The Economic Growth and Tax Relief Reconciliation Act of 2001 introduced the Roth 401(k) as a retirement plan that employers may offer to their employees as of January 1, 2006. Of course, there are questions that need to be considered, the most important being, should you contribute to a Roth 401(k)?
The Roth 401(k) is a salary-deferral program similar to a traditional 401(k) plan. It allows employees to defer money into the plan to accumulate funds for retirement. For 2021, the deferral limit for the Roth 401(k) is $19,500, plus a catch-up contribution limit of $6,500 for individuals age 50 or older.
Yes, you can receive your employer’s matching contributions; however, all employer money will remain as pretax contributions to the account.
Qualified distributions from the Roth 401(k) are tax free and will not increase your taxable income at retirement. Qualified distributions from the Roth 401(k) are subject to a five-year waiting period, plus additional requirements specified in the plan document. In addition, the Roth 401(k), unlike the Roth IRA, is subject to RMD rules at age 72 (or retirement, whichever is later).
Let’s assume you are 35 years old, earning $40,000 annually, in the 24 percent tax bracket, and planning to retire at age 65. You are deferring 10 percent of your annual salary.
Same take-home pay. This option (see table on next page) shows Roth 401(k) contributions based on keeping your paycheck deductions and take-home pay the same as if contributing to a traditional 401(k) plan. Your net contribution to the Roth 401(k) would be lower than the contribution to the traditional 401(k) plan.
If, upon retirement, you are in the same 24 percent tax bracket, the Roth 401(k) will be worth the same amount as the traditional 401(k).
Results Summary:
Traditional 401(k) | Roth 401(k) | |
Net Annual Contributions | $4,000 | $3,040 |
Balance at Retirement | $404,292 | $303,219 |
Taxes for IRA at Retirement | ($97,030) | $0 |
Value at Retirement (Age 65) | $307,262 | $307,262 |
*Assumptions:
Reduced take-home pay. This option shows Roth 401(k) contributions based on increasing your paycheck deductions for current taxes, thereby reducing your take-home pay. Your net contribution to the Roth 401(k) would be the same as your contribution to a traditional 401(k).
Results Summary:
Traditional 401(k) | Roth 401(k) | |
Net Annual Contributions | $4,000 | $3,040 |
Balance at Retirement | $404,292 | $303,219 |
Taxes for IRA at Retirement | ($97,030) | $0 |
Value at Retirement (Age 65) | $307,262 | $307,262 |
The Roth 401(k) is a great savings opportunity for many people and not just for highly compensated employees. It can provide participants with a tax-advantaged way to save for retirement and can provide flexibility and choice to retirees. The Roth 401(k) is an important consideration in putting you a step ahead in supporting your desired retirement lifestyle.
As a guest blogger, I'm unable to respond directly to comments posted below, but if you have any questions, please feel free to contact me directly and I would be happy to help!
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
Kristen Smith is a guest blogger, representing Axial Financial Group in Burlington, MA. She offers securities as a Registered Representative of Commonwealth Financial Network, Member FINRA/SIPC. CRR, LLP (also represented as CRR, CRR CPA), Axial Financial Group, and Commonwealth Financial Network are separate and unrelated entities. Kristen can be reached at 781-273-1400 or ksmith@axialfg.com. This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend that you consult a tax preparer, professional tax advisor, or lawyer.