Why Roth?

One significant way in which Roth 401(k) plans differ from traditional 401(k) plans concerns the timing of taxes. Because traditional 401(k) plan contributions come from pretax earnings, you pay income taxes when you withdraw money from your account. But with Roth 401(k) plans, you make contributions with after-tax dollars. Because of this, qualified distributions are not taxed — meaning that there’s never any federal income tax on the growth in the account. In this respect, they’re similar to Roth IRAs.

Qualified distributions from a Roth 401(k) typically are those you make on or after you turn age 59½, after your death or because of a disability — as long as it’s been at least five tax years since the first day of the taxable year in which you made your initial designated Roth contribution.

401(k) vs. IRA

Several differences between Roth 401(k) plans and Roth IRAs are worth noting. The most you can contribute to a Roth IRA in 2017 is $5,500, or $6,500 if you’re age 50 or older by the end of the tax year. That’s about one-third of the amount you can contribute to a Roth 401(k). For 2017, the Roth 401(k) contribution limits are $18,000 — plus another $6,000 if you are age 50 or older. The 401(k) limits apply on a per-person basis, so the combined total of your contributions to both traditional and Roth 401(k) accounts can’t exceed $18,000, or $24,000 if you’re at least age 50.

The higher limit isn’t the only contribution advantage Roth 401(k)s have over Roth IRAs. The ability to contribute to a Roth IRA is reduced or even eliminated if a taxpayer’s income exceeds certain amounts; no such limits apply to Roth 401(k)s.

But Roth IRAs do have some advantages. One is that you don’t have to take required minimum distributions during your life (unless you inherited the account). With a Roth 401(k) plan, you must start taking distributions by the time you hit age 70½ — unless you’re still working and not a 5% owner in the company. However, you can avoid the RMD requirements by rolling over your Roth 401(k) balance to a Roth IRA.

Another Roth IRA advantage is wide latitude in choosing your investment options. With a Roth 401(k), you have to work with the options offered by your employer.

Your contributions to a designated Roth account are reported on your Form W-2, “Wage and Tax Statement.” Even though distributions from Roth 401(k) plans aren’t taxed, they’re reported on Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.”

How to participate

If your employer offers a Roth 401(k) plan, to participate you simply designate some or all of your 401(k) elective deferrals as Roth contributions. Roth 401(k) plans now are offered by 47% of plan sponsors, according to a June 2016 report by the Transamerica Center for Retirement Studies.

As with a traditional 401(k) plan, your employer can match your contributions to a Roth 401(k) plan. But the matches are allocated to the pretax account, which is similar to how they’re treated in the traditional 401(k) plan. This means the matches will be treated as ordinary income when withdrawn.

An excellent tool

Roth 401(k) plans can be a great retirement savings tool — especially for high-income earners and for those concerned that their tax rate may be higher in retirement. Your accounting professional can help you determine if a Roth 401(k) plan makes sense for you.

© 2017