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Did you say Roth 401(k)? Here’s what you need to know

You may not have heard of a Roth 401(k) or know much about it, but with a majority of companies now offering this retirement savings plan, it could be a good opportunity to fund your future.

Here’s what you need to know:

Roth 401(k) money grows tax-free

Like a traditional 401(k), a Roth 401(k) is an employer-sponsored savings plan. But unlike a traditional 401(k), you make your contributions after you’ve paid taxes. Since you contribute that money ahead of time, you won’t owe the government when it’s time to make withdrawals. This is a great way to save if you think you might be in a higher tax bracket in retirement than you are now.

Your employer can help fund your retirement dreams

There’s a nice little perk that may come with a Roth 401(k), as well as with a traditional 401(k): matching contributions from the sponsoring company. This can turn into big bucks over time. Take note, though: Company matches are made with pre-tax dollars, so you’ll owe the IRS when you withdraw your contributions and gains.

You can sock away significant cash

A Roth 401(k) has high contribution limits, so you can stash three times more money than in a Roth IRA. And while single-filers who earn $139,000 or more don’t qualify for a Roth IRA, there are no income limits to contribute to a Roth 401(k) so those at all salary levels can participate.

You’re forced to take money out at a certain age

Like a traditional 401(k), you have to start taking minimum distributions starting at age 721 unless you’re still working at the company sponsoring your plan. That’s a negative, as each withdrawal reduces the amount of money that’s growing tax-free.

You can mix and match retirement plans

The world is your oyster. You don’t have to choose just one of the retirement plan options out there. For instance, to hedge your bets on future tax rates, you can contribute to both a Roth 401(k) and a traditional 401(k). Your combined contributions, though, can’t exceed the annual $19,500 limit or $26,000 maximum for workers 50 or older.

Comparing the plans
Roth 401(k) Traditional 401(k) Roth IRA
Description Retirement plan offered by employers Retirement plan offered by employers An individual retirement account you can open on your own
Contributions Payroll deductions of after-tax dollars Payroll deductions of pre-tax dollars Funded outside of the workplace with after-tax dollars
Income limits to contribute None None $139,000 single $206,000 married
2020 annual contribution limits $19,500 for under age 50, $26,000 if 50 or older2 $19,500 for under age 50, $26,000 if 50 or older2 $6,000 for under age 50, $7,000 if 50 or older3
Possible employer match Yes Yes No
Taxes on withdrawals None4,5,6 Taxed as ordinary income6 None5
Required distribution age 727 727 None

Source: Internal Revenue Service, 2020

So, is a Roth 401(k) right for you?

A Roth 401(k) might make the most sense if you expect to be in a higher tax bracket in retirement. In that scenario, you would pay lower taxes now on your current contributions and no taxes on your investments and gains when you start withdrawing. (Remember, you’ll still have to pay taxes on your employer’s contributions and earnings.)

If you’re making more money today than you expect to make in retirement, you might be better off with a traditional 401(k). That way, you’d pay taxes upon withdrawal, when your tax rate is lower. Doing some research on traditional 401(k)s, IRAs and Roth IRAs will help you to find the options that best suit your needs.

As with any big money decision, consider consulting a financial advisor or another financial professional.

1. Effective 3/27/20, in accordance with the CARES Act, all 2020 RMDs have been waived. 2019 RMDs, taken on or after January 1, 2020 that were required to be taken by April 1, 2020 are waived.

2. If you contribute to both a traditional 401(k) and Roth 401(k), your combined contributions cannot exceed the maximum threshold of $19,500 (or $26,000 for those age 50 and above).

3. If you contribute to both a Roth IRA and traditional IRA, your combined contributions cannot exceed the maximum threshold of $6,000 (or $7,000 for those age 50 and above).

4. Except employer match.

5. Tax-free withdrawals are allowed if the account has been open for five years and you’re 59 ½ or older.

6. Effective 3/27/20, in accordance with the CARES Act, a Coronavirus-Related Distribution (CRD) of as much as $100,000 of all your eligible employer-sponsored retirement plan or IRA assets is permitted before December 31, 2020. The CRD may be repaid to an eligible retirement plan within three years. Individuals who choose not to repay the distribution will be required to include the taxable portion of the distribution in income evenly over three years from the date of distribution, unless they elect otherwise. With limited exceptions, the 10% additional tax that usually applies to distributions prior to age 59½ is waived for CRDs.

7. If you were age 70 1/2 or older as of 12/31/2019, you would be required to take a required minimum distribution (“RMD”) for 2019. Effective 1/1/2020, in accordance with new legislation, the required beginning date for RMDs for individuals who turn age 70 1/2 on or after 1/1/20 is age 72. You may defer your first RMD until April 1st in the year after you turn age 70 1/2 or 72, as applicable, but then you’d be required to take two distributions in that year. You may be able to delay your RMD if you are still working for the sponsoring company and don't own 5% or more of that company.

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The material provided on this website is for informational use only and is not intended for financial, tax or investment advice. Bank of America and/or its affiliates, and Khan Academy, assume no liability for any loss or damage resulting from one’s reliance on the material provided. Please also note that such material is not updated regularly and that some of the information may not therefore be current. Consult with your own financial professional and tax advisor when making decisions regarding your financial situation.

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