What Is a Roth 401(k)?
A Roth 401(k) is an employer-sponsored retirement savings account funded with after-tax dollars, meaning income tax is paid upfront on the contributions. Withdrawals from the account during retirement are tax-free, offering substantial tax benefits for future retirees.
This differs from traditional 401(k) plans, which use pretax contributions and defer income taxes until retirement withdrawals.
Key Takeaways
- A Roth 401(k) is an employer-sponsored retirement plan with contributions taxed upfront.
- Roth 401(k) earnings and withdrawals after retirement are tax-free.
- The minimum age for required minimum distributions (RMDs) is 73 as of January 1, 2023, unless the account holder was 72 in 2022.
- Contribution limits are annually adjusted for inflation according to the IRS guidelines.
- Early withdrawals (before age 59½ or before the account is five years old) incur penalties.
How Roth 401(k) Plans Work
Roth 401(k) participant agrees to automatic payroll deductions, transferred to the retirement account, possibly with employer matching contributions. While the Roth 401(k) option has been available since 2006, traditional 401(k)s have existed since 1978; both offer unique tax advantages.
- A traditional 401(k) offers an immediate tax break by reducing the employee’s gross income for the year with deferred tax on withdrawals.
- A Roth 401(k) requires upfront tax on contributions but allows tax-free withdrawals during retirement.
More Employers Offering Roth 401(k)s
The Transamerica Institute survey indicates that 77% of plan sponsors offered a Roth 401(k) option at the end of 2022.
Roth 401(k) Contribution Limits
Contribution limits for Roth 401(k) are based on age and yearly adjusted for inflation by the IRS. For 2023, the limit for individuals is $22,500, with an additional $7,500 for those aged 50 and older as a catch-up contribution. In 2024, the contribution limit rises to $23,000, with the catch-up contribution remaining the same. Contribution limits ensure participants cannot contribute more than their taxable income for that year.
| Roth 401(k) Contribution Limits | ||
|---|---|---|
| Year | Less than Age 50 | 50 Years or Older |
| 2023 | $22,500 | $30,000 |
| 2024 | $23,000 | $30,500 |
Roth 401(k) Withdrawal Rules
Withdrawals from a Roth 401(k) are tax-free as long as they meet the criteria for being a qualified distribution:
- The account held for at least five years.
- The withdrawal made after reaching at least age 59½, or due to disability or death. As of January 1, 2023, RMDs must be taken at age 73 per the SECURE Act 2.0. Missing an RMD can incur penalties, now at 25% of the missed amount or 10% if corrected promptly.
Unlike Roth 401(k)s, Roth IRAs are not subject to required minimum distributions.
Advantages and Disadvantages of Roth 401(k)s
Advantages
- Suitable for those expecting to be in a higher tax bracket during retirement.
- Tax-free dividends on retirement distributions.
- Contributions grow tax-free.
Disadvantages
- Contributions require paying taxes upfront.
- Immediate inflow decrease as contributions reduce net income for the current year.
Roth 401(k) vs. Other Retirement Accounts
While Roth 401(k) plans are employer-sponsored, other options like traditional 401(k)s, IRAs, and 403(b)s also help in retirement savings.
401(k) Plans
Similar to Roth 401(k)s, traditional 401(k) plans use automatic payroll deductions. Contributions, however, reduce taxable income for the year they are made, whereas taxation occurs upon retirement withdrawals. For 2023, employees under 50 can contribute up to $22,500 (rising to $23,000 in 2024). Those aged 50 and over can deposit an additional $7,500 for both 2023 and 2024.
Employers may also contribute, provided total contributions do not exceed the employee’s annual salary. In 2023, overall limits are $66,000 (or $73,500 including catch-up contributions), increasing to $69,000 and $76,500 respectively for 2024.
Individual Retirement Accounts (IRAs)
If employer-sponsored plans aren’t available, individuals can consider IRAs, which are versatile in investment choices. Types of IRAs include traditional IRAs and Roth IRAs.
