What Is a Roth 401(k) — and Should I Have One?

Moving Up.

A Roth 401(k) is an employer-sponsored retirement account that allows employees to contribute money for retirement.

When you contribute to a Roth 401(k), you contribute money that you have already paid taxes on. When you withdraw the money in retirement, you pay no taxes on either the contributions or the gains you have earned while the money was invested in the account.

Read on to learn about the changes to Roth 401(k) contributions in 2020 and how this savings account might fit into your retirement planning.

Benefits of a Roth 401(k)

A Roth 401(k) has several benefits when compared with other types of retirement accounts.

Tax-Free Distributions

Because you have already paid taxes on the money you contribute to your Roth 401(k), you will not be taxed on your distributions. This can be helpful if you are in a higher tax bracket after retirement than you are now.

You will also not be taxed on any gains that your investments return in your Roth 401(k). This is a big advantage over taxable retirement accounts like traditional 401(k)s. If you start saving early, you may have significant gains over the lifetime of your account.

Employer Matching

Like a traditional 401(k), your employer can match all or part of your Roth 401(k). This is free money, so you should always contribute at least enough to get the full employer match.

The employer match must be deposited into a traditional 401(k) account since you will be taxed on your distributions from that account. This is because your employer contributes pretax money into this account, and they’re not going to pay your taxes for you.

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Contribution Limits

If you have an IRA — Roth or otherwise — you can only contribute $6,000 in 2020, plus another $1,000 if you’re 50 or older. With a 401(k), you can contribute up to $19,500 plus another $6,500 if you’re 50 or older.

These Roth 401(k) limits are the total you can contribute, whether you have a traditional account, a Roth account or both. That nest egg can grow much faster if you use a 401(k) instead of an IRA.

Income Limits

Anyone can contribute to a Roth 401(k) if their employer offers one, no matter how much they earn.

Roth 401(k) Withdrawal Rules

The withdrawal rules for Roth 401(k)s are a little bit of a hybrid of traditional 401(k) and IRA rules.

  • You must begin taking withdrawals at age 72 1/2 unless you’re still working or own less than 5% of a business.
  • You can take withdrawals with no penalty when you reach age 59 1/2 or are disabled.
  • You pay taxes on withdrawals made from accounts you’ve had less than 5 years.

Keep in Mind

Note that upon your death, your heirs will not pay a penalty when they take distributions.

Understanding Taxes With a Roth 401(k)

Withdrawals from a Roth 401(k) are not taxed if they’re considered qualified distributions. In order for a distribution to be considered qualified, it must meet these criteria:

  • The account must have been held for at least five years.
  • You must be at least 59 1/2 years old.
  • Qualified distributions may also be taken if you’re disabled, or if you die and the account is passed on to your heirs.

Your entire qualified distribution is free of taxes. This means that the money you contributed, plus all of the gains you earned on the money while it was invested, can be withdrawn tax-free. This is what makes the Roth 401(k) such a powerful retirement savings tool.

Roth 401(k) Contribution Limits

In 2020, you can contribute a total of $19,500 to all 401(k) accounts, plus an additional $6,500 catch-up contribution if you are over age 50. If you have other accounts, whether they’re traditional or Roth 401(k)s, this is the total maximum amount you can contribute to all of your accounts combined. Employer contributions don’t count toward this limit.

Is a Roth 401(k) Better Than a 401(k)?

The primary difference between a Roth 401(k) and a traditional 401(k) is when you pay taxes on the money. Your contributions to a Roth 401(k) are taxed before they go into the account. Money invested in a traditional 401(k) is not taxed until you withdraw it from the account.

This affects you now and later:

Roth 401(k)

  • When you contribute taxed income to a Roth 401(k), you will see a decrease in your take-home pay.
  • Since the money you contribute to a Roth 401(k) has already been taxed, you won’t pay taxes on it when you withdraw it.

Traditional 401(k)

  • Contributing pretax income to a traditional 401(k) helps protect your paycheck and lowers the taxable income reported on your W-2.
  • You will pay taxes on the money you contribute to a traditional 401(k).

There are two factors to consider when thinking about the income tax you’ll pay during retirement: tax brackets and tax laws. It is possible to be in a higher tax bracket during retirement than you are now — especially if you’re just starting your career. And it’s impossible to predict how the tax law will change between now and when you retire.

Can You Have a Roth 401(k) and a Traditional 401(k)?

Yes, you can have a Roth 401(k) and a traditional 401(k) at the same time. You also may have the option of contributing to both plans if your plan allows it. However, your employer will not match contributions to a Roth 401(k).

Roth 401(k) vs. Roth IRA

If you don’t have a 401(k) plan at work, you can open a Roth IRA. A Roth IRA has some, but not all, of the benefits of a Roth 401(k). Here’s how these retirement plans stack up:

Roth 401(k) vs Roth IRA
Roth 401(k) Roth IRA
Contributions Taxed Taxed
Income Limits None $137,000 per year for individuals

$203,000 per year for couples

Maximum Contribution $19,500 per year plus an extra $6,500 for those over 50 years old. $6,000 plus an extra $1,000 for those over 50 years old.
Taxes on Qualifying Withdrawals None None
Required Distributions 72 1/2 None

Is a Roth 401(k) Right for You?

A Roth 401(k) is a great option for younger people: Not only will your money have more time to accumulate more of that tax-free growth from investments, but you could be avoiding a lot of taxes.

When you’re earlier in your career and earning less, you’re likely paying a much lower tax rate than you would be later in life. So paying your taxes now is more likely to be the bigger money-saver.

However, even if you’re closer to retirement or paying a high tax rate now, a Roth 401(k) is still a good idea. If you have both a traditional 401(k) or IRA and a Roth 401(k), you can be strategic about how you draw down to keep your taxable income low in retirement.

No matter where you are on the path to retirement, it helps to speak with a financial advisor who can discuss your goals and explain your options.

This article has been updated with additional reporting since its original publication.

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About the Author

Karen Doyle is a personal finance writer with over 20 years’ experience writing about investments, money management and financial planning. Her work has appeared on numerous news and finance
websites including GOBankingRates, Yahoo! Finance, MSN, USA Today, CNBC, Equifax.com, and more.