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Roth 401(k) Contributions: Should You Be Making Them?

| March 19, 2019
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Should you be making Roth 401(k) contributions?

The Roth 401(k) feature allows you to invest after-tax dollars (allowing them to grow on a tax-deferred basis) and take qualifying distributions tax-free. The following questions and answers can help you decide if Roth 401(k) contributions are right for you. (Not all employers offer a Roth 401(k) option.)

Making Contributions

What is the difference between regular 401(k) contributions and Roth 401(k) contributions?

When you make a regular 401(k) deferral, the amount is taken out of your pay on a pre-tax basis. The tax is deferred until your account is distributed to you, at which time your contributions and investment earnings are subject to income tax.

A Roth 401(k) contribution is made on an after-tax basis, meaning that you’ve already paid current income tax on it. Since it was taxed at the time of deferral, it won’t be taxed again when it is later distributed to you. And if you meet several qualifications, the investment earnings on your deferrals will not be taxed when you receive them. So, the earnings can be tax-free, not just tax-deferred.

Who is eligible to make these contributions?

If you are eligible to contribute to your 401(k) plan and your plan permits them, you are eligible to make Roth 401(k) contributions.

Can I make both regular 401(k) contributions and Roth 401(k) contributions at the same time?

Yes. Your plan’s recordkeeper will maintain separate accounting for these two types of contributions.

Is there an income limitation for making Roth 401(k) contributions?

No. You are not eligible to contribute to a Roth IRA if your gross income exceeds certain limits, but those income restrictions do not apply to Roth 401(k) contributions.

Will my Roth 401(k) contributions be eligible for any company match?

Employers may or may not match Roth 401(k) contributions. Check with your Plan Administrator.

When must I designate a deferral as a Roth 401(k) contribution?

You must designate your contribution as a Roth 401(k) contribution at the time the deferral is made. You will need to complete and submit the proper form to your plan administrator in order to begin making Roth 401(k) contributions.

Your designation of contributions as Roth 401(k) deferrals is irrevocable. This means that you may not change your designation of specific contributions as Roth 401(k) contributions after they’ve been made to the plan.

You may, of course, change your contribution rate and any split between regular 401(k) contributions and Roth 401(k) contributions as often as the plan permits. See your Plan Highlights for more information.

Taking Distributions

Will distribution of my Roth 401(k) contributions be non-taxable?

The distribution of your contributions will be tax-free, since you already paid income tax on them when they were made to the plan.

In order for the earnings on those contributions to be tax-free, they must be distributed only after you reach age 59½, you become disabled, or your death. Also, your Roth 401(k) contributions must have been in the plan for at least five years from when you first made a Roth 401(k) contribution.

When does the five-year period start?

The five-year period begins on the 1st day of the year in which you make your first Roth 401(k) contribution. Contributions made in a later year do not start a new five-year waiting period.

Will I have to take required distributions of my Roth 401(k) contributions beginning at age 70½?

Yes. Like your regular 401(k) contributions, you must begin taking minimum distributions from your Roth 401(k) account at age 70½. (Note that a Roth IRA has no mandatory distribution requirement.)

Can I withdraw the earnings on my Roth 401(k) contributions to use them to buy my first home, without tax or penalty?

No. That provision is available only in Roth IRAs.

Roth 401(k) vs. Roth IRA

Can I have a Roth IRA and also make Roth 401(k) contributions to my 401(k) plan?

Yes.

How do the Roth IRA and Roth 401(k) contribution limits differ?

In the 2018 tax-year, you may contribute up to $5,500 to a Roth IRA, plus $1,000 as a catch-up contribution if you are at least age 50. In your 401(k) plan, you can contribute up to $18,500 (plus $6,000 as a catch-up if you’re at least age 50).

The key point is that your regular (pre-tax) 401(k) contributions and your Roth 401(k) (after-tax) contributions both count toward the $18,500 limit in 2018 ($24,500 if making catch-up contributions). Any contributions made to your Roth IRA do not count towards your annual 401(k) contribution limit. 

Contributions limits for retirement accounts increase for the 2019 tax year. For 2019, the limit for Roth IRA contributions is $6,000 annually, plus a $1,000 contribution if you are 50 years or older. The 2019 401(k) contribution limit is $19,000 (plus $6,000 as a catch up if you're at least age 50). 

There is no easy answer to the question "Should I be making Roth 401(k) contributions?" because no two people have the exact same financial situations. As with any financial consideration, careful consultation with a financial professional about what is best for you, is a good idea before you make your choice.

Have questions? Let's Talk.

Contact Anne.

Important Disclaimers:

Securities offered through LPL Financial, Member FINRA/SIPC.

This material is for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific
to your needs, such advice services must be obtained on your own separate from this educational material.

Future tax laws can change at any time and may impact the benefits of the Roth 401(k). Its tax treatment may change.

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