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

Jul 30, 2024

Approx. Reading Time: 3 min. 

Person putting money in piggy bank

Since it became available in 2006, many employers have added a Roth 401(k) option to their benefits packages for retirement savings.  

Though not required, a Roth contribution is available for most employer retirement plans in addition to traditional offerings. Roth Individual Retirement Accounts, or Roth IRAs, are another choice for retirement savings. 

Among these options, is a Roth 401(k) appropriate for your situation?  

To Roth or Not to Roth

To start, consider the advantages and disadvantages of both types of 401(k) contributions. A traditional or pre-tax contribution to a 401(k) may lower your current income subject to taxation. While earnings in the account grow tax-deferred, your retirement distributions will be subject to ordinary income tax. 

On the other hand, your contributions to the Roth bucket of a 401(k) are made with after-tax dollars, and potential earnings and distributions are tax-free, with some caveats. For example, you must reach the age of 59 ½ and hold the account for at least five years. Non-qualified distributions may be subject to income tax, and a 10% early withdrawal penalty may also apply.

Ultimately, to Roth or not to Roth isn’t so much an investment question as it is a question of when to pay taxes. Is it better to pay taxes on your retirement funds now or later? The most appropriate choice for you may depend on your current tax situation and long-term financial goals. 

Roth 401(k)s

Keep in mind that the 401(k) annual employee deferral limits – $23,000 for taxpayers under 50 and $30,500 for those 50 or older in 2024 – apply to all employee 401(k) contributions, regardless of whether they are made on a pre-tax or after-tax basis.  

Under the Small Business Jobs Act of 2010, participants in traditional 401(k), 403(b), and 457(b) plans can convert funds into Roth accounts within their plans, assuming there is a Roth option. Because contributions to traditional 401(k)s are made on a pre-tax basis, any funds transferred from traditional to Roth 401(k) accounts are taxed in the calendar year of conversion.  

Here’s another point to consider. Even if you make contributions exclusively to a Roth 401(k) account, you may still owe tax on withdrawals from pre-tax funds contributed by your employer to a traditional 401(k) account. However, as of Secure 2.0, employer contributions can be made after tax as well.  

What About the Roth IRA?

The Roth 401(k) is only available through an employer-sponsored plan, whereas the Roth IRA is available to all taxpayers. How do the two Roth options compare? 

First, you can save more money in a Roth 401(k) than in a Roth IRA. The 2024 annual contribution limit for IRAs is currently $7,000 for taxpayers under 50 and $8,000 for those 50 or older. On the other hand, the Roth 401(k) is subject to the more generous elective salary deferral limits that apply to conventional 401(k)s, such as $23,000 or $30,500 for those age 50 or older in 2024.  

Further, the Roth IRA is subject to Modified Adjusted Gross Income (MAGI) limits; only those with MAGIs below $161,000 for single filers and $240,000 for married joint filers are eligible to contribute up to the maximum after-tax dollars to a Roth IRA in 2024. These income limits do not apply to Roth 401(k)s.  

In addition, contributions to a Roth 401(k) can be made through payroll deductions, which put retirement savings on autopilot. To participate, an employee currently contributing to a traditional 401(k) plan could, for example, opt to have their contributions diverted to a Roth version of the same plan (if the plan allows for Roth contributions).  

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

If you are interested in contributing to a Roth 401(k), ask your company’s benefit administrator if this option is available for your retirement plan. If not, expressing interest in the Roth 401(k) may prompt your employer to adopt the option. 

To learn how to maximize your retirement savings, reach out to an advisor using the form below. 

Source: “Is the Roth 401(k) an Option for You?” FMeX. 2024. 891.pdf (fmexcontent.s3.amazonaws.com)

Contributing source: Internal Revenue Service. “Roth Comparison Chart.” IRS, Updated 11 Mar. 2024, https://www.irs.gov/retirement-plans/roth-comparison-chart#:~:text=You%20can%20split%20your%20annual,re%20eligible%20for%20catch%2Dup 

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