Roth Option for 401(k) & 403(b) Plan

You may have another option for your retirement investments. Employers can add a Roth option to the retirement plans they sponsor. This article refers to 401(k) plans, but the same information applies to 403(b) plans.

Where the Roth 401(k) Originated

This option was created as part of the 2001 Tax Act and became effective in 2006. The option commonly is referred to as the Roth 401(k).

Employer-sponsored retirement plans will not be required to allow Roth contributions. The employer sponsoring the plan will decide whether to offer this feature.

How You Can Make Contributions

If the employer plan does offer the Roth option, plan participants may choose to designate all or a portion of their contributions to the plan as Roth 401(k) contributions.

What does this mean? Like contributions to a Roth IRA, Roth 401(k) contributions must be made with after-tax dollars. These contributions would not reduce your taxable income like contributions to a traditional 401(k) do, but they would provide the potential for great long-term benefits.

The annual contribution limits are the same for Traditional 401(k) and Roth 401(k) contributions:

  • The combined limit for 2021 is $19,500.
  • If you are age 50 or older, you may be able to make an additional "catch-up" contribution of $6,500 for 2021.
  • You can divide your contributions as you like between the traditional 401(k) and Roth 401(k) plans, as long as you don't exceed the annual limits. The election to treat part of the contributions as Roth 401(k) contributions is irrevocable and must be made before the contributions are made to the plan.

If your employer matches contributions, the employer match money and any earnings on that money will be held in a separate account from your Roth 401(k) contributions. An employer cannot match a Roth 401(k) contribution with an after-tax contribution, so the match contribution is taxable as ordinary income when withdrawn.

What About Withdrawals & Taxes?

Like the Roth IRA, the Roth 401(k) offers tax-free withdrawals if the account is at least five years old and you are at least age 59½. Early withdrawals may be subject to income taxes and a 10% penalty tax. Withdrawals can only be made upon reaching age 59½, severance of employment, hardship, death, disability and plan termination.

Unlike the Roth IRA, the Roth 401(k) does not allow penalty-free withdrawals for special purposes, such as a first-time home purchase.

You may be able to roll over distributions from a Roth 401(k) to a Roth IRA or another 401(k) or 403(b) plan that accepts Roth contributions if you want to keep the money invested. You must begin taking required minimum distributions from a Roth 401(k) at a certain age1, which is different from Roth IRA rules but consistent with the traditional 401(k) and IRA rules.

Why the Roth 401(k) Might Be for You

If your employer offers a Roth 401(k), consider the following benefits:

  • Tax-free withdrawals: In comparison, withdrawals from a traditional 401(k) are taxed as ordinary income. Remember that early withdrawals from a Roth 401(k) may be subject to income taxes and a 10% penalty tax.
  • No income restrictions: Unlike the Roth IRA, the Roth 401(k) does not limit or restrict contributions if your adjusted gross income is above a certain amount.
  • Higher contribution limits: If you want to take advantage of a Roth account, the Roth 401(k) has higher contribution and catch-up limits than the Roth IRA. You may be eligible to contribute to both types of Roth accounts.
  • No income tax for your beneficiaries: The beneficiaries of your Roth 401(k) will not have to pay income tax on the assets in your account if it was open for at least five years. (Estate tax still may apply.) Traditional 401(k) money is fully taxable to heirs.

The Roth 401(k) may not be for everyone. For example, it may not be for you if you are in a lower tax bracket in retirement. That's because you would have paid taxes at a higher rate when you contributed the money (since Roth contributions are made with after-tax money).

Carefully consider all of your options for retirement investing before deciding which type of account or accounts will be most appropriate for you.

1The SECURE Act, effective January 1, 2020, changed the age at which RMDs begin.

  • If you were born before 7/1/1949, you must begin RMDs at age 70½.
  • If you were born on or after 7/1/1949, you must begin RMDs at age 72.

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This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.