A Wiser Retirement®

265. Roth 401(k) vs. Roth IRA: Which One is Right for You?

• Wiser Wealth Management • Episode 265

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Curious about the difference between a Roth 401(k) and a Roth IRA? Join us on this episode of A Wiser Retirement® Podcast as we discuss key aspects of retirement planning, the importance of setting clear financial goals, and the distinctions between a Roth 401(k) and a Roth IRA. Discover valuable insights on maximizing your savings, navigating contribution limits, and making the most of employer matching programs—all to help you build a secure financial future.

Related Podcast Episodes:
- Ep 232: Is the Backdoor Roth IRA Strategy Right for You?
- Ep 173: Making the Most of Your Airline 401k

Related YouTube Videos:
- Why Every Parent Should Consider a Roth IRA for Their Child
- What makes a Roth IRA better than other IRAs? Which IRA is right for me?

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- Schedule a Complimentary Consultation: Discover how we can help you achieve financial freedom.
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This podcast was produced by Wiser Wealth Management. Thanks for listening!

Understanding Retirement Account Contribution Options

Speaker 1

So the max that you can put into your 401k, you can defer the $23,500 plus your catch-up if you're within those 50 or up, or the 60 to 63, the higher amount you can put that in. But your employer can then put in the match or their own contribution. So the maximum is $70,000 plus catch-up. Welcome to a Wiser Retirement Podcast. Are you curious about all of the different retirement plan options and contributions? I'm Shauna Theriault, and today I'm joined by Missy Beach. Each week we bring you practical advice on retirement, investing and planning for your financial future. Don't forget to subscribe to the podcast wherever you're listening. Let's get started. So we're in February. We're recording this a little bit earlier, but we're in February now and listeners are hearing this, and so we just passed National Quitters Day, not that long ago right.

Speaker 1

So everyone sets all their New Year's resolutions and then jump out of the gate and National Quitters Day.

Speaker 2

What is it? The second week of February, yes or no? January, january. That's all you have to get to, and quit Exactly.

Speaker 1

So I noticed the gym is still really busy. I go every day. I've only missed one day when we had the snow because they closed. I did not work out at home although I could, but I've noticed that the gym is still busy.

Speaker 2

Hey, did you hear that news story about one gym that is not accepting new members in January? Because those are all the quitters, the people that sign up in January. They're like we don't want you because you're just going to make all of our regulars mad because you're showing up for those two weeks in January or the month of January Interesting.

Speaker 1

And then you leave. I wonder if that creates like a buzz, like I want to be part of that because I couldn't be.

Speaker 2

Exactly.

Speaker 1

So it is smart, though, to help you help keep your goals. It's like use the whole month of January, Just figure out what it is and set like personal goals. Set you know something with personal, something with health, something with finances, set out what do I want to earn this year, and using like the whole month of January to kind of set those goals. So that way you're like planning it out and you don't feel like you have to start like January 1 and then you have changed up the pattern.

Speaker 2

Oh, that's so true. Yeah, you don't have to sit down in one sitting and figure out what you're doing for the entire year.

Speaker 1

That's a lot of pressure, absolutely, I feel like I, have to develop mine over time. Well, and then it's like attainable, right, Because you're just like setting it out. Did you and the family? Do you and the family like set goals for the year? Yeah?

Speaker 2

I mean, I do personally, my husband does, and then we try to get the boys to do that as well.

Speaker 1

That's so exciting.

Speaker 2

They're a little bit harder to pin down, but they realize the value now.

Speaker 1

What about you all? Oh, yeah, no, I think that's great, cause when they get out of school, it's like okay, we've just set goals. And you know, um, we did do goals this year. All of my whole family sat down and, um, the girls set goals too. So they're 17, 16 and 11. And they I think they were really good goals. They were having to do with like a little bit of personal health, and not that they're unhealthy, but it's like I want to do this. Some of it had to do with their sport and then other with school. So I'm like, well, that's good, because then you learn how to set them.

Speaker 2

So then, when it turns into being productive adults, the financial goal setting will be a piece of cake.

Speaker 1

Right, absolutely. We haven't set financial goals for the girls yet, but we do have those custodial accounts. So when they get like Christmas money or birthday money, they put it in the custodial accounts. They don't spend it and we buy investments and they get to see what those investments are. And so ETFs, of course just you know S&P 500 really but it makes it so that they're they have a buy into it so they can see it grow and see what it does and all of that. It's kind of exciting.

