Roth 401(k) Basics
Elective deferral contributions to a traditional retirement plan are contributed on a pre-tax basis and help lower your current taxable income. Roth elective deferral contributions, however, are much like a Roth IRA in that contributions are made on an after-tax basis. Money in the Roth account and any earnings will be distributed tax-free if withdrawn after age 59½, death, disability and at the end of the five-year taxable period during which the participant’s deferral is first deposited into the Roth 401(k) account (a.k.a. the Five Year Rule). A Roth 401(k) account can be rolled over to another plan that permits Roth 401(k) contributions or to a Roth IRA. If rolled into a Roth IRA, the tax-free nature remains and the money is not subject to the minimum distribution requirement at age 72 as in the Roth 401(k).
Who Would Likely Benefit?
- People who believe taxes will be greater in the future
- Young investors who believe they will be in a higher tax bracket in the future
- Investors who do not qualify for the Roth IRA due to income limit
- Low-income investors who are tax-exempt
- Investors who use Roth 401(k) as a planning tool in conjunction with traditional 401(k) plans
- Allows participants to hedge against risk of higher future tax rates
Who Would Likely Not Benefit?
- People certain that future tax rates will decrease
- People expecting to experience a significant drop in income upon retirement
- People with high temporary income
- People needing access to their funds within the first five years of deferrals
|Traditional 401(k)||Roth 401(k)|
|Tax treatment of deferrals||Before tax||After tax|
|Tax treatment of earnings||Tax deferred||Tax-free|
|Tax treatment of final distributions||Taxable at ordinary income|
|402(g) Salary Deferral Limits||Traditional* + Roth*||Traditional* + Roth*|
|Catch-up Limit||Traditional* + Roth*||Traditional* + Roth*|
|Distribution Restrictions||Subject to 401(k) rules, qualified distribution||Subject to 401(k) rules, qualified distribution and Roth 401(k) account must be open for five tax years|
In summary, Roth 401(k) contributions have potential to allow individuals more flexibility in saving for retirement, whereby giving investors more control over the taxable alternatives. Accelerate Retirement recommends a cautious approach when weighing the pros and cons.
ACR# 3395710 01/21