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