A Roth 401(k) is a relatively recent alternative to a traditional 401(k) retirement plan, with different tax advantages.
- 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.
- You can contribute to both a Roth 401(k) and a traditional 401(k) if your employer offers them.
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. But 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. Another key difference between the two Roths is that unless you are still working for the company through which you have the Roth, you must generally take required minimum distributions (RMD) from your Roth 401(k) starting at age 72; Roth IRAs, on the other hand, have no RMDs during your lifetime.
Unlike Roth IRAs, Roth 401(k)s are subject to required minimum distributions.
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: $19,500 plus another $6,500 in catch-up contribution if you're 50 or older. (Those are the limits for 2020 and may rise in future years in step with the cost of living.)
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. That includes Publication 4222, 401(k) Plans for Small Business, and Publication 4530, Designated Roth Accounts Under 401(k), 403(b) or Governmental 457(b) Plans.