Roth 401(k) Plans
The Roth 401(k) combines some of the most advantageous aspects of both the 401(k) and the Roth IRA. Under the Roth 401(k), employees may contribute funds on a post-tax elective deferral basis, in addition to, or instead of, pre-tax elective deferrals under their traditional 401(k) plans. An employee’s combined elective deferrals — whether to a traditional 401(k), a Roth 401(k), or to both — cannot exceed the IRS limits for deferral of the traditional 401(k). Employers’ matching funds are not included in the elective deferral cap, but are considered for the maximum section 415 limit, which is $51,000 for 2014.
Employers are permitted to make matching contributions on employees’ designated Roth contributions. However, employers’ contributions cannot receive the Roth tax treatment. The matching contributions made on account of designated Roth contributions must be allocated to a pre-tax account, just as matching contributions are on traditional, pre-tax elective contributions. (Pub 4530)
In general, the difference between a Roth 401(k) and a traditional 401(k) is that income contributed to the Roth version is taxable in the year it is earned, while income contributed to the traditional version is taxable in the year it is distributed from the account. Furthermore, earnings on the traditional version are taxable income in the year they are distributed, while earnings on the Roth version are not taxable ever.
There are restrictions on the nontaxability of Roth earnings: typically, the distribution must be made at least 5 years after the first Roth contribution and after the recipient is age 59½.
A Roth 401(k) plan will probably be most advantageous to those who might otherwise choose a Roth IRA, for example, younger workers who are currently taxed in a lower tax bracket, but expect to be taxed in a higher bracket upon reaching retirement age. Higher-income workers may prefer a traditional 401(k) plan because they are currently taxed in a higher tax bracket, but would expect to be taxed at a lower rate in retirement; also, those near the Roth IRA income limits may prefer a traditional 401(k), since its pre-tax contributions lowers Modified Adjusted Gross Income (MAGI) and thus increases eligibility for Roth IRA contributions. Another consideration for those currently in higher tax brackets is the future of income tax rates in the U.S. The Roth 401(k) offers the advantage of tax free distribution, but is not constrained by the same income limitations. For example, in tax year 2014, normal Roth IRA contributions are limited to $5,500 ($6,500 if age 50 or older); whereas, up to $17,500 could be contributed to a Roth 401(k) account, provided no other elective deferrals were taken for the tax year (no traditional 401(k) deferrals taken).
- Roth 401(k) contributions are irrevocable – once money is invested into a Roth 401(k) account, it cannot be moved to a regular 401(k) account.
- Employees can roll their Roth 401(k) contributions over to a Roth IRA account upon termination of employment.
- It is the employer’s decision whether to provide access to the Roth 401(k) in addition to the traditional 401(k). Many employers find that the added administrative burden outweighs the benefits of the Roth 401(k).
- Unlike Roth IRAs, owners of Roth 401(k) accounts (designated Roth accounts) must begin distributions at age 70 and a half, as with IRA and other retirement plans.