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Retirement Basics: What Is A Roth 401(k)?

China iTech Ghana
Thursday, September 30, 2021 | views Last Updated 2021-09-30T21:51:36Z
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A Roth 401(k) is a defined contribution retirement plan funded by after-tax dollars. The Roth 401(k) plan shares many similarities with the Traditional 401(k) plan, although the latter is funded with pre-tax dollars. 


A Roth 401(k) also shares its after-tax contributions approach with the Roth IRA plan. However, there are important differences you should understand between a Roth 401(k), a Traditional 401(k) and a Roth IRA. Let’s take a closer look at all the details.


Tax Differences: Roth vs Traditional 401(k)

Taxes and when you pay them are key to understanding the difference between a Roth 401(k) and a Traditional 401(k). You contribute to a Roth 401(k) after tax: Income tax is withheld from your paycheck, and then your Roth 401(k) contribution is deposited in your account. When you take qualified distributions in retirement, you pay no income tax on the withdrawals.


Contrast this treatment with a Traditional 401(k), where contributions are made pre-tax. The money deposited in your Traditional 401(k) account is deducted from your paycheck before income taxes are withheld from your pay. Pre-tax contributions to a Traditional 401(k) lower your taxable income, reducing the amount you pay in taxes today. When you take qualified distributions in retirement, you owe income tax on the withdrawals.


When to pay income taxes on your 401(k) retirement savings is a core consideration in deciding between a Roth vs Traditional 401(k). Ask yourself: When will you be in a higher income tax bracket: Today, when you’re making contributions—or years from now, when you withdraw money in retirement?


•  If you believe your taxes will be lower during retirement than they are now, contributing to a Traditional 401(k) may be a better strategy. Avoid higher taxes today, and pay lower income taxes when taking distributions.


• If you think that your income taxes are lower now than they will be when you withdraw money from your account, a Roth 401(k) might be a better choice. Pay lower income taxes on contributions you make now, and avoid higher income taxes later on. If you’re just starting out in your career and have a low salary and a low tax rate, contributing to a Roth 401(k) might make more sense than to a Traditional 401(k).


Another thing to keep in mind: If your employer offers matching 401(k) contributions, they must be deposited in a Traditional 401(k) account. Even if you’ve opted to contribute to a Roth 401(k), your employer’s matching contributions still are deposited in a separate Traditional 401(k) account. You’ll pay taxes on the distributions from the account funded by your employer’s match, even while your Roth distributions are tax-free.


Roth 401(k) Contribution Limits

Both Roth 401(k)s and Traditional 401(k)s have the same contribution limits: In 2020 and 2021, employees age 50 or younger may contribute up to $19,500, with additional catch-up contributions of $6,500 available for savers who will be 50 by the end of the year.


These limits are cumulative: If you have more than one 401(k) account—for instance, both a Roth 401(k) and a Traditional 401(k), or 401(k) accounts with two employers after changing jobs—combined contributions to both accounts cannot exceed a total of $19,500, or $26,000 for those who are 50 or older.


The combined limit on employer matching contributions and employee contributions is the lower of $58,000 in 2021 ($57,000 for 2020) or 100% of an employee’s compensation (up to a maximum of $290,000 in 2021 and $285,000 in 2020). For employees over 50, the combined limit is $64,500 in 2021 and $63,500 in 2020, inclusive of the $6,500 catchup contribution. If employer contributions do not carry you to the total contribution limit in a given year, some plans permit you to make non-Roth, after-tax contributions to a Traditional 401(k).

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