In Roth IRA Conversion Rules Highlighted Russ commented that his employer is starting a Roth 401k plan.
The Roth 401k plans are relatively new and many people haven’t heard of them yet. Employers are slowly starting to offer them to employees.
Let’s explore how the Roth 401k works, the benefits over the Roth IRA, and why it is taking time for employers to offer them!
What is a Roth 401k?
The Roth 401k is a great retirement savings vehicle with many of the same benefits as a Roth IRA including:
- Tax free growth.
- Ideal for investors currently in a low tax bracket, but anticipate being in a higher tax bracket in retirement. This is the case for many younger workers.
- Offers the ability to diversify accounts against tax treatment using a combination of regular 401k and Roth 401k. A great idea because of the uncertainty of taxes in the future.
In addition, for those who are interested but restricted from participating in a Roth IRA, the Roth 401k makes sense. Additional benefits over the IRA include:
- No income limits. Great for higher paid workers.
- Contribution levels are higher. See Roth 401k and Roth IRA Limits.
As always, there are other points to consider including the investment options and expenses of the investments when deciding whether or not to participate in a Roth 401k.
Why Employers are Slow to Implement
The Roth 401k didn’t have a lot of employers that immediately put it into place because the original legislation made it only a temporary plan existing from 2006-2010. That changed in 2006 when the Pension Protection Act was signed making the Roth 401k permanent. Employers may still be reluctant because they have to account for the following:
- Keeping the highly paid employees contributions in line with the others to keep the plan qualified.
- Additional education needed to help employees make the right choice between the traditional pre-tax option and the new after-tax option.
- And of course the plan sponsor would charge additional fees.
Other Roth 401k Tidbits
- Employer matching funds will still be deposited into the pre-tax 401k account.
- Further advantages for proprietors of owner-only businesses are detailed in an old article from Investment Advisor.
Ask Your Employer to Offer a Roth Option
If your employer doesn’t offer a Roth option in your 401k, ask for it. At my old job, I campaigned for access to the Roth 401k. I emailed my HR department numerous times and encouraged other coworkers to do the same. We eventually got the option for a Roth 401k (It probably had nothing to do with our emails, but it is fun to think it did!)
If your company doesn’t offer a Roth 401k there are strategies that you can use to get extra money into a Roth IRA.
And don’t forget, if you have both, you can contibute to a Roth 401k and a Roth IRA at the same time.
Roth 401k Q&A
Here are some questions I received about the Roth 401k from a reader, Julie:
If I switch to the Roth 401k versus the regular 401k will my income reported on my tax statements be higher for the year?
Yes, it will. The Roth 401k uses contributions with after-tax money. Therefore your income will be higher on your W-2 (Wage and Tax Statement) than it was using a regular 401k.
If so, it’s even harder to qualify for the Roth IRA, correct?
Yes. If you were nearing the income phaseouts and limits for the Roth IRA, contributing to the Roth 401k could make you ineligible to contribute to the Roth IRA. However, the contribution limits are higher for a Roth 401k, so depending how close you are you could come out ahead. In addition, you could implement a strategy using a combination of the traditional and Roth 401k to keep your eligibility.
How do you figure out if it’s worth it or not to switch?
Dinkytown offers a great calculator to help determine which option is better. Of course the calculator does not take into account other considerations that may impact the decision.
Can you have a Roth 401k and a Roth IRA at the same time?
You sure can. Here are details on contributing to a Roth 401k and a Roth IRA at the same time.
For a deeper look at the pros and cons of a Roth 401k see To Roth 401k or Not to Roth 401k?