retirement

Roth 401(k): Retirement plan with a tax twist

Retirement » Basics » Roth 401(k): Retirement Plan With A Tax Twist

The Roth 401(k) is similar to the traditional plan, but with an interesting tax twist.

First offered in 2006, Roth 401(k) plans are finding their place among workplace retirement plans.

The addition of the Roth 401(k) in the company roster of retirement plans "adds significant complexity that has to be effectively explained to participants," says David Wray, board member and past president of the Plan Sponsor Council of America.

Contribution limits to a Roth 401(k) are the same as for regular 401(k) plans, but with the Roth 401(k), your contributions are made with after-tax earnings. That means you pay taxes upfront on your contributions.

Paying taxes now means you won't be subject to taxes once you withdraw them, as long as the account has been open for five years -- and you're 59 1/2 years old.

Employers can contribute funds on your behalf, too. However, these matching contributions are tax-deferred. This means that only employee contributions to Roth 401(k) plans are tax-free upon withdrawal.

Here's the lowdown on how they work.

Traditional vs. Roth 401(k)

401(k)Roth 401(k)
Funding limits each year$17,500 per individual
$23,000 for those over 50
$17,500 per individual
$23,000 for those over 50
Employer matchYesYes
Contributions fromPretax earningsAfter-tax earnings for employee contributions only
EarningsGrow tax-deferred until withdrawnGrow tax-free forever
WithdrawalsMust start by age 70 1/2No time restriction if you roll account into a Roth IRA

Bottom line: Roth 401(k)s are a smart choice if you expect your tax bracket to go up in the future. Even though you have to start taking withdrawals at age 70 1/2, they will be tax-free and won't increase your taxable income. But if you want more time for your entire nest egg to grow, it's easy to get around the rule, says Ed Slott, author of "Your Complete Retirement Planning Road Map."

"Simply roll the Roth 401(k) into a Roth IRA, and you can leave the money intact, plus you can keep putting money away if you continue to work beyond that," says Slott.

Can't decide which plan you prefer? Enroll in both as long as combined contributions don't exceed annual funding limits.

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