Speaker 2

And we've done the exact same thing with our boys. I mean just sock away that birthday Christmas money and don't spend it on worthless stuff they already have enough stuff?

Speaker 1

We don't need stuff. No, it'll serve them well.

Speaker 2

So exactly More S&P 500.

Speaker 1

Exactly, oh, and what we're going to talk about today is IRAs and retirement accounts and 401ks. If your teen is working and has earned income, they can do probably. I would do a Roth for them, probably as much as up to 7,000, but not, you know, up to the max of 7,000 or what they earn. So if they have a summer job and they made $2,000, they can put $2,000 in a Roth. So those are little fun things to do with your kids and get them thinking about saving.

Speaker 2

Yes, so my boys have earned income from their jobs. So we look at their W-2s. What did you make? Let's see how much of that you can put in the Roth IRA, nice. And so then do the compounding exercise. What rate of return are we going to assume till you're retired? And they're like, oh really, mom, yeah, so power of compound interest.

Speaker 1

That's what you've always taught them right. First words Okay, I know you told me that you told your boys that when we had dinner that one night. Now, my 11 year old I'm like what combats inflation? She's like the power of compounding interest. I'm like yep and we need it, missy taught you that.

Speaker 2

I love it this day and age of inflation.

Speaker 1

So we get a lot of questions. I think there's some confusion and of course we talk to the masses on this show, but we get some confusion on Roth versus traditional and I know we've talked a lot about that. But you know, I think we just want to clarify. Missy and I were talking about it. You know there's there's IRA accounts and there's 401k accounts and then each have each.

Speaker 3

So do you want to expand?

Speaker 2

on that Missy of what we're talking about, Because it's a little confusing Sure, and I think the confusion lies now that 401k plans have the Roth side of a 401k, and that's where a lot of people get confused because they equate Roth with earnings limits and so once you get into 401k territory, all that's blown away and you have unlimited earning capacity to contribute to a Roth IRA. So let's just start on the 401k side. So when you're investing in your employer's 401k, it doesn't matter how much you make you can sock it away on either the pre-tax side of the 401k that's valuable for higher earners, because you're getting a deduction for those contributions to the pre-tax side, meaning you're lowering your taxable income Today, today, on this tax return. But then when you take it out in retirement, you're going to pay ordinary income tax. You know, maybe it's better because maybe you're in a lower tax bracket, or maybe your tax bracket doesn't change, who knows? That's something to consider.

Speaker 2

But there's the Roth side of the 401k. You could make $2 million and guess what? You can put money into the Roth side of the 401k. And that's where a lot of people think they're out of the running for putting money into a Roth account because they make too much. No, in a Roth side of the 401k you can still do it.

Speaker 2

The rub is, when you're putting money in the Roth side of the 401k, you're paying tax on that, right. So you're not lowering your taxable income this year, the year you're making that contribution. The beauty, though, is that it's growing tax-free. When you take it out in retirement, you're not paying tax on it ever again. So it's kind of a balancing act. Does it make sense to pay the tax now on those 401k contributions, or does it make sense to pay it in retirement? So that's kind of the 401k side of it. Then you have the outside retirement accounts, either a traditional IRA or a Roth IRA. So in that world, if you have a company plan, a 401k, you're not going to be contributing to an outside IRA because it's not going to be deductible we're a big fan of, you know, unless you're trying to max out in other places.

Speaker 1

We're a big fan of having multiple places. You know to pull assets. So having Roth and pre-tax and taxable assets and so really your cashflow matters where you put it right. It matters what you're trying to do and what your long-term goals are as well. You want to have some liquidity and taxable accounts. So putting everything you have into retirement accounts limits you. But you know to your point, missy, you have these 401ks. You know the pre-tax is where you can really maximize your tax savings because as a W-2 employee you don't have a lot you can deduct really you know to save you money and so especially high income earner. So you know, pre-tax, then 401k and then the IRA side. You have the same two options there, but they're a little bit different with the limitations and the deductibility.

Speaker 1

Absolutely so with, like you mentioned, to do a Roth IRA. So let's talk about the dollar amounts first of all. Okay, so for the IRA portion, you can do what 7,000 this year. They always adjust for inflation and when it goes up to like the next thousand, they just round up. So I think it was the same last year. So it's 7,000 to a traditional IRA or a Roth IRA. Now, in the event of your boys, for example, if they only made 2000, hopefully they're making more, but you know, if they only made $2,000, hopefully they're making more, but you know, if they only made $2,000, you can't put $7,000, you can only put $2,000. So you're limited to your earnings there as well. So for the traditional $7,000 plus, if you're over 50, you can do an additional thousand, right.

