Are you thinking about offering retirement plans at your small business? There are a lot of retirement options to choose from. Two common retirement plans for employees are individual retirement arrangement/account (IRA) plans and 401(k) plans.
Maybe you are considering establishing a Roth, or post-tax contribution, retirement plan. What is the difference between Roth IRA and Roth 401(k) plans? To answer that question, first take a look at what IRA plans and 401(k) plans are.
Individual retirement arrangement (IRA) plans
An IRA is one type of retirement account business owners can offer employees at their company. There are different types of IRA plans to choose from:
- Traditional IRA
- SEP IRA
- SIMPLE IRA
- Roth IRA
Money deferred to traditional, SEP, and SIMPLE IRA plans are pre-tax contributions. That means that your employees defer wages to these retirement accounts before you withhold taxes. This reduces the amount of taxes taken out of your employees’ paychecks. But, they will need to pay taxes later when they use the funds.
Contributions to Roth IRA plans are after-tax deductions. That means that you will withhold taxes from your employees’ wages and retirement contributions. Your employees will not need to pay taxes in the future when they use the funds.
There are different employee requirements, contribution limits, and employer contribution requirements for each type of IRA plan. For more information on types of IRA plans, consult the IRS.
401(k) plans
A 401(k) is a type of retirement plan you can choose to offer employees. Like IRA plans, there are different types of 401(k) plans you might consider:
- Traditional 401(k)
- Safe harbor 401(k)
- SIMPLE 401(k)
- Solo 401(k)
- Roth 401(k)
Contributions to traditional, safe harbor, SIMPLE, and solo 401(k) accounts are pre-tax deferrals. You will defer employee wages to their retirement accounts before you withhold taxes. When the employee wants to use the retirement funds, they will pay taxes.
Money deferred to a Roth 401(k) are contributed on a post-tax basis. The funds are contributed after taxes are withheld. When the employee goes to withdraw their funds, they won’t need to pay taxes.
There are differences in flexibility, contribution limits and requirements, and the size of your business when choosing a 401(k) plan. For more information on the different types of 401(k) plans, check out the IRS website.
Roth IRA vs. Roth 401(k)
Now that you have an understanding of IRA plans and 401(k) accounts, read on to learn about the difference between a Roth IRA and a Roth 401(k).
Roth IRA plan
An individual opens and contributes to an individual retirement account through a financial institution. Created in 1997, a Roth IRA is a post-tax version of a traditional IRA. There are additional differences between a Roth IRA and a traditional IRA.
If an individual wants to open a Roth IRA plan, they do not need to have a traditional IRA plan. But, there are limits. An individual can only contribute to a Roth IRA if their modified AGI (adjusted gross income) is less than one of the following:
- Single: $161,000
- Married filing jointly: $240,000
Here are answers to some common questions that you or your employees might have about Roth IRA plans.
How much can I contribute to my Roth IRA?
Account holders can contribute up to $7,000 or their taxable compensation for the year. If the holder is 50 or older, they can contribute $8,000.
Can employers match employee contributions?
Since an IRA is an individual account, employers do not make matching contributions to their employees’ plans. Therefore, there are no matching contributions to a Roth IRA plan.
Can I borrow against my Roth IRA?
With some retirement plan options, participants can take out loans before they have access to the money. Account holders are not allowed to take out loans with a Roth IRA plan, but they can take money from their account before the age of 59.5. However, these withdrawals are subject to an additional 10% tax.
When are account holders required to start making withdrawals?
Individuals with a Roth IRA plan can start making penalty-free withdrawals at age 59.5 but are not required to start making withdrawals at any time. Account holders can keep the money in their account indefinitely. Unlike a traditional IRA, the account holder can continue to contribute to their Roth IRA even after they turn 70.5 years.
If the Roth IRA owner dies, the beneficiary must receive distributions from the account.
Do employers need to file an annual form to offer a Roth IRA plan?
Employers do not need to file any annual forms with the IRS to offer Roth IRA plans.
