Money Girl explains the main differences between a Roth 401k and Roth IRA, and who can have them.
Q: I was at a recent retirement seminar at work where they said I could contribute a total of $30,500 to a Roth 401k and a Roth IRA. Can you explain how that works and what is the difference between a Roth 401k and a Roth IRA?
A: A 401k is a type of retirement plan that’s managed by an employer or created by someone who is self-employed. An Individual Retirement Arrangement or IRA is a plan that’s created and managed by an individual.
Here are the total amounts you can contribute to both types of retirement plans for 2015:
- 401k (traditional or Roth): $18,000 (or $24,000 if you’re age 50 or older)
- IRA (traditional or Roth): $5,500 (or $6,500 if you’re age 50 or older)
You’ll notice that if you’re age 50 or older, you can contribute a total of $30,500 ($24,000 + $6,500). If you’re younger, you can contribute a total of $23,500 to a 401k and an IRA.
Now, let’s cover what it means to have a Roth account. The major difference between a traditional and a Roth account is how your money is taxed. When you put money into a traditional retirement account, your contributions are made on a pre-tax basis. Later on, your contributions and any earnings are taxed when you take withdrawals.
With any kind of Roth account, your contributions are made on an after-tax basis. But neither your contributions nor earnings are taxed when you take withdrawals in the future.
See also: How to Get a Roth IRA?
You can contribute to a traditional account, a Roth account, or a combination of both, up to the annual allowable limits. For instance, you could contribute $2,000 to a traditional IRA and $3,500 to a Roth IRA in the same year, if you’re under age 50.
However, a Roth IRA has a special rule that limits or prohibits high earners from making contributions. For instance, if you’re a single taxpayer you can’t participate in a Roth IRA once your modified adjusted gross income reaches $131,000 for 2015.
But what’s terrific about a Roth 401k is that there are no income restrictions! So, you can max out a Roth 401k every year, no matter how much you earn. On the other hand, whether you can max out a Roth IRA depends on your income and tax filing status.
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