Speaker 2

Exactly.

Speaker 1

Okay, so that's on the IRA side. Where the flip side, you have the 401ks. You can defer 23,500 this year, so that's substantially more that you can put in here, um, and you have the catch-up of 7,500 if you're over 50. So that would really be what 31,000 you can put in there Exactly. But there's this weird other catch-up provision for 401ks this year.

Speaker 3

I think we've mentioned it.

Speaker 1

I know During the tax planning zone I know 60 to 63. Right, so they can do 11,250 in catch-up, not in addition to the 7,500. Instead of addition to the $7,500. So instead of, instead of yes, so you know they can put an additional amount there. So that would be what. $3,450, I guess $3,450. That seems so random that you can defer. Okay. So those are very two different amounts. Now for again, no income limitation on the 401k side for the Roth, but the individual side. When you're looking at an individual Roth IRA, what is the income limitation on that?

Speaker 2

Yeah, so I guess for married couples you max out at what is it? $146,000.

Speaker 1

For Roth yeah, I think it's $236,000 to $246,000 for Roth. Yeah, I think it's 236 to 246. Oh, okay, I'm sorry, that's married couples yeah, for married um, married filing jointly. I think the the phase out. I think if you make more than 246, basically um, you can't contribute to a Roth.

Speaker 2

Oh, okay, I'm sorry, I was thinking of the IRA.

Speaker 1

Yes, if you, you have a spouse there's so many numbers, we always have to reference our papers too. So it's like you have the IRAs and okay. So we get this question a lot Well, can I contribute to an IRA? Maybe. So if you have a plan at work, it depends what your income is Exactly. If you have no plan at work, then you can contribute and it doesn't matter what you make. You can deduct the whole thing unless your spouse has a plan at work. So it's so confusing. The IRA is like OK. They first ask you do you have a plan at work? Does your spouse have a plan at work?

Speaker 1

OK, and then, yeah, the decision tree branches, Exactly so the income limitations are different for both of those. So if you have a plan, then there's an income limitation, or if your spouse has a plan, there's a separate one if you don't have one. And all of that, If neither one of you have a plan which means you can't do this 23,500, then you can deduct the full 7,000 for each of you and spousal. So you know, it really just depends on your situation and that's a way to do it.

Speaker 2

And the thing to note is that when we say up to $246,000, that includes the phase-out range, which is $10,000, of $236,000 to $246,000. So at $246,000, you're totally phased out. I mean that's a tight phase out range.

Speaker 1

Isn't that word confusing? That just means like a phase out. When we say that in taxes, that just means like if you're below this it's fine, if you're between these numbers, then you can do partial deduction, and then if you're above it, you can't deduct any of it.

Speaker 2

Yeah, so it starts at $7,000, at $236,000 of income for married filing joint. Then as you go up from $236,000 of income to $246,000, it whittles down to zero pretty darn fast.

Speaker 4

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Maximizing Retirement Account Contributions

Speaker 1

Now let's get back to the episode. You can still contribute to the IRA, though you just cannot deduct it, so it's considered an after-tax contribution.

Speaker 2

And then you have to track your basis on the Form 8606, which you've got, to make sure your CPA or you, if you're filing your own tax return keeps track of your basis on there, because that's really important when you start taking distributions in retirement, that you're not paying tax on that same $7,000 again.

Speaker 1

Yes, that would be frustrating for sure, if you don't track that. I've seen people do that. Yeah, it's like how do you go back and do that? I guess you could figure it out, but that would be.

Speaker 2

A lot of amendments.

Speaker 1

It would. So that's, you know, an after-tax contribution. So it grows still tax deferred right, and so you pay tax on the earnings, but just never on that basis.

Speaker 2

And I feel like that's a situation where we really look deep with clients. If it's to the, I'm not going to get a tax deduction for it. We really look deeper to decide okay, is that really worth it, or should that just be going into a taxable brokerage account to preserve more liquidity for it?

Speaker 1

Right, because let's say you're going to retire maybe a bit early, before full retirement I don't know if that's early, but before full retirement age, for example and so you know you have all of your money in retirement accounts. I love having taxable assets to draw from, okay, and we mean like brokerage, money that's invested, you know, between banks, taxable brokerage accounts, those kinds of things. To have those options available to you in retirement to be able to say, well, where's the best place for me to draw from? Is it Roth, is it brokerage account, is it pre-tax? All of that I love just having the options thereof.

