While many people are familiar with the benefits of traditional 401(k) plans, others are not as acquainted with Roth 401(k)s.
Since January 1, 2006, employers have been allowed to offer workers access to Roth 401(k) plans.¹ And some have rolled out offerings as part of their retirement programs.
As the name implies, Roth 401(k) plans combine features of traditional 401(k) plans with those of a Roth IRA.2,3
With a Roth 401(k),contributions are made with after-tax dollars—there is no tax deduction on the front end—but qualifying withdrawals are not subject to income taxes. Any capital appreciation in the Roth 401(k) also is not subject to income taxes.
What to Choose?
Fast Fact: Roth 401(k) plans were made permanent by the Pension Protection Act of 2006.
Source: IRS, 2018
The choice between a Roth 401(k) and a traditional 401(k) comes down to determining whether the upfront tax break on the traditional 401(k) is likely to outweigh the back-end benefit of tax-free withdrawals from the Roth 401(k).4
Often, this isn’t an “all-or-nothing” decision. Many employers allow contributions to be divided between a traditional 401(k) plan and a Roth 401(k) plan—up to overall contribution limits.
One subtle but key consideration is that Roth 401(k) plans aren’t subject to income restrictions like Roth IRAs. This can offer advantages to high-income individuals whose Roth IRA has been limited by these restrictions. (See accompanying table.)
Source: IRS, 2018
Roth 401(k) plans are subject to the same annual contribution limits as regular 401(k) plans—$18,500 for 2018, ($24,500 for those over age 50). These are cumulative limits that apply to all accounts with a single employer; an individual couldn’t save $18,500 in a traditional 401(k) and another $18,500 in a Roth 401(k).
Another factor to consider is that employer matches are made with pretax dollars, just as they are with a traditional 401(k) plan. In a Roth 401(k), however, these matching funds accumulate in a separate account that will be taxed as ordinary income at withdrawal.
Setting money aside for retirement is part of a sound personal financial strategy. Deciding whether to use a traditional 401(k) or a Roth 401(k) often involves reviewing a wide-range of factors. If you are uncertain about what is the best choice for your situation, you should consider working with a qualified tax or financial professional.