What Is a Roth 401(k)?
What to Choose?
The choice between a Roth 401(k) and a traditional 401(k) comes down to determining whether the upfront tax break on the traditional 401(k) is likely to outweigh the back-end benefit of tax-free withdrawals from the Roth 401(k). The information in this material is not intended as tax advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult a professional with tax or legal experience for specific information regarding your individual situation.
Often, this isn’t an “all-or-nothing” decision. Many employers allow contributions to be divided between a traditional 401(k) plan and a Roth 401(k) plan – up to overall contribution limits.
Considerations
One subtle, but key, consideration is that Roth 401(k) plans aren’t subject to income restrictions, like Roth IRAs are. This can offer advantages to high-income individuals whose Roth IRA has been limited by these restrictions.
| Traditional 401(k) |
Roth 401(k) | Roth IRA | |
|---|---|---|---|
| Contributions | Contributions are made with pre-tax dollars | Contributions are made with after-tax dollars | Contributions are made with after-tax dollars |
| Income Limits | No income limits to participate | No income limits to participate | For 2021, contribution limit is phased out between $198,000 and $208,000 (married, filing jointly), and between $125,000 and $140,000 (single filers) |
| Maximum Elective Contribution* | Contributions are limited to $19,500 in 2021, ( $26,000 for those over age 50)* | Aggregate contributions are limited to $19,500 in 2021, ($26,000 for those over age 50)* | Contributions are limited to $6,000 for 2021, ($7,000 for those over age 50)* |
| Taxation of Withdrawals | Qualifying withdrawals of contributions and earnings are subject to income taxes | Qualifying withdrawals of contributions and earnings are not subject to income taxes | Qualifying withdrawals of contributions and earnings are not subject to income taxes |
| Required Distributions | In most cases, distributions must begin no later than age 72 | In most cases, distributions must begin no later than age 72 | There is no requirement to begin taking distributions while owner is alive |
|
* This is an aggregate limit by individual rather than by plan. The total of an individual’s aggregate contributions to his or her traditional and Roth 401(k) plans cannot exceed the deferral limit – $19,500 in 2021 ($26,000 for those over age 50). Source: IRS.gov, 2021 |
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Roth 401(k) plans are subject to the same annual contribution limits as regular 401(k) plans – $19,500 for 2021; $26,000 for those over age 50. These are cumulative limits that apply to all accounts with a single employer; for example, an individual couldn’t save $19,500 in a traditional 401(k) and another $19,500 in a Roth 401(k).4
Another factor to consider is that employer matches are made with pretax dollars, just as they are with a traditional 401(k) plan. In a Roth 401(k), however, these matching funds accumulate in a separate account, which will be taxed as ordinary income at withdrawal.
Setting money aside for retirement is part of a sound personal financial strategy. Deciding whether to use a traditional 401(k) or a Roth 401(k) often involves reviewing a wide range of factors. If you are uncertain about what is the best choice for your situation, you should consider working with a qualified tax or financial professional.
1. To qualify for the tax-free and penalty-free withdrawal of earnings, Roth 401(k) distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawal also can be taken under certain other circumstances, such as a result of the owner’s death or disability. Employer matches are pretax and not distributed tax-free during retirement. Under the SECURE Act, generally, once you reach age 72, you must begin taking required minimum distributions.
2. Under the SECURE Act, in most circumstances, you must begin taking required minimum distributions from your 401(k) or other defined contribution plan in the year you turn 72. Withdrawals from your 401(k) or other defined contribution plans are taxed as ordinary income, and if taken before age 59½, may be subject to a 10% federal income tax penalty.
3. Roth IRA contributions cannot be made by taxpayers with high incomes. In 2021, the income phaseout limit is $140,000 for single filers, $208,000 for married, filing jointly. To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawal also can be taken under certain other circumstances, such as a result of the owner’s death or disability. The original Roth IRA owner is not required to take minimum annual withdrawals.
4. IRS.gov 2021
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright 2021 FMG Suite.
Post by Phil Ratcliff
Phil Ratcliff, President of rebel Financial, is a senior financial advisor that holds an AIF®, CFP®, ChFC®, and CLU® certifications. He started his career at American Express Financial Advisors in 2003, then moved to AXA Advisors for 7 years before founding rebel Financial LLC in 2013.
