participation so check with your advisor if you have relatively high income. A non-working spouse can have a Roth IRA.
A 401(k) is an employer sponsored plan. Your employer sets up the plan and either administers the plan directly or uses a third party administrator to maintain the plan. Under most circumstances the employer states clearly who can participate in the plan. The money contributed to the plan is normally deducted from your paycheck before income tax is withheld. That is because that money is tax-deferred. There won’t be any current income tax on that money.
Sometimes employers will match some of the money contributed as an incentive. Particularly when the employer contributes to the plan there will probably be a vesting schedule. That means that the money contributed by the employer isn’t really yours until you meet a certain criteria for service or participation in the plan. The plan will also stipulate whether “in-service” withdrawals can be made, and the conditions under which they can be made.
During the “accumulation phase” withdrawals from a 401(k) plan can trigger a “taxable event.” However, with a Roth IRA if the program has been in place for more than five years and you are older than 59.5, or have become disabled or need the money for a first-time home purchase, there isn’t a penalty tax of 10%. You can also use the money for higher education costs. Withdrawals for education prior to your reaching age 59.5 will be subject to income tax even though they are not subject to the additional 10% penalty tax. You can withdraw up to the total of your payments without income tax or the additional 10% penalty tax.
Treatment can be different under a 401(k.) The plan itself might not allow in-service withdrawals and income tax and penalty could also be charged. During the accumulation phase the 401(k) plan will offer a limited number of investment options, often including an option to purchase company stock. Those are the only investment options available. However, a Roth IRA can be funded with a variety of investments and changed whenever it is deemed best by you.
When you retire with a 401(k) the IRS will require that starting after you reach 70.5 you must make withdrawals every year. These are scheduled in the code. With a 401(k) these withdrawals are treated as ordinary income and are fully taxed. This is not a requirement of your Roth IRA. Withdrawals are not required and when you decide to take them, they are free of income tax if you are over 59.5 years old.
You can name a beneficiary with both types of plans; however with the Roth IRA if the plan has been held for more than five years, the funds can pass to an heir tax-free.
The key issue is that deposits in a 401(k) are currently not included in your income tax and may be matched by your employer. The contributions to a Roth IRA are made with after-tax dollars. When you retire all of the money in your 401(k) plan will be taxed as withdrawn as ordinary income, however, none of the money from a Roth IRA will be taxed.