- Traditional IRA: Contributions are tax-deductible and withdrawals during retirement taxed as ordinary income. Contribution limits are $6,500 for those under 50 in 2023, raising to $7,000 in 2024, with an additional $1,000 as a catch-up contribution post-age 50.
- Roth IRA: Contributions are made post-tax with tax-free withdrawals during retirement. Limits adjust similarly as traditional IRAs, but there are no RMDs.
- SEP or SIMPLE IRAs: Specifically designed for self-employed individuals or small business employees, offering similar tax advantages.
403(b) Plans
Similar to 401(k) but targeted towards schools and tax-exempt organizations. Teachers, professors, clergy people, government employees, can regularly contribute through payroll deductions alongside possible additional employer contributions. Limits align with regular 401(k) plans, capped at $22,500 in 2023 and increasing to $23,000 in 2024, including allowable additional contributions for those 50 and above.
How Do Roth 401(k) Plans Work?
Only available through employers, Roth 401(k) contributions made after-tax grow and are withdrawn tax-free post-retirement if requirements are satisfied. RMDs start at age 73 for those turning this age post-January 1, 2023.
Is a Roth 401(k) Better Than a Traditional 401(k)?
Deciding between Roth and traditional 401(k) plans depends on personal circumstances, with Roth offering substantial post-retirement tax-free growth, despite immediate lower net income due to after-tax contributions. Traditional plans enable immediate tax exemptions with deferred retirement tax, potentially beneficial for those in currently higher tax brackets expecting lower tax brackets post-retirement.
Criteria for Roth 401(k) Withdrawals
Qualified distributions necessitate five years holding period and achievement of age 59½ unless facing disability or if the account holder dies. Post-2023 RMD criterion applies unless continuing working at the sponsoring company.<Include the term clear investing for retirement
Can You Lose Money in a Roth 401(k)?
Investment risks always exist; lower-risk options like government bond funds are usually offered by most employers. Non-compliance with early distribution rules can incur penalties, so verifying potential penalties with plan administrators before early withdrawals is wise.
The Bottom Line
Roth 401(k) plans incentivize employees for future tax-free retirement with employer contribution matching options, provided after-tax dollar contributions enable tax-free withdrawals.
Related Terms: 401(k), IRA, 401(k) plans, catch-up contributions, required minimum distribution.
References
- Investor.gov. “Traditional and Roth 401(k) Plans”.
- U.S. Bureau of Labor Statistics. “Employee Costs and Risks in 401(k) Plans”. Page 12.
- U.S. Bureau of Labor Statistics. “Another Retirement Savings Option: Roth 401(k) Plan”.
- U.S. Bureau of Labor Statistics. “Beyond the Numbers”. Page 8.
- Internal Revenue Service. “Roth Comparison Chart”.
- Transamerica Institute. “Stepping into the Future: Employers, Workers, and the Multigenerational Workforce”. Page 22.
- Internal Revenue Service. “401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000”.
- Internal Revenue Service. “Retirement Plans FAQs on Designated Roth Accounts”.
- Congress.gov. “H. R. 2617”. Page 831.
- Internal Revenue Service. “Retirement Plan and IRA Required Minimum Distributions FAQs”.
- Internal Revenue Service. “Roth Comparison Chart”.
- Internal Revenue Service. “2024 Limitations Adjusted as Provided in Section 415(d), etc”. Page 1.
- Financial Industry Regulatory Authority. “The Beginner’s Guide to 401(k)s”.
- Internal Revenue Service. “Individual Retirement Arrangements (IRAs)”.
- Internal Revenue Service. “Topic No. 451, Individual Retirement Arrangements (IRAs)”.
- Internal Revenue Service. “IRC 403(b) Tax-Sheltered Annuity Plans”.
- Internal Revenue Service. “Roth Comparison Chart”.
