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Roth 401(k) (English)

Consider saving after-tax income in a Roth 401(k) Plan

 

Tax-postponed income and earnings vs. tax-free earnings

A 401(k) plan allows plan participants to defer a portion of their current income to the plan. These deferrals, known as "pre-tax" deferrals, are excluded from taxable income when deferred, but are taxed, along with earnings, when distributed from the plan (unless the plan participant rolls the withdrawal into an IRA). Overall, with a 401(k) plan, tax on the deferrals and earnings is postponed.

Roth 401(k) plan deferrals are made from "after-tax" income. However, there is no taxation of the earnings attributable to the Roth deferrals when a "qualified" distribution of the Roth earnings is made from the plan. The result is that a distribution of the Roth earnings may be tax-free, rather than tax-postponed.

 

Timing of distributions of Roth deferrals and earnings

Because Roth deferrals are treated in the same manner as regular 401(k) plan deferrals, the same distribution restrictions apply. In general, a distribution may only be made upon a hardship (employee deferrals only, not the earnings), the attainment of age 59-1⁄2, death, disability, or termination of employment.

 

A "qualified" distribution

In order to avoid the taxation of earnings attributable to Roth deferrals, a distribution from the plan must be a "qualified" distribution. A "qualified" distribution is one that is made after the participant attains age 59-1⁄2, becomes disabled, or dies. In addition, a "qualified" distribution occurs only if the distribution is made after the end of the five-year period beginning with the calendar year in which the participant first made a Roth deferral to the 401(k) plan (or to a prior plan if there is a rollover of Roth deferrals from the prior plan to the 401(k) plan).

If a distribution is not “qualified,” then the portion of the distribution in excess of the participant’s Roth deferrals is taxable. In addition, if a distribution is not “qualified,” then the distribution of these taxable earnings may be subject to a 10% premature distribution penalty tax.

 

Plan participant considerations

  • Depending on whether an employer offers a traditional 401(k) and a Roth 401(k), the participant might need to choose how to split deferrals between pre-tax and post-tax income.
  • Participants should consult the plan’s financial advisor for information on investments and factors to consider in deciding which type of deferral is right for them and their particular situation.
    • Participants who think their tax rate might be higher in retirement might want to consider making Roth 401(k) deferrals.
    • Participants who think their tax rate will be lower in retirement might want to continue making deferrals on a pre-tax basis.

A comparison of a Traditional 401(k) and a Roth 401(k)

Benefit Traditional 401(k) Roth 401(k)
Tax-deferred contributions? Yes No
Tax-free distributions No Yes1
Maximum total annual contributions to the plan?2 $18,500 (in 2018) $18,500 (in 2018)
Catch-up contributions?3 Yes; $6,000 a year maximum (in 2018) Yes; $6,000 a year maximum (in 2018)
Income limits for high earners?4 No No
  • 1Tax law requirements must be met. To qualify, withdrawals must be taken more than five years after the first Roth contribution is made and after age 59-1/2 or upon death or disability.
  • 2Traditional and Roth 401(k) contributions are combined in applying maximum plan contribution.
  • 3Traditional and Roth 401(k) catch-up contributions are combined in applying maximum plan catch-up limit.
  • 4Unlike with Roth IRAs, there is no income limit on who can contribute to a Roth 401(k). However, both traditional and Roth 401(k) contributions may be limited by a plan’s nondiscrimination rules.

Roth 401(k) (Spanish PDF)