Interested in a Roth 401(k)? Here's how they work

Answers to the most important questions about the Roth 401(k).

  • By Bill Bischoff,
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As the name suggests, a Roth 401(k) combines features of the traditional 401(k) with those of the Roth IRA. It’s offered by employers like a regular 401(k) plan, but as with a Roth IRA, contributions are made with after-tax dollars. While you don’t get an upfront tax-deduction, the account grows tax-free, and withdrawals taken during retirement aren’t subject to federal income tax, provided you’re at least 59½ and you’ve held the account for more than five years.

The Roth 401(k) can offer advantages to high-income individuals who haven’t been able to contribute to a Roth IRA because of the income restrictions. For 2019, eligibility for Roth IRA contributions phases out between adjusted gross income of $122,000 and $137,000 for unmarried individuals and between $193,000 and $203,000 for married joint-filing couples. There are no such income restrictions for Roth 401(k) accounts.

Save more for retirement

Here's an infographic guide to annual contribution and tax deduction limits for 2019.

In addition, Roth 401(k) accounts are subject to the same contribution limits as a regular 401(k) — a maximum of $19,000 for 2019, or $25,000 for those who will be 50 or older by the end of the year — allowing individuals to stock away thousands of dollars more in tax-free retirement income than they would through a Roth IRA. (In 2019, annual Roth IRA contributions are limited to $6,000 or $7,000 for those who will be 50 or older as of year-end.)

The hitch: The 401(k) contribution limits apply to all types of 401(k) plans, so a 40-year-old person cannot save $19,000 in a regular 401(k) and another $19,000 in a Roth 401(k). But you could save $9,500 in each or any combination that adds up to $19,000 or less.

Workers who are offered the Roth 401(k) option face a difficult choice: Contribute to a Roth 401(k) and suffer a cut in take-home pay (since contributions are made with after-tax dollars), or stick with a traditional 401(k) and hope that in retirement, their tax rate will be lower than it is now. Alternatively, they could hedge their bets by contributing to both types of accounts.

Making a sound decision largely hinges on your estimation of the tax rates you’ll pay during your retirement years. If you expect your tax rate to be the same or higher in retirement than it is now, you might be better off with a Roth 401(k). This is likely to be the case with young people who are just starting their careers and expect their income to increase in the future. For folks who are in a low tax bracket, it may not be a bad idea to pay those taxes now and never have to worry about what tax brackets might become in the future. On the other hand, if you’re in your peak earning years and you figure your tax bracket will be lower in retirement (good luck with that assumption), you’ll benefit from continuing with traditional 401(k) contributions.

In reality, of course, things are much more complicated. For one, no one can predict with certainty what tax rates will be in the future, though the consensus is that they’re likely to rise to help the government offset budget deficits and pay for Social Security and Medicare.

Still have questions about the Roth 401(k)? We thought so. And we’ve gone ahead and answered the most important ones.

Who is eligible for a Roth 401(k)?

Anyone whose employer offers it. This is where it gets tricky: Among the major concerns for employers are the costs associated with managing the plan, and educating their workforce about this investment option. Companies are much more likely to offer a Roth 401(k) if their employees indicate that they intend to participate. So if you want a Roth 401(k) option to be added to your plan, make sure to let your employer know.

What happens to the employer match?

Employer matches are made with pretax dollars, and the match accumulates in a separate account that is taxed as ordinary income at withdrawal.

What are the early withdrawal rules?

Early Roth 401(k) withdrawal rules are subject to the same requirements as traditional 401(k)s, according to the IRS.

What happens if I leave my job?

The Roth 401(k) balance can be rolled over into a Roth IRA.

Is the Roth 401(k) option here to stay?

Yes. At one time, the Roth 401(k) option was temporary, but it was made permanent by 2006 legislation. So this is a deal you can count on.

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