A Roth 401(k) Provides Real Benefits

October 1, 2017

A Roth 401(k) Provides Real Benefits

The Roth 401(k) became eligible for plan sponsor use over ten years ago, in 2006.  However, it startles me that only an estimated 58% of employers offer this feature to their plan participants (Roth 401(k) uptake). The 2017 Roth 401(k) contribution limits dwarf the limits of a Roth IRA contribution. The Roth 401(k) employee elective contribution limit is $18,000. Participants over age 50 can make an additional “catch-up” contribution of $6,000 (total of $24,000).

There are many benefits to contributing to a Roth 401K) and I have listed them in bullet point format below.  But one key advantage is their tax-free withdrawal. Participants with large 401(k) balances amassed through traditional pre-tax contributions should start hedging their tax liability.  Roth 401(k) withdrawals (both contributions and earnings) are not taxed provided it`s a qualified distribution.  To qualify, a distribution must be held for at least five years and made because of the attainment of age 59 1/2 or later, a disability, or upon death.

Roth 401(k) Points:

  • Unlike with Roth IRA contributions, there are no income limitations to participate
  • After-tax Roth 401(k) contributions and earnings accrue tax-free, thereby creating tax-free distributions in retirement
  • 2017 participant contribution limits are $18,000 with an age 50+ catch-up contribution of $6,000. Please compare this to Roth IRA contribution limits of $5,500 and an age 50+ catch-up contribution of $1,000
  • Plan sponsors can also provide a match to Roth 401(k) contributions
  • Participants can contribute to both the pre-tax 401(k) and after-tax Roth 401(k)s (aggregated to $18,000/$24,000 maximum) to create a tax hedging strategy when taking withdrawals in retirement
  • Loans and certain withdrawals are permissible
  • Please note, that Roth IRAs do not have Required Minimum Distributions (RMD) at age 70 ½. To take advantage of this benefit, your 401(k) plan may allow rollovers of your Roth 401(k) balance to the Roth IRA.  This will reduce your total 401(k) account balance and thereby reduce your RMD amount.

If your 401k plan already has a Roth feature then I suggest contributing to it immediately, even if it is only a one-time contribution.  The five-year qualified distribution clock starts ticking from the date of initial contribution. Five years is a requirement to make qualified distributions.  Starting the clock earlier than later can help toward satisfying that requirement.

Many of us are unsure of which tax bracket we may fall into at retirement and/or what tax brackets will be in the future. Building a pool of Roth 401(k) assets helps avoid taxable distributions on a portion of withdrawals in the future. Avoiding taxes is an effective way to help achieve retirement success.  Check with your employer if the Roth feature is available in your 401(k). If not, then perhaps you should inquire further as to why not.