When it comes to retirement, a lot of investors choose either a traditional 401(k) plan or a Roth IRA. But what if you could have the best of both in one account? Enter the Roth 401(k).
Introduced just 11 years ago, Roth 401(k)s are now offered in about 60% of all U.S. workplace retirement plans 1 and provide participants with a chance to contribute after-tax money up to their plans’ contribution limits.
Keep reading to see if a Roth 401(k) may be right for you, too.
Income and contribution limits.
You may contribute to a Roth 401(k) regardless of your income. In 2017, a Roth IRA doesn’t allow you to contribute if your income exceeds $133,000 ($196,000 for married couples filing jointly).2 Speaking of contributions, you can save up to $18,000 in a Roth 401(k) (just as you can in a traditional 401(k)) in 2017. That’s three times more than you can contribute to a traditional or Roth IRA ($5,500). If you’ll be age 50 or older this year, you can save another $6,000 in your Roth 401(k) — six times more than the extra $1,000 you can save in a Roth or traditional IRA.3 You can also keep contributing to your Roth 401(k) after age 70½ if you’re still working and don’t own 5% or more of the company you work for.3
Benefits of after-tax contributions.
You contribute after-tax dollars to your Roth 401(k). This means you won’t realize any immediate tax benefits like you do with pre-tax 401(k) contributions. But you won’t have to pay taxes later on those contributions. The earnings, including dividends and capital gains, could come back tax-free as well if the withdrawal is qualified, meaning it has been in the account for at least five years and you are 59½ or older at the time of the withdrawal. That tax-free cash could come in handy during retirement, especially if you end up in a higher tax bracket than you’re in now.
Employer matching contributions.
Not all employers offer a matching contribution, but if yours does, you’ll want to take advantage of it. It’s one of the biggest benefits you have, whether you make Roth 401(k) or pre-tax contributions. Matching contributions easily boost your savings, and with compounding, those contributions and their earnings grow over time.4 Keep in mind that matching contributions are made with pre-tax dollars. You’ll have to pay taxes on them and their earnings when you start taking distributions.5
Loans available, distributions required.
If your workplace retirement plan allows loans, you can borrow up to 50% of your Roth 401(k) account balance, or $50,000 minus the highest outstanding loan balance in the past 12 months, whichever is less (just as you can with a traditional 401(k)). Keep in mind that a loan could be considered a taxable distribution if you’re under age 59½ and you don’t pay it back according to its terms.6 You can’t avoid Required Minimum Distributions (RMDs) with a Roth 401(k) like you can with a Roth IRA, which means you’ll have to start withdrawing money at age 70½. But you can roll over your Roth 401(k) account to a Roth IRA, which may help you avoid RMDs altogether.7
Roth 401(k)s may not be right for everyone, but they could be a good fit for some. If you have access to a workplace retirement plan and aren’t making Roth 401(k) contributions already, it’s worthwhile to at least check it out. This one simple step could have you taking advantage of one of the best benefits your plan offers.
1 Austin, R. (2015). 2015 Trends & Experience in Defined Contribution Plans. Aon.com. Retrieved April 01, 2017, from http://www.aon.com/attachments/human-capital-consulting/2015-trends-experience-dc-plans-highlights.pdf
2 Amount of Roth IRA Contributions That You Can Make For 2017. Internal Revenue Service. Retrieved April 02, 2017, from https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2017
3, 5, 6 Richmond, S. (2017, March 30). Roth 401(k) vs. Roth IRA: Is One Better? Investopedia.com Retrieved April 02, 2017, from http://www.investopedia.com/articles/personal-finance/063015/roth-401k-vs-roth-ira-one-better.asp
4 Frankel, M. (1970, January 01). The 4 Best Roth IRA Benefits. Fool.com. Retrieved March 21, 2017, from https://www.fool.com/retirement/iras/2015/08/04/the-5-best-roth-ira-benefits.aspx
7 O’Shea, A. (2016, December 08). You Know About the 401(k) – But What About the Roth 401(k)? NerdWallet.com. Retrieved April 02, 2017, from https://www.nerdwallet.com/blog/investing/forget-the-401k/