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What Is A Roth 401(k)?

A Roth 401(k) plan that allows you to make after-tax contributions and then withdraw the money tax-free in retirement.
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
Interest Rates Last Update: April 15, 2024
The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
Interest Rates Last Update: April 15, 2024

The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.

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Table Of Content

What Is A Roth 401(k)?

A Roth 401(k) is a type of retirement savings plan that allows you to make after-tax contributions and then withdraw the money tax-free in retirement. It is a hybrid of a Roth IRA and a traditional 401(k).

Here's how a Roth 401(k) works:

  • Contributions: Like a traditional 401(k), contributions to a Roth 401(k) are made with after-tax dollars, meaning you contribute money on which you have already paid income taxes. These contributions are deducted from your paycheck before taxes are withheld.

  • Tax Treatment: The main difference between a Roth 401(k) and a traditional 401(k) is how the withdrawals are taxed. With a Roth 401(k), qualified withdrawals in retirement are tax-free. This means you won't pay any taxes on the money you withdraw as long as certain conditions are met.

  • Withdrawals: To be eligible for tax-free withdrawals, you must generally be at least 59½ years old and have had the Roth 401(k) account for at least five years. If you meet these criteria, you can take out the money without paying any taxes on it. Early withdrawals (before age 59½) may be subject to income taxes and a 10% penalty, unless certain exceptions apply.

  • Employer Matching: Just like with a traditional 401(k), some employers offer a matching contribution to employees who contribute to their Roth 401(k). However, the employer's matching contribution is made with pre-tax dollars and will be taxable upon withdrawal.

Roth 401(k)s can be an attractive option for those who expect their tax rates to be higher in retirement compared to their current tax rates. By paying taxes on contributions now, they can potentially benefit from tax-free withdrawals in retirement when their income tax rates might be higher due to higher earnings or changes in the tax code.

Pros And Cons of Roth 401(k)

Here are the main pros and cons of a Roth 401(k):

Pros
Cons
Tax-Free Withdrawals
Upfront Tax Payment
No RMDs during lifetime
Employer Match is Taxable
Diversification of Tax Treatment
Early Withdrawal Penalties
Potential for Higher Future Tax Rates
Limited Availability

Qualified withdrawals in retirement are tax-free, providing potential tax savings compared to a traditional 401(k) where withdrawals are taxed as ordinary income.

Unlike traditional 401(k)s, Roth 401(k)s do not have required minimum distributions (RMDs) during the account owner's lifetime. 

This allows for more flexibility in managing withdrawals in retirement.

By having both a traditional 401(k) and a Roth 401(k), individuals can create a tax-diversified retirement portfolio, giving them options for tax-efficient withdrawals in retirement.

Roth 401(k) contributions are made with after-tax dollars, making them advantageous for individuals who anticipate being in a higher tax bracket during retirement.

Contributions to a Roth 401(k) are made with after-tax dollars, which reduces your take-home pay compared to a traditional pre-tax 401(k).

If your employer provides a matching contribution to your Roth 401(k), the matching funds are considered pre-tax and will be taxed upon withdrawal, reducing the tax-free benefits.

If you withdraw money from a Roth 401(k) before reaching age 59½, you may be subject to income taxes and an additional 10% early withdrawal penalty on the earnings portion of the distribution.

There are some exceptions to this penalty, such as for first-time homebuyers or certain qualifying hardships.

Not all employers offer Roth 401(k) options, so if you prefer a Roth 401(k) over a traditional 401(k), you may need to find an employer that provides this option.

Contribution Limits

The contribution limits for Roth 401(k)s are set by the IRS and are adjusted annually for inflation. For 2023, the contribution limit for a Roth 401(k) is $22,500. If you are age 50 or older, you can make an additional catch-up contribution of $7,500, for a total of $30,000.

The contribution limits for Roth 401(k)s are the same as the contribution limits for traditional 401(k)s. However, there is one important difference: the contribution limits for Roth 401(k)s are not subject to income limits. This means that anyone, regardless of income, can contribute to a Roth 401(k).

If you contribute more than the annual limit to your Roth 401(k), you will have to pay a 6% excise tax on the excess contribution for each year it remains in your account.

Here is a table of the Roth 401(k) contribution limits for the past few years:

Year
Roth 401(k) Contribution Limit
2023
$22,500
2022
$20,500
2021
$19,500
2020
$19,000

Roth 401(k) or Traditional 401(k): Which Is Better?

