What is a Roth 401(k) and why do I need one? (2024)

FAQs

What is a Roth 401(k) and why do I need one? ›

What is a Roth 401(k)? A Roth is a feature of many 401(k) and similar employer-sponsored retirement plans. Roth contributions are made on an after-tax basis and any investment earnings on Roth contributions are tax-free subject to various requirements.

It can be a surprisingly complicated choice, but many experts prefer the Roth 401(k) because you'll never pay taxes on qualified withdrawals. Contributions are made with pre-tax income, meaning you won't be taxed on that income in the current year.

The list of cons may be short for Roth 401(k)s, but missing tax deferral is a big one. When faced with a choice of paying more tax now or later, most people choose to pay later, hence the low participation rates for Roth 401(k)s.

Key Takeaways

A Roth 401(K) is a type of employer-sponsored retirement savings plan. Contributions made to Roth 401(k) are taxed but earnings and withdrawals made during retirement are tax-free. Contribution limits are adjusted annually for inflation and are announced each year by the Internal Revenue Service (IRS).

Retirement contributions to Roth 401(k)s are made with after-tax dollars. Traditional 401(k) contributions are made with pretax dollars. Roth 401(k) withdrawals in retirement are tax-free but traditional 401(k) withdrawals are subject to income tax.

Contributions and earnings in a Roth 401(k) can be withdrawn without paying taxes and penalties if you are at least 59½ and have had your account for at least five years. Withdrawals can be made without penalty if you become disabled.

In the case of a Roth 401(k), you contribute with after-tax dollars. So, your employer would include your contributions in box 1 from your W-2. Whether you own a traditional or Roth 401(k), as long as you didn't take out any distributions, you don't have to do a thing on your federal or state return!

A “qualified distribution” is a distribution that is made: at least 5 years after the first contribution to your Roth account; and. after you're age 59½ or on account of you being disabled, or to your beneficiary after your death.

Roth IRAs don't give you a tax break on contributions, but investment gains and withdrawals are tax-free. Since there are no pre-tax contributions, you can withdraw your principal at any time without penalty. That flexibility may be nice, but it could also leave you short on retirement funds.

Key takeaways

Generally, you have 4 options for what to do with your savings: keep it with your previous employer, roll it into an IRA, roll it into a new employer's plan, or cash it out. How much money you have vested in your retirement account may impact what decision you make.

Can I open a Roth 401k on my own? ›

Finally, a Roth 401(k) is only available through an employer plan. As long as you meet the above MAGI income requirements, you can open a Roth IRA on your own as part of your retirement strategy.

Unlike Roth IRAs, Roth 401(k)s do not have any income limits. Regardless of how much you earn, you can contribute to a Roth 401(k), if your employer offers one.

A Roth 401(k) is a tax-advantaged retirement account that combines features of both a traditional 401(k) and a Roth IRA. Like a traditional 401(k), contributions to a Roth 401(k) are made on a pre-tax basis, meaning that they are deducted from your paycheck before taxes are taken out.

In a 401(k) vs. Roth IRA matchup, a Roth IRA can be a better choice than a 401(k) retirement plan, as it typically offers more investment options and greater tax benefits. It may be especially useful if you think you'll be in a higher tax bracket later on.

Roth individual retirement accounts (IRAs) offer several key benefits, including tax-free growth, tax-free withdrawals in retirement, and no required minimum distributions (RMDs). One key disadvantage: Roth IRA contributions are made with after-tax money, meaning there's no tax deduction in the years you contribute.

The savings you could secure in retirement by contributing to a Roth account now could be substantially more than the savings you would get with pretax contributions if you're younger with a longer investing horizon. You can contribute up to $7,000 to a traditional IRA or up to $23,000 to a 401(k) in 2024.

Tax diversification: High-income earners often find themselves in higher tax brackets. A Roth 401(k) account gives you more flexibility in managing your tax liability during retirement. Having a Roth account also allows you to be strategic about the tax treatment of your investment choices.

By converting to a Roth IRA, you'll have assets that won't be taxed when withdrawn, potentially allowing you to better manage your tax brackets and enable more personalized tax planning during retirement.