Speaker 2

And Shauna. That is a really great message to clients, because I think people get fixated on I've got to save more for retirement. And when they think retirement they think IRA, 401k, roth IRA and they get so fixated on that. You see people come through our doors and it's all in the retirement bucket. They have no flexibility like you just described, in the event that they want to retire early, and some people now want to retire in their 50s and they've got everything locked up in retirement accounts till 59 and a half For the most part. Sure, there's ways to get it out.

Speaker 2

Rule of 55 and all those things. But then you're getting into more complex strategies and things like that, that you got to lock into a stream of payments and things like that. But the easiest thing is to make sure you've got a diversified pool of assets in terms of tax nature.

Speaker 1

I completely agree with you. I think they do, and it's not like you have to spend the difference. Or we also hear in light of that it's like when you're looking at your future required minimum distributions and they see that number, it's like, oh, I have to spend that much.

Speaker 4

No, you don't.

Speaker 1

You have to take it out, but you can leave it invested in a brokerage account. That doesn't mean you're spending that much. In fact it's better if you don't spend it all, because you just preserve it that much longer. You know, and maybe your plan shows it's all spent and that's okay as long as long as your, your plan and your cashflow is lasting and meeting the goals that you're intending it. You know. Whatever your long-term goals are, that's okay too, but it doesn't necessarily mean you have to spend it all. It just means you have to take it out and pay tax on that portion or give it to charity.

Speaker 2

True.

Speaker 4

There's other things there's other techniques that we work with.

Speaker 2

Absolutely and so there's so many ways to skin the cat 100%.

Speaker 1

The other question we get um in this realm is this far as the deferral. So it's like, okay, I defer 23,500, but then, well, where does my employers go? We get that question a lot. He's like that's my max. Well, what is the overall max?

Speaker 2

Oh yeah, they think I can't put in 23,500 because I want to get my match Right Exactly. And that's where the fallacy is. You can put in 23.5 all day long. The employer match doesn't count towards that max contribution amount of 23.5.

Speaker 1

Or the catch-up.

Speaker 2

Or the catch-up.

Speaker 1

Right.

Speaker 2

Yeah, perfect. So you contribute up to that max level all day long. The employer can do their match on top of that Right, as long as you don't exceed 70,000 this year 70,000.

Speaker 1

Right, that's a lot to put in a retirement plan. Exactly, I know there's a lot of clients that don't get that much and you know some of our clients do get that much from employers but most of them don't. Most of America don't get $70,000 a year into retirement plans.

Speaker 1

No, unless you've got a really generous employer contribution, like some of the airlines, you're not going to Well and I've seen some like the airlines, where other companies where maybe they got rid of the pension, so they're making it up by contributing more like 10%, say, or even higher percentage into the 401k.

Speaker 2

Yeah, where it's not a match, it's just a contribution, exactly.

Speaker 1

To kind of make up for that pension going away. So the max that you can put into your 401k, you can defer the $23,500 plus your catch up if you're within those 50 or up or the 60 to 63, the higher amount. But you can put that in. But your employer can then put in the match or their own contribution. So the maximum is 70 grand plus catch up.

Speaker 2

Yes, oh, here's another myth that I think young adults fall into. I see this with, like, really young clients or kids of clients. When they start out they think maxing out their 401k is just doing the percentage that will get their employer match. So say, the employer matches whatever up to 6%. The employees doing 6%. They think they're maxing out because they're getting all the employer contribution that they can. And I'm like, hey, well, you could put in 23.5. And they're like, oh, I thought I was maxing out. I get the full match. I'm like, well, that's great, you're maxing out your free money from the employer, but you could still be socking away more. So just because you're getting the full match, you're not maxing out your annual limit that you could be putting in Completely great point, I think.

Speaker 1

Just one more looking at the Roth IRA versus the pre-tax versus the Roth and this. So I don't know that we did very much on the Roth IRA and so in that scenario there's the income limitations for the Roth. There's the income limitations for the Roth. There's the income limitations for the IRA if you have a plan or your spouse has a plan, otherwise it's fully deductible. Those two vehicles is what you can do the backdoor Roth for where you can contribute to an IRA that's maybe not tax deductible because you're in a plan and then subsequently convert it. Now if you have money in an IRA already, then you have to look at the tax. There could be some tax due on that conversion.

