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You may have another option for your retirement investments as of Jan. 1, 2006. Employers now 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.
This new option was created as part of the 2001 Tax Act, although it did not go into effect until 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.
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:
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a Roth 401(k) contribution with an after-tax contribution, so the match contribution is taxable as ordinary income when withdrawn.
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 age 70½, which is different from Roth IRA rules but consistent with the traditional 401(k) and IRA rules.
If your employer offers a Roth 401(k), consider the following benefits:
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.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.