More and more companies are now starting to offer Roth 401(k)s to their employees, which is great. If you have the option to invest in a Roth 401(k), I highly recommend it. However, there are important things you should know about this account, just like every other tax deferred account.
What is a Roth 401(k)
A Roth 401(k) is a retirement savings plan that combines the best of a 401(k) and Roth IRA. This plan was only created into law in 2006, and as such, many firms don’t offer it as an option yet. A Roth 401(k) is great because the employee contributes after-tax dollars, and as such, doesn’t pay tax on withdraw from the fund.
Contributions to a Roth 401(k)
Just like a regular 401(k), employees make contributions from their paychecks to the Roth 401(k). However, with a Roth 401(k), the contributions made are from after-tax dollars. The maximum contribution to all 401(k)s (both traditional and Roth) cannot exceed $16,500 in 2011 if you are under 50, and $22,000 if over 50. Matching funds from an employers are not included in this cap.
Employees can contribute to both traditional and Roth 401(k)s as long as the limit above is not exceed and the employer offers both.
Employer Matching Contributions
One of the biggest benefits of 401(k)s is that employers can match contributions as an incentive to employees. In 2011, the maximum match for employers is $49,000.
However, if you have a Roth 401(k), and you get an employer match, it cannot go into your Roth 401(k) because it cannot receive the after-tax treatment. Instead, any employer matches must be deposited in to a pre-tax traditional 401(k).
Withdraws and Transfers
Just like I mentioned in a Roth IRA is Not That Hard To Understand, there are some restrictions on withdraws and transfers, but they aren’t that complicated.
First, withdraws. Earnings on Roth 401(k)s will be tax free as long as the distribution is made at least 5 years after the first Roth 401(k) contribution and the attainment of the current retirement age of 59 1/2.
As for contributions, you cannot withdraw them penalty-free like you can with a Roth IRA. Once you make a contribution to a Roth 401(k), it is irrevocable.
You can roll your Roth 401(k) into a Roth IRA upon termination of employment.
Finally, unlike a regular Roth IRA, you must take required minimum distributions on a Roth 401(k) at age 70 1/2, just like a regular 401(k).
If you have access to a Roth 401(k), it is a great way to save for retirement. There are a few special circumstances involved, but they aren’t that hard to understand. Your money can grow and be withdrawn tax-free, which is great!
If you want a full breakdown, check out this guide: Roth 401k vs. Traditional 401k.
Readers: do you have a Roth 401(k)? Do you wish your company offered one? What are your thoughts?