The main differences between a Roth 401(k) and a traditional 401(k) are when you pay taxes on your contributions and earnings, and the restrictions on withdrawals.

Here is a table that summarizes the key differences between Roth 401(k)s and traditional 401(k)s:

Roth 401(k)
Traditional 401(k)
When you pay taxes
After-tax
Pre-tax
When your earnings grow
Tax-free
Tax-deferred
When you withdraw
Tax-free, as long as you meet certain requirements
Taxed as ordinary income, as long as you meet certain requirements
Required Minimum Distributions (RMDs)
Do not have RMDs during the account owner's lifetime
Must start taking RMDs once you reach age 72.

The best type of 401(k) for you will depend on your individual circumstances, such as your current tax bracket, your expected tax bracket in retirement, and your income.

If you expect to be in a higher tax bracket in retirement than you are now, a Roth 401(k) may be a good option for you. This is because you will pay taxes on your contributions now, when your tax rate is likely to be lower, and then withdraw the money tax-free in retirement.

On the other hand, if you expect to be in a lower tax bracket in retirement than you are now, a traditional 401(k) may be a good option for you. This is because you will defer paying taxes on your contributions until you withdraw the money in retirement, when your tax rate may be lower.

Ultimately, the decision of which type of 401(k) is right for you is a personal one. There is no right or wrong answer, and the best choice for you will depend on your individual circumstances.

Roth 401(k) or Roth IRA: Which Is Better?

A Roth 401(k) and a Roth IRA are both retirement savings accounts that offer tax-free withdrawals in retirement. However, there are some key differences between the two accounts.

Here is a comparison table between Roth 401(k)s and Roth IRA:

Roth 401(k)
Roth IRA
Who offers it?
Employers
Financial institutions
Investment options
Varies by employer
Varies by financial institution
Deposits
Automatic payroll deductions
Self-funded
Withdrawal Rules
Tax-free after age 59½
Contributions can be withdrawn at any time, earnings tax-free after age 59½

The best type of 401(k) for you will depend on your individual circumstances, such as your current tax bracket, your expected tax bracket in retirement, and your income.

If you expect to be in a higher tax bracket in retirement than you are now, a Roth 401(k) may be a good option for you. This is because you will pay taxes on your contributions now, when your tax rate is likely to be lower, and then withdraw the money tax-free in retirement.

On the other hand, if you expect to be in a lower tax bracket in retirement than you are now, a traditional 401(k) may be a good option for you. This is because you will defer paying taxes on your contributions until you withdraw the money in retirement, when your tax rate may be lower.

Ultimately, the decision of which type of 401(k) is right for you is a personal one. There is no right or wrong answer, and the best choice for you will depend on your individual circumstances.

Exceptions For Withdrawals Before Age 59½

There are a few exceptions to the early withdrawal penalty for Roth 401(k)s. These exceptions allow you to withdraw money from your Roth 401(k) before you reach age 59½ without having to pay the 10% early withdrawal penalty.

The exceptions are as follows:

  • Qualifying education expenses: You can withdraw money from your Roth 401(k) tax-free to pay for qualified education expenses, such as tuition, fees, books, and supplies.
  • First-time homebuyer expenses: You can withdraw money from your Roth 401(k) tax-free to buy your first home.
  • Hardship withdrawals: You can withdraw money from your Roth 401(k) tax-free if you experience a financial hardship, such as job loss, medical expenses, or an unexpected expense.
  • Death: If you die, your beneficiaries can withdraw money from your Roth 401(k) tax-free.
  • Permanent disability: If you become permanently disabled, you can withdraw money from your Roth 401(k) tax-free.

It is important to note that even if you qualify for an exception, you may still have to pay taxes on the earnings that have accumulated in your account.

FAQs

Yes, many employers allow employees to contribute to both types of accounts, providing tax diversification and flexibility in retirement.

No, there are no income limits for contributing to a Roth 401(k), unlike Roth IRAs, which have income restrictions.

Yes, employers can make matching contributions to a Roth 401(k), but these employer contributions will be made with pre-tax dollars and will be taxable upon withdrawal.

Yes, when you leave your job or retire, you can roll over your Roth 401(k) to a Roth IRA, which may offer more investment options and greater control over your funds.

Some employers allow participants to take loans from their Roth 401(k) accounts, but this is a loan that must be repaid, not a withdrawal.

Picture of Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
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