What Is a Roth 401(k) Retirement Plan?

A Newer Retirement Savings Option Combining Roth IRA and 401(k)

Apr 7, 2009

In 2006, a new tax-free retirement savings option became available to employees of some companies. It's not a Roth IRA, it's a Roth 401(k). Here's how it works.

A 401(k) is an employer-sponsored retirement savings plan that allows employees to start saving money for retirement by setting aside a certain percentage of the employee’s paycheck toward contributions. Retirement savings from the 401(k) is tax-deferred, meaning the person is taxed only at the time of withdrawal after age 59-1/2.

On January 1, 2006, a new retirement investment savings plan came into effect that combines the features of a traditional 401(k) with a Roth IRA. The Roth 401(k) provides all the tax-free benefits of a Roth IRA while preserving the retirement savings potential of a traditional employer-sponsored 401(k) retirement plan.

What Percentage of Income Should a Person Contribute to a Roth 401(k) Retirement Plan?

Roth 401(k) contribution limits are essentially the same as a traditional 401(k). While maxing out the person’s 401(k) contributions would of course be advantageous over the long run, most people simply cannot afford to do so. Therefore, employees should generally opt to set aside approximately 8-10 percent of income for 401(k) contributions, up to $16,500 ($22,500 if 50 or over) in 2009.

If the employee has an existing 401(k) plan with the employer, he or she can contribute to a Roth 401(k) so long as the combined contributions do not exceed the $16,500 ($22,500 if 50 or over) limit. The employee can designate amounts to be contributed to each plan, however participants cannot swap money in between plans once the decision is made.

How are Withdrawals Made from a Roth 401(k) Retirement Plan?

Upon reaching age 59-1/2, retirees can begin withdrawing distributions from their Roth IRA retirement plan tax-free. However, the person can also wait until age 70-1/2, when it becomes mandatory to begin making withdrawals. Additionally, the Roth 401(k) account must have been active for five years to begin receiving distributions, or penalties will apply.

Do Employers Provide a Matching Roth 401(k) Retirement Plan?

Just like a traditional 401(k) retirement plan, some employers offer matching on their Roth 401(k) plans. If this is the case, two accounts will be set up per employee. The first account contains the employee’s after-tax contributions that are tax-free upon withdraw at age 59-1/2. The second account contains the employer’s before-tax contributions and any investment earnings, which are taxable upon distribution.

The Bottom Line on Roth 401(k) Retirement Plan

Bottom line, all employees should participate in a 401(k) retirement savings plan whether traditional 401(k) or Roth 401(k). However, the Roth 401(k) offers a significant advantage over its traditional counterpart: distributions are tax free upon withdrawal beginning at age 59-1/2. While the Roth 401(k) is especially useful for workers anticipating a higher tax bracket at retirement age, everyone can benefit from this tax-free retirement savings option.

The copyright of the article What Is a Roth 401(k) Retirement Plan? in Retirement Planning is owned by Daniel Gansle. Permission to republish What Is a Roth 401(k) Retirement Plan? in print or online must be granted by the author in writing.