What Is a Roth 401(k)?

If you’re saving for retirement, you’re likely familiar with 401(k) plans. These plans allow you to save with pre-tax dollars, allowing you to maximize the dollars you contribute today. But in addition to traditional 401(k)s, many employers also offer a Roth version. If your employer offers a Roth 401(k), here are four reasons you should consider allocating some of your savings to it.

How Does a Roth 401(k) work?

A Roth 401(k) is like a traditional 401(k) with one key exception: Instead of making pre-tax contributions today, your contributions are taxed in the year you make them (that is, you’re contributing post-tax dollars). That means in retirement you can withdraw your money (both your contributions and any growth on it) generally tax-free. While it can be tempting to want to avoid paying taxes now on your contributions, there are several reasons why you may want to bite the tax bullet today and contribute to a Roth 401(k).

Roth 401(k) taxes

Traditional wisdom is that you’re likely to be in a lower tax bracket in retirement. Therefore, it makes sense to avoid paying taxes on your 401(k) contributions today and then pay the tax when you withdraw your money in retirement. And that may be the case. But if all your retirement funds are in a traditional 401(k) when you get to retirement, you open yourself up to risk. It’s possible that you’ll actually earn more in retirement than you do today. Also, tax brackets (and tax rates) can change. You can minimize some of that risk by contributing to a Roth 401(k) and paying taxes today on a portion of your future retirement income.

Roth 401(k) flexibility

When you have a choice of accounts to draw from in retirement — both taxable and non-taxable — you'll have flexibility to combine various streams of income in a way that allows you to minimize taxes and maximize income. For example, let's say one year in retirement you're inching close to the top of the 24 percent tax bracket, and you want to draw additional income to make a major purchase. If you pull the money from a taxable asset, you may inadvertently bump yourself into the next higher tax bracket — increasing your overall tax liability. But if you could augment your income with tax-free money from a Roth 401(k), you could avoid moving to a higher tax bracket.

Roth 401(k) income limits

Roth IRAs impose an income restriction. In 2023, for example, you can contribute the maximum amount to a Roth IRA only if your modified adjusted gross income is under $218,000 for married filing jointly or under $138,000 for a single filer or head of household. These restrictions do not apply to a Roth 401(k), which makes it an attractive option for higher-wage earners.

Roth 401(k) withdrawals

With a traditional 401(k), the IRS requires that you take required minimum distributions (RMDs) from your account beginning at your retirement or at age 72, whichever is later. While a Roth 401(k) is subject to these same RMD rules, RMDs can usually be avoided by simply rolling over your Roth 401(k) into a Roth IRA at retirement.

If you have access to a Roth 401(k), your employer may also offer the option to convert some of your existing traditional 401(k) to a Roth 401(k). You'll have to pay the taxes on whatever amount you convert, but once you convert, your contributions will grow tax-free. It's worth considering if you're currently in a lower tax bracket and want to protect existing retirement savings from future tax increases.

You can contribute to a Roth 401(k) and a traditional 401(k)

While the yearly contribution limit to a 401(k) ($22,500 in 2023, and $30,000 if you’re age 50 or over) applies to the cumulative funds you contribute to a Roth or traditional 401(k), you aren't limited to one or the other.

Is a Roth 401(k) right for you?

The answer depends on your financial circumstances. While everyone’s situation is different, it usually makes sense to contribute to both a Roth and traditional 401(k). Doing so allows you to get some tax break today while also giving yourself future flexibility to manage your taxes in retirement.

This publication is not intended as legal or tax advice. Financial Representatives do not give legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor.