Okay, next question is from Rob. It says, “Are there drawbacks to hitting 25 percent with a company 401K, which is pre-tax and Roth, and not getting to a personal Roth IRA?”
So, okay, it sounds like this person is maxing out step six, right? Roth 401Ks, which is still tax-free, so I’m going to argue that that kind of lives in step five. Brian, I think the real question here is, “Hey, are there benefits to Roth IRAs over Roth 401Ks, or what’s the difference?”
I’ll start with one that’s really, really easy. Roth IRAs are so good, they’re so valuable that the government says, “Hey, once you make over a certain level of income, you can’t even do this anymore. We’re not going to let you high-income earners put money into these things.” Now, of course, there is the backdoor Roth strategy, which is an option, but take that out of the equation for a second. With a Roth 401K, there are no income limits, so you can make a million dollars a year and still max out your $22,500 Roth 401K without income limits. So, for some people, you may not be able to do a Roth IRA because you’re precluded from doing backdoors due to your income being too high. So the 401K might be the only option to build those tax-free assets. Save that scenario. What are some other big benefits and differences between Roth IRAs and Roth 401Ks?
Sure, and because I think he’s saying, “I just want to skip the step of the Roth IRA and just jump right into the employer plan.” Sure, because it’s easy, I mean, and simplicity is better in a lot of ways. But I want to make sure because it was easy forever also to say, “Hey, Roth IRAs don’t have to have the RMDs like the 401K versions of the Roth accountancy,” but they changed that with the most recent tax legislation. That’s been now, you know, equalized. But I wrote down some quick things. First of all, investment choices. What if your 401K plan was a 401K that has a Roth option but it’s all sub-accounts with an insurance company? It has high internal expenses, doesn’t offer you index funds. Then you’re probably gonna say, “Hey, I like the Roth IRA because it gives me choices. I control the custodian. I could go do the index funds, I can do the index Target Retirement funds,” and those three biggest custodians you can go to do some due diligence on is like Charles Schwab, Vanguard, or Fidelity Investments because you have control with the Roth IRA. You don’t have control with your 401K.
The other thing is just, it’s outside your employer. So, you know, when you do things with your 401K, your employer’s HR department and potentially leadership, they can see everything you’re doing, they know what’s going on. Whereas with a Roth IRA, you control that. Once again, it’s all about control, it’s completely outside of your employer, so it’s on you.
And then the third thing, and I hesitate to say this one, this is one that Beau brings up, cringe, but it’s a break-glass opportunity. So, you get really, really in a crunch. Think about medical emergencies or something that you’re just like, “I’m at my wit’s end.” It’s either this or I use credit card debt, or I go to the person that will break my legs if I don’t pay them back. Then I’m gonna say, “Yeah, you can go look at your Roth IRA because you can pull the basis out completely tax-free.” That’s a powerful tool. I don’t want you ever to use it. Like I said, you better have a person standing over you threatening to break your legs to do something like that. But it is definitely a valuable resource if you are in that type of situation.
But what I liked, and you went down this path, Bo, what I love is instead of saying either-or, I love the fact that you can actually do and you can do both. Because, you know, you think about, I know that’s pie in the sky for a lot of people, but there are folks, that’s why when we do the Financial Order of Operations, typically I’m talking about doing the Roth IRA first because that gives you options as you’re going through there because you get that extra flexibility to break glass opportunity, you control it. Those are all benefits.
And then I want you to kind of stack on the Roth benefit to the step six. If you’re doing the Roth 401K, just because, you know, it is something that you don’t have as much control, the emergency pull-out, yes, you can take a loan, but I’ve shared on previous Q and A’s that there’s a taxability feature or penalty feature there that could happen. Just be careful. You, I think you may have mentioned this if I’m repeating you, apologies, but you talked about how your 401K could be bad. It could have like sub-accounts and high internal expenses. Even if your 401K is good, maybe you have a Fidelity 401K, Vanguard, a really good 401K, just the nature of 401K structure itself, there are ongoing costs that are often passed on to participants, whether that be for the administrator, the record keeper, the TPA. Okay, so there’s a really good chance even inside of a very good 401K plan, opening up a Roth IRA on your own at a low-cost provider will still be a little bit cheaper. If so, if for no other reason, just cost savings for not having to pay a TPA for the 5500 filing and all that kind of stuff, I think it kind of tilts the Roth IRA in that direction. Yeah, it’s funny you said because, you must have looked at yours. I look at my online account, it’s one of those three low-cost providers, and they just took a few hundred dollars out again. And you know, and it’s the thing, we have squeezed that thing down as lean as possible, but even we have to pay some of those fees, right?