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).
The Verdict
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?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him here and here.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
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engin33r says
My employer does not have a Roth 401k. That being said I don’t think I would use the option even if they did.
I currently live in CA so my state income tax is around 10%. If I were to leave CA at anytime then that would be 10% in extra savings if I were to stick with the 401k.
The idea of tax free money is very nice but i don’t know if it can make up that 10% compounded over time. Of course if I stay in CA this is a moot point but who knows what the future holds 🙂
MoneyCone says
“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.”
That is a key point.
I suppose if a roth 401k is rolled over into a roth ira, the entire amount in roth 401K is treated as earnings (since they can’t be withdrawn before 59-1/2 years)?
Well written post!
Dave @ Money In The 20s says
My employer does have a Roth 401k and I contribute to it. I am very happy with the Roth option. If they didn’t have it, I would likely be contributing to a Roth IRA instead.
Buck Inspire says
My company doesn’t have this option. Great to see we have so many retirement options. I currently have Roths and 401k’s working for me. Thanks for the knowledge!
Andrea @SoOverDebt says
My company offers a 403b, but I don’t participate. Mainly because they “may” offer a match, but they don’t tell employees how much AND they don’t do it until Dec 31st every year.
Instead, I have a Roth IRA and I’m pleased with it so far. If I ever worked for a company that offered a Roth 401k, I would definitely contribute as long as they offered a match!
Robert says
I can’t stand companies that do that from an employee perspective. But I do understand why they do it – they don’t know how much they have left to spend.
Spruce Up Your Finances says
My company does not offer the Roth401k either but I’m find with the regular 401k. The match is pretty decent at 4% and I usually contribute more than the 4%.
Did not know that the Roth 401k matching is using pre-tax money so I guessed it would be included in the regular 401k.
Barb Friedberg says
All workplace retirement accounts are great ways to save. We’ve had roth IRA’s since they came out, but not the 401K roth’s as our workplaces haven’t offered them. It’s a tradeoff between tax savings now or later. You can’t go wrong with one, in the long run.
Alicia says
I just started a Roth IRA with Scottrade on my own, and now my company is going to start a 401k. If they don’t offer a match is it even worth it to do it with my company? Or would you suggest just doing what i’m already doing. Can you have more than 1 Roth Ira going? Or is it a limit per person per year? BTW, do you know the limit under 55 in 2015?
Thanks so much!!
Robert Farrington says
You can do both a Roth IRA and 401k. If you’re company doesn’t match, I would max your Roth IRA first, then invest in the 401k.
You can have as many Roth IRA accounts as you want, but there is a total contribution limit for all Roth IRAs for the year.
For 2015 the limit is $5,500 if you’re under 55.
Jake says
From the article: “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.”
And: “In 2011, the maximum match for employers is $49,000.”
How can the employer match that much when the maximum contribution limits are so much less?
Robert Farrington says
Well, the limits have gone up for 2016 – it’s $18,000 for employee contribution, $24,000 if over 50, and your employer can contribute to reach a maximum of $53,000.
How can employers contribute that much? Because it’s considered a profit sharing contribution and as long as employers give everyone the same percentage, it can be whatever they choose. Some employers match dollar for dollar up to a certain percentage (typically up to 5% or 6%). That’s probably what you’re used to hearing.
However, the best plans contribute much, much more. For example, Conoco Phillips matches 900% of the first 1% of contributions, and then gives you an additional 6%-9% kicker based on your age. So, if you made $100,000 and contributed 1% to your 401k, you would put in $1,000, and your employer would put in anywhere from $15,000 to $18,000. That’s a great match.