Loading the player...

What is a 'Roth 401(k)'

A Roth 401(k) is an employer-sponsored investment savings account that is funded with post-tax money up to the plan's contribution limit. 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. The traditional 401(k) plan is funded with pretax money, which results in a taxes on future withdrawals.

BREAKING DOWN 'Roth 401(k)'

Employee contributions are made using after-tax dollars with no income limitations to participate. A Roth 401(k) is subject to contribution limits based on the individual’s age. For example, the contribution limit for individuals in 2018 is $18,500 per year. Individuals 50 and older can contribute an additional $6,000 in 2018  as a catch-up contribution, according to the IRS. Withdrawals of any contributions and earnings are not taxed as long as the withdrawal is a qualified distribution. Distributions are required for individuals at least 70 ½ years old unless the individual is still employed and not a 5 percent owner of the business.

Qualified Distribution of a Roth 401(k)

Contributions and earnings in a 401(k) are eligible to be withdrawn without an income tax assessment as long as certain criteria are met. First, the Roth 401(k) account must have been held for at least five years. Additionally, the withdrawal must have occurred on the account of a disability, on or after the death of an account owner, or when an account holder reaches at least 59 ½ years old.

Roth 401(k) Vs. Traditional 401(k)

The main difference between a Roth 401(k) and a traditional 401(k) relates to the taxation of funding and distributions.

When a traditional 401(k) is funded, the account holder the contribution is deducted from the employee's pre-tax income. Alternatively, contributions made to a Roth 401(k) are made after taxes are already taken out.

When a distribution is made from a traditional 401(k), the account holder is subject to taxation on the contributions and its earnings. Alternatively, the account holder is not subject to any taxation from Roth 401(k) distributions so long as they are qualified.

A Roth 401(k) Strategy

The benefits of a Roth 401(k) have the most impact on individuals currently in low tax brackets who anticipate moving into higher tax brackets in the future. This is because contributions are taxed now at a lower tax rate and distributions are tax-free when the individual is in a higher tax bracket. For this reason, a Roth 401(k) is not advised for individuals who expect to drop tax brackets, such as individuals close to retirement and expect a drop in income.

RELATED TERMS
  1. Roth Option

    A Roth Option is available within some employer-sponsored qualified ...
  2. Designated Roth Account

    Designated Roth account is a separate account in a 401k, 403b ...
  3. Qualifying Investment

    Qualifying investments are tax-deferred, allowing investors to ...
  4. Roth IRA

    A Roth IRA is an individual retirement plan that bears many similarities ...
  5. Qualified Distribution

    A qualified distribution is made from a Roth IRA and is tax and ...
  6. Catch-Up Contribution

    A catch-up contribution is a type of retirement savings contribution ...
Related Articles
  1. Financial Advisor

    How to Choose Between a Roth or Traditional 401(k)

    A Roth 401(k) offers potential advantages, but may or may not be the right choice for a given client. Here's how to decide.
  2. Retirement

    The Roth 401(k): Should I Invest in It?

    Here's how the Roth 401(k) can play a role in your retirement strategy.
  3. Retirement

    Which Type of 401(k) Is Best for You?

    Roth 401(k) or traditional 401(k)? The correct answer has the potential to add hundreds of thousands of dollars to your net worth during your lifetime.
  4. Retirement

    Tax Tips on Roth and Regular 401(k)s

    There are many ways to reduce your tax burden when saving for retirement. From converting to a Roth 401(k) to sticking with a traditional 401(k), here's how.
  5. Retirement

    Traditional vs. Roth 401(k): Traditional Still the Best Choice

    Despite the new tax laws, a traditional versus Roth 401(k) is still a better choice for most.
  6. Retirement

    Congress May Take Away Your 401(k) Tax Reduction (or Not)

    As part of overhauling the U.S. income tax system, Congress is considering taking away your 401(k) tax reduction. But Trump just said no.
  7. Financial Advisor

    Why Advisors Should Focus on Roth 401(k)s

    The use of Roth 401(k) plans is slowly rising which means advisors need to stay educated about the latest rules.
  8. Retirement

    Which Is Best: A Roth IRA or Roth 401(k)?

    When choosing between a Roth IRA or Roth 401(k) asking these questions can help you decide.
  9. Retirement

    Strategies For Your Roth 401(k)

    A Roth 401(k) can add much to your retirement funds, especially if you start saving early and end up doing well financially. Here are the steps to take.
  10. Retirement

    3 Reasons Your 401(k) Is Not Enough for Retirement

    Learn the basic structure of a 401(k), and a number of reasons why it may not be substantial enough to secure an individual's living upon retirement.
RELATED FAQS
  1. What are the Roth 401(k) contribution limits?

    Understand the current contribution limits for designated Roth 401(k) accounts, including additional allowable payments for ... Read Answer >>
  2. Are Roth 401(k) plans matched by employers?

    Discover the difference between a Roth 401(k) and a traditional 401(k), and explore the role of an employer contribution ... Read Answer >>
Trading Center