How Can I Start or Set up a Roth 401(k)?

Advice for employees and also employers

A Roth 401(k) is a relatively recent alternative to a traditional 401(k) retirement plan, with different tax advantages to a 401(k) or traditional IRA account. Not all employers offer them, but it is worth investigating as a retirement vehicle option.

Key Takeaways

  • With a Roth 401(k), you don't get a tax break for your contributions, but your withdrawals can be tax-free.
  • Unlike Roth IRAs, there are no income limits on Roth 401(k)s, so anyone can open one regardless of how much they earn.
  • Not all employers offer a Roth 401(k) option to their employees.
  • You can contribute to both a Roth 401(k) and a traditional 401(k) if your employer offers them.
  • The IRS offers information about Roth 401(k) accounts for both employers and employees on its website.
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How a Roth 401(k) Works

Like Roth IRAs, Roth 401(k)s are funded with after-tax dollars. You don't get any tax benefit for the money you put into the Roth 401(k), but when you begin to take distributions from the account, that money will be tax-free, as long as you meet certain conditions such as holding the account for at least five years and being 59½ or older.

Traditional 401(k)s, on the other hand, are funded with pretax dollars, providing you with an upfront tax break. These contributions are deducted from your income in the year they are contributed to the 401(k). However, any distributions from the account will be taxed as ordinary income. This basic difference can make the Roth 401(k) a good choice if you expect to be in a higher tax bracket when you retire than when you opened the account. That could be the case, for example, if you're relatively early in your career or if tax rates shoot up substantially in the future.

If You're an Employee

You can fund a Roth 401(k)—sometimes referred to as a designated Roth—if your employer offers one as part of its retirement plan options. Not all employers do, but their numbers are growing, especially among large companies. If your employer matches your contributions, or some percentage of them, that money, unlike your own Roth 401(k) contributions, is considered a pretax contribution and is therefore taxable when you withdraw it.

Unlike Roth IRAs, which have income limits, you can open a Roth 401(k) regardless of how much money you earn. Be mindful that there are contribution limits that restrict the amount of money both you and your employer can contribute to the account. For individuals, the 2022 contribution limit is $20,500, and the 2023 contribution limit is $22,500. Individuals 50 years or old may also perform a catch-up contribution of $6,500 in 2022 and $7,500 in 2023.

Steps to Setting Up Your Roth 401(k)

Step 1: Sign up. When you start a new company that offers a Roth 401(k) plan, you have the option of enrolling in the retirement plan. You are not obligated to do so, and you are not automatically enrolled or have investments withdrawn from your paycheck.

Step 2: Choose your account type. As mentioned below, you may have the option of choosing between a Roth 401(k), a traditional 401(k), or both. Consider the tax implications of all options. If you're unsure about which to choose, your human resources may have a contact at the brokerage firm you have your plan through to help with investing questions.

Step 3: Choose your investments. With the actual account(s) now set up, it's time to choose your investments. A 401(k) plan will often come with a limited number of fund options to choose from. You may set up automatic payroll deductions that contribute and invest in funds of your choosing at the allocation of your choice.

Unlike Roth IRAs, Roth 401(k)s are subject to required minimum distributions.

If You're an Employer

If you already offer a 401(k) plan to your employees and would like to add a designated Roth 401(k) option to it, your plan's service provider or custodian should be able to help. The IRS also has information for employers on its website, irs.gov, including Publication 4222, 401(k) Plans for Small Business and Publication 4530, and Designated Roth Accounts Under 401(k), 403(b) or Governmental 457(b) Plans.

The IRS does restrict the total annual employee and employer contribution. In 2022, this aggregated contribution limit was the lesser of 100% of the employee's compensation or $61,000. In 2023, this aggregated contribution limit was the less of 100% of the employee's compensation or $66,000. This limit can be increased by the catch-up contribution amount for people 50 or older (an additional $6,500 in 2022 and $7,500 in 2023).

Special Considerations

If you'd like to hedge your bets, you can have both a Roth 401(k) and a traditional one and split your contributions between them. The maximum total you can contribute to the two accounts is the same as if you had just one account.

Since gains in a Roth 401(k) are not taxable upon qualifying withdrawals, many investors prefer to have investments with greater upside (i.e. stocks) in this tax-sheltered account. On the other hand, since you'll need to pay taxes on traditional 401(k) withdrawals, that account is usually better suited for more stable investments (i.e. bonds).

With a 401(k) plan, you likely don't have much of a say in the investing fees. You don't have control over which brokerage firm your company uses, though you can change the fees you pay by selecting lower fee fund options. The concept of portfolio fees becomes more important should you leave the company and consider transferring your retirement portfolio to a lower cost provider.

Last, many individuals prioritize contributing enough into their 401(k) to receive the full match from their employer. For example, if your employer awards a dollar for dollar match on 4% of your salary, investors are often wise to take full advantage of the match by contributing at least 4% of their salary.

Can I Start a 401(k) If I'm Self-Employed?

Yes, if you're self-employed and don't employ others, you are eligible to open a solo 401(k). You can contribute as employer and employee, choose between a traditional or Roth plan, and may still qualify if the business is run with a spouse.

How Much Should I Start a 401(k) With?

There are no minimum balances for your 401(k), and most if not all of the investment options will have no minimum requirements either. A 401(k), especially when taking advantage of the employer match, is built slowly over time, so do not worry if you are not able to contribute much when you first start your plan.

Is Starting a 401(k) A Good Idea?

Individuals looking to have strong financial health in retirement may strongly benefit from starting a 401(k). Not only are there tax incentives for doing so, you may receive matching funds from your employer to help you save.

The Bottom Line

Though not all companies offer a Roth 401(k), the account usually helps many on their path to retirement. Though there are no immediate tax deductions to be had with a Roth 401(k), earnings accumulate tax-free and can be withdrawn upon retirement with no tax liability. To get started, sign up for an account through your company's human resource department and consider your investment options.

Article Sources
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  1. Internal Revenue Service. "Roth Account in Your Retirement Plan."

  2. Internal Revenue Service. “Roth Comparison Chart.”

  3. Internal Revenue Service. "Retirement Plans FAQs on Designated Roth Accounts."

  4. Internal Revenue Service. "Retirement Plans FAQs on Designated Roth Accounts."

  5. Internal Revenue Service. "401(k) Plan Overview.”

  6. Internal Revenue Service. "401(k) Limit Increases to $22,500 for 2023, IRA Limit Rises to $6,500.”

  7. Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs.”

  8. Internal Revenue Service. "Publication 4530, Designated Roth Accounts Under 401(k), 403(b) or Governmental 457(b) Plan."

  9. Internal Revenue Service. "Publication 4222, 401(k) Plans for Small Business."

  10. Internal Revenue Service. "401(k) Plans - Deferrals and Matching When Compensation Exceeds the Annual Limit."

  11. Financial Industry Regulatory Authority. “Investing in Your 401(k).”

  12. Internal Revenue Service. "One-Participant 401(k) Plans."

  13. Internal Revenue Service. “A Guide to Common Qualified Plan Requirements.”

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