Although Roth 401(k) accounts have been around for 10 years, many employers don’t offer them and many people still don’t understand them. As the name implies, these plans are a hybrid — taking some characteristics from Roth IRAs and some from employer-sponsored 401(k)s.
A 401(k) with a Roth twist
An employer with a 401(k), 403(b) or governmental 457(b) plan can offer designated Roth 401(k) accounts.
As with traditional 401(k)s, eligible employees can elect to defer part of their salaries to Roth 401(k)s, subject to annual limits. The employer may choose to provide matching contributions. For 2016, a participating employee can contribute up to $18,000 ($24,000 if he or she is age 50 or older) to a Roth 401(k). The most you can contribute to a Roth IRA for 2016 is $5,500 ($6,500 for those age 50 or older).
Note: The ability to contribute to a Roth IRA is phased out for upper-income taxpayers, but there’s no such restriction for a Roth 401(k).
The pros and cons of a Roth 401(k)
Unlike traditional 401(k)s, contributions to employees’ accounts are made with after-tax dollars, instead of pretax dollars. Therefore, employees forfeit a key 401(k) tax benefit. On the plus side, after an initial period of five years, “qualified distributions” are 100% exempt from federal income tax, just like qualified distributions from a Roth IRA. In contrast, regular 401(k) distributions are taxed at ordinary-income rates of up to 39.6%.
In general, qualified distributions are those:
- Made after a participant reaches age 59½, or
- Made due to death or disability.
Therefore, you can take qualified Roth 401(k) distributions in retirement after age 59½ and pay no tax, as opposed to the hefty tax bill that may be due from traditional 401(k) payouts. And unlike traditional 401(k)s, which require retirees to begin taking required minimum distributions after age 70½, there’s no mandate to take withdrawals from Roth 401(k)s.
If you’d like to add a Roth 401(k) to your benefits lineup, contact us for more information.
