Saving on a Roth 401 (k) might be a better way to do so if taxes on converting a Roth IRA are prohibitive. When comparing a Roth IRA to a Roth 401 (k), each has its own set of advantages and benefits. Neither is intrinsically better than the other. For many, it may at some point help to switch between them to take advantage of the benefits of both.
Roth 401 (k) and Roth IRAs are retirement savings accounts that allow you to contribute money after taxes and make tax-free withdrawals when you retire. They are an alternative to traditional 401 (k) and traditional IRAs, which allow pre-tax contributions but require tax payments for withdrawals. A Roth IRA allows investors to have much more control over their accounts than a Roth 401 (k). With a Roth IRA, investors can choose from the entire investment universe, including stocks, bonds and individual funds.
In a 401 (k) plan, you are limited to the funds offered by your employer's plan. With a Roth 401 (k), tax-free and penalty-free withdrawals before age 59 and a half are generally limited to loans and specific exceptions. Since both Roth and Roth 401 (k) IRAs only accept after-tax contributions, neither provides tax relief in the year the contributions are made. If your employer doesn't offer a counterpart and you're eligible for both a Roth 401 (k) and a Roth IRA, you'll need to weigh the pros and cons of each type of account.
If your 401 (k) plan funds exceed 1 percent and you've reached the maximum employer contribution limit, consider investing in a Roth IRA. Both Roth 401 (k) plans and Roth IRA plans use after-tax money, meaning the homeowner doesn't have to pay income taxes when receiving distributions. If your 401 (k) investments are expensive, contribute enough for the company to pay you back, and then go directly to a brokerage agency to open a Roth IRA. However, under certain circumstances, such as buying a home for the first time or incurring birth expenses, you can withdraw the profits from your Roth IRA without penalty if you've held the account for less than five years and without paying fines or taxes if you've held it for more than five years.
Employers can match their contribution to pre-tax money, and when Roth is funded with after-tax money, the matching funds and their profits will be deposited in a regular 401 (k) account. A Roth 401 (k) has a minimum required distribution starting at age 72, but account holders can transfer it to a Roth IRA and avoid the requirement altogether. In this scenario, you'll want to contribute enough to get the balance and then allocate the rest of your retirement funds to a Roth IRA until you reach the contribution limits. Based on your plan's investment menu, employees would be better off taking full advantage of their employer's contribution and then funneling extra retirement money into a Roth IRA.
Created by the Economic Growth and Tax Relief Reconciliation Act of 2001, Roth 401 (k) are a hybrid that combines many of the best parts of 401 (k) and traditional Roth IRAs to provide employees with a unique option when planning for retirement.