Roth 401(k) vs. Roth IRA: Why They Are NOT the Same Account
Roth 401(k) vs. Roth IRA: Why They Are NOT the Same Account
๐ WHO THIS IS FOR
- Target Profile: High-income employees ($200k+) maximizing retirement contributions.
- Primary Objective: Tax-Free Growth & Asset Protection (Shielding assets from creditors).
- Not Suitable For: Low-income earners who need the immediate tax deduction of Traditional accounts.
EXECUTIVE SUMMARY
- The Confusion: Investors assume “Roth is Roth.” They treat Roth 401(k)s and Roth IRAs as identical buckets. They are not. They operate under different sections of the tax code (401 vs 408A).
- The Trap: A Roth 401(k) has stricter withdrawal rules. You cannot withdraw contributions penalty-free before age 59ยฝ (the “Pro-Rata Rule” applies). A Roth IRA allows you to withdraw contributions anytime, tax-free.
- The Shield: However, a Roth 401(k) has superior legal protection. Under ERISA law, 401(k) assets are 100% protected from creditors and bankruptcy. IRAs have limited state-level protection.
- Authority Baseline: This analysis incorporates the SECURE Act 2.0 updates, which finally aligned the RMD rules (eliminating RMDs for Roth 401(k)s starting in 2024), removing one major disadvantage.
You might have $1M in a Roth 401(k) and think it’s a liquid emergency fund. It is not. If you try to pull $50k out of a Roth 401(k) for an emergency, you will trigger taxes and penalties on the growth portion immediately. Understanding the “ordering rules” of withdrawals is the key to liquidity. According to Team BMT Analysis, the optimal strategy is to build the bulk in Roth 401(k) for protection, but keep a “Roth IRA” sidecar for liquidity. Source: IRS Pub 590-B / Kitces Research
Scenario: You are 45. Account has $100k ($80k Contributions / $20k Growth).
- Withdraw $10k from Roth IRA:
Rule: Contributions come out first.
Tax/Penalty: $0. (It’s your money). - Withdraw $10k from Roth 401(k):
Rule: Pro-Rata. Every dollar is 80% Contribution / 20% Growth.
Math: You withdrew $8k principal (tax-free) and $2k growth (taxable).
Tax/Penalty: You owe tax + 10% penalty on the $2k.
Verdict: The Roth 401(k) is illiquid until age 59ยฝ.
BMT Verdict: Never roll a Roth IRA into a Roth 401(k) (even if allowed). You are voluntarily surrendering liquidity. However, always roll a Roth 401(k) into a Roth IRA upon retirement to unlock the favorable withdrawal rules. The direction of the rollover matters.
Feature Comparison Matrix
| Feature Score (0-10) | Roth IRA | Roth 401(k) |
|---|---|---|
| Liquidity (Pre-59.5 Access) | 10 | 2 |
| Asset Protection (Creditors) | 5 | 10 |
*Chart Note: The chart quantifies the trade-off. Roth IRA wins on flexibility; Roth 401(k) wins on safety. High-net-worth individuals in litigious professions (doctors, developers) should prioritize the 401(k) shield.
Regulatory Update: Before 2024, Roth 401(k)s had Required Minimum Distributions (RMDs) at age 73, while Roth IRAs did not. The SECURE Act 2.0 eliminated this discrepancy. Now, both accounts are exempt from lifetime RMDs. This removes the urgency to roll over solely for RMD avoidance.
โ BOUNDARY CLAUSE: This Structure Breaks Down If:
- Income Limit Exceeded: High earners cannot contribute directly to a Roth IRA ($161k+ limit). They must use the Backdoor Roth strategy. Roth 401(k) has no income limit.
- Bad Plan Menu: If your 401(k) only offers high-fee funds (1%+ expense ratio), the tax benefit is eroded by fees. In that case, prioritize the Roth IRA (where you can buy cheap ETFs).
Execution Protocol
1. Contribute to 401(k) up to Employer Match (Free Money). 2. Max out HSA (Triple Tax Free). 3. Max out Roth IRA (Liquidity Bucket). 4. Max out Roth 401(k) (Growth Bucket).
When you leave your job, roll the Roth 401(k) into your Roth IRA. Why? The 5-year clock for earnings withdrawals on a Roth IRA is based on when you opened your first Roth IRA. By rolling over, the 401(k) money adopts the (likely older) “seasoning” of your IRA.
If you are sued, do NOT roll over your 401(k) to an IRA. Keep it in the plan. ERISA protection is federal and absolute. IRA protection varies by state (e.g., California protects only “reasonable support,” not the full balance).
Understanding the nuance between these two accounts allows for “Juridical Arbitrage”โplacing assets where they are safest or most accessible depending on your life stage.
WEALTH STRATEGY DIRECTIVE
- Do This: Open a Roth IRA with $1 today, even if you don’t fund it fully. This starts the 5-year “aging” clock. When you eventually roll over a huge Roth 401(k) later, it will instantly be considered “seasoned.”
- Avoid This: Using Roth 401(k) funds to buy a first home. The “$10,000 First Time Homebuyer” exception applies ONLY to IRAs, not 401(k)s. You must roll it over first to use this perk.
Frequently Asked Questions
Can I have both?
Yes. You can contribute $23,000 to a Roth 401(k) AND $7,000 to a Roth IRA in the same year (if income allows). They have separate limits. This allows for $30k+ of tax-free space annually.
Does employer match go to Roth?
Under SECURE 2.0, employers can now put the match into the Roth bucket (if they choose), but the employee must pay tax on it immediately. Traditionally, the match always went to the Pre-Tax bucket.
What is the 5-Year Rule?
There are two 5-year rules. 1) For contributions: Always tax-free (IRA). 2) For earnings: Must be 59ยฝ AND account open for 5 years. Roth 401(k)s have a separate 5-year clock for each employer plan. Roth IRAs have one aggregated clock.