Roth 401(k) plan
A Roth 401(k) account is also known as a designated Roth account. In addition to a 401(k) account, there are other types of designated Roth accounts: 403(b) and governmental 457(b) plans. Designated Roth accounts are additional, separate accounts from 401(k), 403(b), and 457(b) plans.
You must offer employees a traditional 401(k) account in addition to a Roth 401(k) account.
Since their start in 2006, Roth 401(k) plans have become popular among businesses. One study revealed that 58% of employers let their employees make contributions to a Roth 401(k) plan.
Take a look at the following answers to some questions you or your employees might have about Roth 401(k) plans.
How much can I contribute to my Roth 401(k)?
Employees with a Roth 401(k) account can contribute up to $23,000 in 2024. If they are 50 years or older, they can contribute an additional $7,500, bringing the total limit to $30,500 in 2024.
Can employers match employee contributions?
With a designated Roth account, you can match your employees’ contributions. However, your matching contribution must be put into the pre-tax account (i.e., 401(k), 403(b), or 457(b) plans.
Since employers can contribute to a Roth 401(k), you will need to conduct annual nondiscrimination tests to ensure the contributions aren’t just benefiting highly-compensated employees. Conduct and pass the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests to keep the Roth 401(k) at your business.
Can I withdraw money from my Roth 401(k) early?
If your employees have a Roth 401(k) plan, they can take out a loan before they have access to the account funds. The employee will then be placed on a repayment schedule for the loan from their retirement account.
The employee can take out loans from multiple different retirement fund accounts. But, the total cannot go over the maximum amount allowed by the government.
The maximum amount, per the IRS, that an employee can borrow from their qualifying accounts is the lesser of:
- The greater of $10,000 or 50% of their account balance, OR
- $50,000
When are account holders required to start making withdrawals?
There is a required minimum distribution age for designated Roth accounts. In April of the year after an account holder turns 70.5 years old or retires, they must receive distributions and make annual withdrawals based on their life expectancy, according to the IRS.
Do employers need to file an annual form to offer a Roth 401(k) plan?
In order to offer a Roth 401(k) plan at your small business, you must file Form 5500, Annual Returns/Reports of Employee Benefit Plan.
What’s the difference between Roth 401(k) and Roth IRA plans?
There are many differences between Roth IRA and Roth 401(k) accounts, like contribution limits, loan options, income requirements, and required minimum distribution age. The major difference between the two you must consider before choosing a retirement plan at work is employer contributions.
With a Roth IRA plan, you are unable to contribute to the employee’s account. The employee opens the Roth IRA at a financial institution. The employee is not obligated to open a traditional IRA account.
With a Roth 401(k), you can make matching contributions. You open the account and offer employees the chance to contribute to the plan. You must also offer a traditional 401(k) plan for each employee.
| Roth IRA | Designated Roth Account Roth 401(k) | |
|---|---|---|
| Contribution Limit (2024) | Under age 50: $7,000 Age 50 or older: $8,000 | Under age 50: $23,000 Age 50 or older: $30,500 |
| Are There Income Qualifications? | Yes: AGI must be less than: $161,000 (single) or $240,000 (married filing jointly) | No |
| Can Account Holders Take Out a Loan From Their Accounts? | No | Yes |
Choosing between Roth IRA or Roth 401(k)
If you are looking to offer your employees a retirement plan and make matching contributions (as part of their benefits package), consider a Roth 401(k) plan. Since a Roth IRA plan is an individual account, you are not able to make matching contributions.
Can you have a Roth IRA and a Roth 401(k)?
Some individuals have both a Roth IRA and a Roth 401(k). If an eligible employee wants to contribute to both accounts, they can increase the amount of contributions.
For example, an employee can contribute to a Roth 401(k) plan at work and a Roth IRA plan through their financial institution. If you establish a Roth 401(k) at your business, let your employees know that they can also open a Roth IRA plan.
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This article has been updated from its original publication date of March 27, 2017.
This is not intended as legal advice; for more information, please click here.
