How is a Roth 401(k) taxed?
A Roth 401(k) is a type of plan that offers employees the ability to contribute after-tax dollars to a qualified retirement plan. These plans have only been available since January 2006, but they are gaining in popularity as more workers attempt to establish retirement income free from tax liability.
Though employee contributions are after-tax dollars, with the opportunity for earnings to grow tax-free, no employer-match contributions can be allocated to the Roth portion of the account. Earnings grow tax-free within the Roth 401(k), and no taxes are incurred upon distribution in retirement. A major tax advantage of a Roth 401(k) is the opportunity for higher-earning individuals to contribute more tax-free dollars into a retirement account. For 2013, the annual income limit for contributions to an individual Roth IRA was $188,000 for a married couple filing a joint return. The Roth 401(k) has no such income restrictions. Contributions are, however, limited to $17,500 per year with another $5,500 for participants over the age of 50.
Like other qualified retirement accounts, no tax is due for each year the funds are in the account. Also, since no deduction is given for contributions and no taxes are due for distributions in retirement, there are hardly any tax ramifications for participating in a Roth 401(k). Distributions made prior to age 59 1/2 are, like other retirement accounts, subject to an early withdrawal penalty. Required minimum distributions, or RMDs, are a burden to some but do not exist on Roth 401(k) accounts, meaning retirees can take out as little as they need. Furthermore, as the distributions are not taxable, they have no impact on the taxability of a retiree's Social Security benefits.