Choosing Between Traditional and Roth 401(k)s

The Roth 401(k) may appeal to workers willing to forego a tax break now in return for getting one at retirement. As its name implies, the Roth 401(k) combines features of a traditional 401(k) with those of a Roth IRA.

Like a traditional 401(k), workers enjoy the convenience of contributing through payroll deduction. But similar to a Roth IRA, contributions are made on an after-tax basis and withdrawals after age 59½ are tax free and penalty free for workers who have maintained their account for five years. There is also a Roth 403(b) plan for workers in the nonprofit sector.

How a Roth 401(k) Works

The Roth 401(k) follows many of the same rules as a traditional 401(k). For the 2017 tax year, federal laws permit a maximum annual contribution of $18,000, although your employer may impose a lower limit. Your employer may provide a matching contribution as part of a Roth 401(k), but any matching contributions are made in pretax dollars. If you are age 50 or older, you may contribute an additional $6,000 for a total of $24,000 in 2017.

You may continue to maintain a traditional 401(k) while directing all or a portion of new contributions to a Roth 401(k). Your contributions to a Roth 401(k), however, are irrevocable -- once made, they cannot be transferred to a traditional 401(k) account and funds in a traditional 401(k) cannot be switched to a Roth 401(k). Both Roth and traditional 401(k)s require distributions after age 70½, but only if you are no longer working. If you continue to work beyond age 70½, you will not be required to take distributions from either type of account. However, distributions must begin when you finally do leave the workforce.

Planning for Retirement

A Roth 401(k) may present a significant benefit when it's time for retirement -- the funds can be rolled over directly to a Roth IRA with no tax payment. Assets in a traditional 401(k) can also be converted to a Roth IRA, but the conversion requires you to pay taxes on the portion of the rollover that has not yet been taxed.

Roth vs. Traditional 401(k)s: A Quick Comparison

The table below presents a summary of the most important differences between Roth and traditional 401(k)s.

Roth 401(k)
Tax Status of Contributions Pretax contributions reduce current taxable income. After-tax contributions do not affect current taxable income.
Tax Status of Distributions After Age 59½ Taxed as current income but penalty free. Tax free and penalty free for investors who have had the account for at least five years.
Rollovers to IRAs May be rolled over directly to a traditional or Roth IRA. May be rolled over directly to a Roth IRA.

To Roth or Not to Roth?

If you're considering a Roth 401(k), you may want to review the following points before making your decision:

Capitalizing on every option available to you may make it easier to pursue your long-term savings goal. If tax-free withdrawals could potentially benefit you, and your employer makes a Roth 401(k) available, consider adding it to your retirement planning mix.