Speaker 1

But that is the mechanics of a backdoor Roth, which I know we've talked about ad nauseum on. These shows the mechanics of that. And then the Roth grows tax-free, the IRA grows tax-deferred and the same. So the tax treatment of both is the same. As far as a 401k and an IRA, now there's sometimes in a 401k where you can do after tax contributions. Sometimes we prefer to put those that in taxable accounts, just so you have that other option. But you can make after tax contributions and you know those will grow. Tax deferred also.

Speaker 1

Just on the earnings kind of like having basis in your ira similar kind of thing there. Um, some will convert or move their after tax 401k to their roth ira when they retire. Just know that'll be taxable event on the part that grew. Um, you know, so there's and so there's after tax contributions in an IRA to the grow tax. So it's very similar in that. But you can put more in the after tax because you can put up to the limit for your contribution limits there. So I think that you know really takes care of the different types of IRAs, retirement accounts. You know, which one do you think is best for people? It's that's really the question, right, and it's really dependent on it's a very personal, individualized thing.

Speaker 2

Exactly, and it's going to depend depending on their stage of life, their career, their family structure and you know, they might fund a certain account for, you know, 10 years and then maybe it's going to flip to some other funding destination. Right, it's not going to always be the same answer from year to year and our strategy is going to change.

Speaker 1

Right.

Speaker 2

And it's all dependent on the circumstances in place at the time. So there's never one cookie cutter answer. Shauna is there.

Speaker 1

It just depends, which is what attorneys and CPAs always say. Right, it depends, it does, though it's an individualized answer depending on the situation. And so you know, if you're in a lower tax bracket, general rule of thumb, maybe you want to do a Roth. If you're in a higher tax bracket, doing pre-tax, but there's nuances with that too and other things to consider, and you know we've done a couple of shows on that. So, but at any rate, and the other thing, the last point too, is just know that your employer contributions that match you or just contribute for you are always pre-tax. Yep, they do have the option of doing the Roth. And what happens? When would they do a Roth portion?

Speaker 2

Oh yeah. So sometimes now an employer will match with Roth dollars If they do guess what that's taxable income to you, because it's after-tax dollars going into your account. So yeah that's logical.

Speaker 1

So someone pays the tax yeah, someone's got to. The employer deducts it. Or you don't pay the tax. Somebody pays the tax on it. It's not just free Roth money. So, you can't be mad.

Speaker 2

I mean they're giving you free money so you have to pay tax on the after-tax money they're giving you.

Speaker 1

Oh, absolutely, and that is a good point. On the match in general, you should always, if you can, for cash flow purposes, at least contribute enough. This is not maxing out, as you pointed out, but contribute enough that you can at least get the match, because if they're matching you dollar for dollar up to a certain point, that's a hundred percent return. Yes, before you even put it in an investment, I know right, you're never gonna get.

Speaker 3

And it's part of your compensation.

Speaker 1

Yeah, that's part of what you're getting paid for they budget for that.

Speaker 2

Yeah, that's your overhead. Is that 401k match? Yeah, they're banking on you taking that yeah.

Speaker 1

And that's part of like to me, that's part of. It's not salary. Here's your bonus, here's your benefits.

Speaker 2

Like, take advantage of that, take it all day long. That's a really great point.

Speaker 1

Love it Well. Thanks for listening to today's episode. If you're interested in learning more about Wiser Wealth Management or want to schedule a consultation to meet with one of our fiduciary financial advisors, you can do so by going to wiserinvestorcom or you can click the link in episode notes. See you next week.

Speaker 3

Thanks for listening to a Wiser Retirement Podcast. We hope you enjoyed today's episode. Make sure to subscribe wherever you're listening. That way you don't miss any new episodes. We'd also appreciate if you could leave a rating and review. If you have any questions about anything that was discussed today, head to wiserinvestorcom and reach out.

Speaker 3

This episode was produced by Rachel Dotson. This podcast is strictly for informational purposes only and is not to be considered as investment advice or solicitation to buy or sell any financial products, securities, digital assets or any other investment vehicles or a basis to make any financial decisions. Wiser Wealth Management Incorporated is a registered investor advisor with the SEC. The host and or guests may personally own securities, digital assets or other investment vehicles mentioned on this podcast. Neither the host nor guests of the show are compensated for their participation and no referral fees are paid to or received by any host or guest for clients, listeners or similar interests. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor, tax professional, insurance professional and or legal professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.