What is a Roth 401(k)? Here’s what you need to know

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When considering your employer-sponsored retirement options, you might be confused by the plethora of different accounts offered by your company: There’s probably a 401(k), a 403(b), or a Roth 401(k).

If you’ve heard of a 401(k) and a 403(b), but not a Roth 401(k), you’re not alone. According to loyalty, 75% of companies to which Fidelity provides retirement services now offer a Roth 401(k) option. However, only 13.6% of those offered a Roth 401(k) use one.

Below, Select spoke with Scott Sturgeon, CFP® and Founder of Wealth of Oreadon how a Roth 401(k) works and who should use them.

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How does a Roth 401(k) work?

Most employers offer 401(k) retirement accounts to employees. Named after a section of the IRS tax code, a 401(k) is an employer-sponsored retirement account where individuals invest pre-tax money, which is deducted directly from their paychecks. , then pay taxes on retirement withdrawals. A 403(b) is similar to a 401(k), but it’s a pre-tax retirement account that’s specifically offered by schools and tax-exempt organizations (like NGOs).

A Roth 401(k) is an employer-sponsored after-tax retirement account that has the features of a Roth IRA and a 401(k). Like a Roth IRA, contributions to a Roth 401(k) are made with income that has already been taxed, allowing investments to grow and be withdrawn in retirement without being taxed. While traditional 401(k)s reduce your taxable income because contributions are deducted directly from your salary, Roth 401(k) contributions will not reduce your taxable income.

Unlike a traditional Roth IRA, there is no income limit for a Roth 401(k), so these accounts are available to everyone (depending on whether your employer offers one), regardless of the amount you win someone.

Although Roth IRAs don’t have required minimum distributions (RMDs) or a minimum amount of money you must withdraw from your account starting at age 72, Roth 401(k)s do have RMDs. This means that Roth 401(k) account holders must begin withdrawing money from their account at age 72 (unless they are still working or do not own 5% of the sponsoring company). plan).

What are the contribution limits?

The contribution limits for a traditional 401(k) apply to a Roth 401(k). For 2022, the maximum an individual can contribute to their 401(k) account is $20,500. In other words, your total contributions to different 401(k) accounts cannot exceed $20,500.

People age 50 and over approaching retirement can make catch-up contributions of up to $6,500, to a maximum of $27,000 per year.

Can you receive matching contributions for your Roth 401(k)?

Some companies will offer to match their employees’ Roth 401(k) contributions. With matching contributions for a regular 401(k), the employer matches the employee’s contributions, usually between 2% and 5% of someone’s paycheck. The employee will then pay taxes on these contributions, matching funds and investment income upon retirement.

Roth 401(k) matching contributions work the same way as 401(k) matching contributions.

“The IRS actually requires that employer-matching contributions to Roth 401(k)s be treated like contributions to a traditional 401(k), meaning that those contribution amounts are considered taxable income when you take them out later,” Sturgeon says. “So your employer may ‘match’ your Roth 401(k) contributions, but it’s actually treated like a traditional 401k contribution for tax purposes.”

Roth 401(k) employer matching contributions go into a traditional 401(k), so you pay taxes on them later, depending on the IRS.

Who is the Roth 401(k) for?

When choosing between a traditional 401(k) and a Roth 401(k), you need to consider whether you want a tax advantage now or later in life. Sturgeon is focused on developing a long-term plan to save for retirement to reduce your tax bill.

“The idea is [that] when your income puts you in a lower position [tax] support, so maybe they will in the future, the Roth option is usually better,” says Sturgeon. “And the reason for that is you’re just taking advantage of the drop [tax] bracket you’re in, versus potentially being in a higher bracket later…”

If you plan to have a lower salary in retirement, a traditional 401(k) may be a better choice.

Additionally, if your employer does not offer you a Roth 401(k) option, you may consider opening your own Roth IRA. However, there are income limits on a Roth IRA – if you earn more than $144,000 as an individual or less than $204,000 as a married couple filing jointly (in 2022), you are not eligible. for a Roth IRA.

Select ranked Charles Schwab, Loyalty investments, Ally Invest and Improvement as offering some of the best Roth IRAs based on factors such as fees, investment options offered, and whether a minimum deposit was required.

At the end of the line

A Roth 401(k) can be a good choice for people who expect to make more money later in life. Although employees don’t pay taxes on employer matching contributions until retirement, a Roth 401(k) can still be useful for people who prefer to foot the tax bill on their own contributions right from the start. departure.

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Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.

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