While many people are familiar with the benefits of traditional 401(k) plans, others are not as acquainted with Roth 401(k)s.
Since January 1, 2006, employers have been allowed to offer workers access to Roth 401(k) plans. And some have introduced offerings as part of their retirement programs.1
As the name implies, Roth-401(k) plans combine features of 401(k) plans with those of a Roth IRA.2,3
With a Roth 401(k), contributions are made with after-tax dollars – there is no tax deduction on the front end – but qualifying withdrawals are not subject to income taxes. Any capital appreciation in the Roth 401(k) also is not subject to income taxes.
WHAT TO CHOOSE?
For some, the choice between a Roth 401(k) and a traditional 401(k) comes down to determining whether the upfront tax break on the traditional 401(k) is likely to outweigh the back-end benefit of tax-free withdrawals from the Roth 401(k).
Please remember, this article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax professional before adjusting your retirement strategy to include a Roth 401(k).
Often, this isn’t an “all-or-nothing” decision. Many employers allow contributions to be divided between a traditional-401(k) plan and a Roth-401(k) plan – up to overall contribution limits.
One subtle but key consideration is that Roth 401(k) plans aren’t subject to income restrictions like Roth IRAs are. This can offer advantages to high-income individuals whose Roth IRA has been limited by these restrictions. (See accompanying table.)
|Roth 401(k)||Roth IRA|
|Contributions||Contributions are made with pretax dollars||Contributions are made with after-tax dollars||Contributions are made with after-tax dollars|
|Income Limits||No income limits to participate||No income limits to participate||For 2022, contribution limit is phased out between $204,000 and $214,000 (married, filing jointly), and between $129,000 and $145,000 (single filers)|
|Maximum Elective Contribution*||Contributions are limited to $20,500 in 2022, ( $27,000 for those over age 50)*||Aggregate contributions are limited to $20,500 in 2022, ($27,000 for those over age 50)*||Contributions are limited to $6,000 for 2022, ($7,000 for those over age 50)|
|Taxation of Withdrawals||Qualifying withdrawals of contributions and earnings are subject to income taxes||Qualifying withdrawals of contributions and earnings are not subject to income taxes||Qualifying withdrawals of contributions and earnings are not subject to income taxes|
|Required Distributions||In most cases, distributions must begin no later than age 73||In most cases, distributions must begin no later than age 73||There is no requirement to begin taking distributions while owner is alive|
|* This is an aggregate limit by individual rather than by plan. The total of an individual’s aggregate contributions to his or her traditional and Roth 401(k) plans cannot exceed the deferral limit – $20,500 in 2022 ($27,000 for those over age 50).|
Source: IRS.gov, 2022
Roth-401(k) plans are subject to the same annual contribution limits as regular 401(k) plans – $20,500 for 2022; $27,000 for those over age 50. These are cumulative limits that apply to all accounts with a single employer; for example, an individual couldn’t save $20,500 in a traditional 401(k) and another $20,500 in a Roth 401(k).4
Another factor to consider is that employer matches are made with pretax dollars, just as they are with a traditional 401(k) plan. In a Roth 401(k), however, these matching funds accumulate in a separate account, which will be taxed as ordinary income at withdrawal.
Setting money aside for retirement can be part of a sound personal financial strategy. Deciding whether to use a traditional 401(k) or a Roth 401(k) often involves reviewing a wide range of factors. If you are uncertain about what is the best choice for your situation, you should consider working with a qualified tax or financial professional.