Is a Roth 401(k) an Option for You?

The Roth option to traditional 401(k) retirement accounts was first available in 2006.  Since then more and more employers are offing the popular addition to retirement savings benefit packages.

So What Is It?

Perhaps the best way to explain a Roth 401(k) IRA (individual retirement account) is to compare it to a traditional IRA and a Roth IRA as it combines some of the better features of the two.  The difference between these three are largely a matter of somewhat tricky taxation implications, withdrawal rules, and a few restrictions.

  • Traditional 401(k)
    • Contributions are per-tax (the money put into the account isn’t taxed at that time).
    • That lowers your current income and the resulting taxation.
    • The account grows tax deferred.
    • Distributions are taxed as ordinary income (when you withdraw funds it is taxed at your rate at the time of withdrawal).
    • Contributions can be made automatically through payroll deductions.
    • You can withdraw without penalty starting at age 59 1/2.
  • Roth 401(k)
    • It’s available only through an employer-sponsored plan.
    • Contributions are after-tax (you pay regular income tax on the funds before adding to the account).
    • Earnings and distribution (withdrawal) are tax-free at age 59 1/2 and beyond if held for five years or more.  That can be a big advantage as investment earnings aren’t taxed.  But if the requirements aren’t met you’ll pay tax as well as a possible 10% early withdrawal penalty.
    • Required minimum distributions must begin at age 70 1/2/
    • Contributions can be made automatically through payroll deductions.
    • There are no income limits.
  • “Traditional” Roth IRA
    • is like a Roth 401 (k) except
    • it’s available to everyone (not just through an employer’s plan) and
    • it’s subject to modified adjusted gross income limits.  It is available only for those making under $135,000 filing single income tax, $199,000 for joint filing.

Yes or No?

So, is a Roth 401(k) right for you?  That depends on your current age, tax situation, and long-term financial goals.

A Roth 401(k) has advantages over a traditional 401(k) in that retirement withdrawals are tax free.  That’s particularly true when your retirement bracket is expected to be lower than your current one.  There may also be some peace of mind considering uncertainty in future brackets and tax rates.  Both the “traditional” Roth and the 401(k) option can benefit younger workers in a lower bracket, especially when you consider that the first $17,900 (currently) of income is effectively not taxed due to deductions and exemptions.

It’s important to note that for all three the annual limits are $19,000 for those under age 50 and $25,000 for those older.  So if you contribute to a Roth or Roth option you may have to reduce contributions to a traditional IRA.  Further, keep in mind that matching contributions from your employer must be to a traditional 401(k) and will be taxed on withdrawal.  Since 2010 it’s been possible to roll over traditional 401(k), 403(b), and 457(b) plans into Roth option, with taxes paid at the year of the rollover.

Like many financial decisions this one is far from clear-cut, and depends on a careful assessment of your particular circumstances and goals.  Our experts would be happy to answer your questions and provide financial consultation services.

Special Note:  The extended IRS filing date for 2020 also applies to IRA contributions.  You can now pay in to your account as late as July 15, 2020.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes:

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>