What Is a Roth Option?

A Roth option, available in some company 401(k) retirement plans, permits an employee to contribute after-tax dollars to an account. 

The Roth 401(k) option is available in more than 50% of company 401(k) plans. The alternative and more common option is the "traditional" 401(k) or 403(b), in which pre-tax dollars are paid in and the taxes are not due until the money is withdrawn during retirement.

Understanding the Roth Option

The appeal of the Roth option is that the money accumulated is not subject to any further taxes when the person withdraws it after retiring, on the balance or the investment returns.

The traditional plan, on the other hand, offers immediate tax savings. The money paid in is subtracted from the employee's taxable income for that year. It is due when the person withdraws it after retiring.

Who Needs a Roth 401(k)?

This type of investment account is well-suited to people who think they will be in a higher tax bracket in retirement than they are now. Notably, the entire balance in the account is tax-free, both the contributions and any investment returns.

A Roth 401(k) is subject to contribution limits that are revised each year. For tax year 2019, the limit for individuals is $19,000. In tax year 2020, it rises to $19,500. People age 50 and above can contribute up to $6,000 more as a "catch-up contribution" in 2019. That rises to $6,500 in 2020.

The traditional 401(k) plan is funded with pretax money, which means the taxes will be paid when the money is withdrawn during retirement. Unlike in a Roth IRA, there are no income limitations to participate.

Under IRS rules, any employer match must go into a tax-deferred 410(k). But much of the appeal of a 401(k) is tax deferral, which allows the account to grow even faster over the decades through compounding.

With a tax-deferred account, withdrawals before age 59.5 are subject to regular income tax and a 10% penalty. With the Roth version, there's no penalty or taxes on the contributed portion.  

Another option would be to split your contributions between the pre-tax and after-tax versions, hedging your bets and giving you the best features of both accounts. 

The 401(k) plan was enacted into law in 1978 and is named after the subsection of the Internal Revenue Service Code that established it. As of Sept. 30, 2017, 401(k) plans accounted for roughly $5.3 trillion of the $27.2 trillion in total retirement plan assets in the United States, according to the Investment Company Institute. Total 401(k) plan balances increased by more than 100% from 2008 to 2017.