While you may have heard of the Roth IRA, there’s a bigger and stronger retirement feature available in many 401(k) plans called the Roth 401(k). It can be a great way to protect your future savings against tax rate increases and/or climbing into a higher tax bracket in retirement.
Contrary to popular belief, the Roth 401(k) isn’t a new plan – it’s simply a feature available in a 401(k), and it can help you save more retirement dollars than its little brother, the Roth IRA. You can choose to put some, none or all your contributions after-tax into your Roth 401(k), saving up to $22,500 in 2023, or $30,000 if you are 50 years of age or older. Compare this to the Roth IRA, which only allows a maximum contribution up to $6,500 in 2023 ($7,500 if age 50 or over).
Roth 401(k) vs. Roth IRA
|Attributes||Roth 401(k)||Roth IRA|
|Contribution Limit (2023)||$22,500||$6,500|
|Age 50+ Catch-up Amount (2023)||$7,500||$1,000|
|Roth Income Limit||None||$138,000*|
Roth tax rules are the exact opposite of how traditional tax-deferred 401(k) contributions work. Your tax-deferred contributions will be taxed when you withdraw the money at retirement; however, you receive no tax deduction on Roth contributions. The benefit is that your Roth withdrawals (including investment gains) can be taken tax-free when you reach retirement.
It’s important to note that any employer match or profit sharing into your 401(k) will always be on a tax-deferred basis as required by law.
Roth 401(k) Has No Income Limits
Unlike the Roth IRA, there is no income limit for contributing to a Roth 401(k). Anyone can have one if their employer’s plan offers this feature. To invest in a Roth IRA and make the maximum contribution, modified adjusted gross income must be below $138,000 if single or $218,000 if married and filing a joint return.
If you don’t have the Roth option in your company 401(k) plan, it’s a great idea to request it. This typically requires an amendment to the plan that’s a minor cost to the business owner.
Tax Hedging Your Nest Egg and Maximizing Your Money
It’s anyone’s guess what tax rates will look like 10, 20, or 30 years from now – let alone knowing what tax bracket you’ll wind up in. Many believe tax rates are only headed up in the years ahead. Others aren’t so sure. If you’re early in your career and climbing the corporate ladder, it’s likely you’ll graduate to higher tax rates by the time you retire.
So, whether you believe tax rates are headed up and/or are climbing the job ladder, a smart strategy can be to divide your contributions between tax-deferred and after-tax (Roth 401(k)). This allows you to hedge your retirement savings and enable more options on how to use your money and manage tax implications in retirement. For instance, you can take money out of the Roth during years when you need to spend more and your tax bracket is higher, and then use the traditional 401(k) funds when your spending is lower.
The Roth 401(k) is a nice big brother to have on your side. There’s no better time than now to consider your needs for the future and be in a strong position to get the most out of your savings.
This article was updated with 2023 contribution limits and applicable figures.
*In 2023, the contribution amount allowed in an Roth IRA begins to decrease at $138K for single individuals, hitting $0 at $153K. For those filing jointly the contribution limit begins to decrease at $218K, hitting $0 at $228K. Conversely, there are no income limitations to contribute into a Roth 401(k)