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Overview of Roth 401K

A Roth 401(k) is a type of employer-sponsored investment account in which an employee contributes after-tax funds that may be withdrawn tax-free in retirement. A Roth 401(k) is often seen as a hybrid retirement savings account combining features of a traditional 401(k) and Roth IRA.

Because distributions are not taxed upon withdrawal, a Roth 401(k) is a great choice for those who anticipate being in a higher tax bracket at retirement age than they are now.

Here’s everything you need to know about the Roth 401(k) to decide whether it’s the right investment vehicle for you.

Contributions

The amount you are allowed to contribute annually to a Roth 401(k) is the same as a traditional 401(k).

For 2019, that means you can save up to $19,000 each year. Employees age 50 or older may contribute an additional $6,000 as a catch-up contribution for a total of $25,000.

Unlike with a traditional 401(k), contributions to a Roth 401(k) are made after taxes and are not taxed upon withdrawal for qualified distributions.

Qualified distributions

You must meet certain criteria for your withdrawal from a Roth 401(k) to count as a qualified distribution.

You may withdraw earnings from your Roth 401(k) tax-free after you reach age 59 1/2 as long as you have held the account for at least five years. Qualified distributions may also be made in the event of death or disability of an account holder who has held the account for at least five years.

Once you reach age 70 1/2, as long as you are not still working or an owner of 5 percent or more of the company sponsoring your Roth 401(k), you must begin withdrawing from it.

Roth 401(k) vs. traditional 401(k)

A Roth 401(k) is similar to a traditional 401(k), but the way in which each type of account is taxed can make a significant difference.

Contributions to a traditional 401(k) are made using an employee’s pretax income. Those contributions grow in the account over time and then are taxed upon distribution, along with earnings.

Roth 401(k) contributions, on the other hand, are taxed before going into the account, and are not taxed upon withdrawal as long as the withdrawal is a qualified distribution.

Account holders may be able to take out a loan from traditional and Roth 401(k)s before age 59 1/2, subject to certain stipulations.

If your employer sponsors both types of plans, you may hold both a traditional 401(k) and a Roth 401(k). Note that contribution limits are combined across these accounts, but you can split your contributions between the two any way you like.

Roth 401(k) vs. Roth IRA

While a Roth 401(k) is an employer-sponsored retirement plan, a Roth IRA is not.

You can open a Roth 401(k) only if it’s offered by your employer. Anyone who earns income may open a Roth IRA, on the other hand, unless they exceed the income limit.

For 2019, you may not contribute to a Roth IRA if your modified adjusted gross income exceeds $137,000 as a single filer or $203,000 for married couples filing jointly. Roth IRA contribution limits are also reduced beginning at $122,000 and $193,000, respectively. There are no income limits to contribute to a Roth 401(k).

Holding both a Roth 401(k) and a Roth IRA can be a great way for those eligible to grow their retirement savings and increase overall contributions. An employee who holds both a Roth 401(k) and a Roth IRA can contribute a total of $25,000 after tax toward retirement in 2019, or $32,000 past age 50 with catch-up contributions.

Another important distinction to keep in mind is that a Roth IRA does not require minimum distributions at any age. That means, unlike a Roth 401(k), you may continue to grow your funds indefinitely and even pass the account on to your descendants.

Employer match

Many employers offer a 401(k) match, which is often considered free money and a great way to add to your retirement savings.

Your employer is able to match your contributions to a Roth 401(k), but the employer’s matching contributions will go into a pretax account, unlike your after-tax contributions.

If you hold both a traditional and Roth 401(k), your employer’s match will go toward the traditional 401(k).

Is a Roth 401(k) the best option for me?

Choosing the best retirement plan for you depends on several factors, including your age, current income and expected tax bracket at retirement age.

A Roth 401(k) combines the large maximum contribution limits and employer match option of a traditional 401(k) with the tax-free growth of a Roth IRA, which makes it a great option for both high earners ineligible for a Roth IRA and young savers who anticipate being in a higher tax bracket at retirement age.

A Roth 401(k) is often considered the best of both worlds and, combined with other retirement accounts, can be a lucrative way to save.

Best practice generally dictates first opening an employer-sponsored account, especially if you’re offered a company match, but it’s smart to split your retirement savings between traditional and Roth accounts, whether employer-sponsored or individual.

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