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The Roth 401k - When and Why?

Last updated:  2/20/2023

Do you have the option to invest in a 401k plan through your work?  If so, that's great.  If you are working for a company that offers a 401k plan, there's a good chance the 401k plan also offers a Roth 401k feature.  Even if you are close to retirement or in the highest tax bracket, the Roth 401k might still be a good option for you.

What is a Roth 401k?  A Roth 401k is a feature that is offered along with a regular 401k plan.  It is basically a hybrid of a regular 401k and a Roth IRA.  Not all 401k plans offer the Roth 401k option, but most do.  From a tax stand-point, it functions like a Roth IRA in that contributions are made on an after-tax basis (so no deduction going in), but any growth is tax-free as long as you leave the money in your account for at least 5 years and you have reached age 59 1/2 (some exceptions apply).

Are there income restrictions?  No.  Unlike a Roth IRA, there are no income restrictions with a Roth 401k.  So you can contribute to your Roth 401k, regardless of your income.

How much can you contribute?  The contribution limits are the same with a Roth 401k as they are with a regular 401k.  In 2023, the contribution limit for anybody under the age of 50 is $22,500.  For people age 50 and over, the contribution limit is $30,000.

Does a Roth 401k make sense for you?  Maybe.  If you are young and have a long time until retirement, then the Roth 401k is likely your best bet.  Nobody knows what tax brackets might look like several years from now.  So having money in your Roth 401k growing tax-free should eliminate that unknown risk.

Does a Roth 401k make sense for you if you are in the highest tax brackets?  Maybe.  If you're in the highest tax bracket now, there is a chance you will also be in the highest tax bracket in retirement.  Many high income earners and high net worth individuals accumulate significant assets and never leave the highest tax bracket, even after they retire.  So by contributing to your Roth 401k, you reduce the unknown risk of what tax brackets might look like in the future.  If you think you will remain in the highest tax bracket in retirement, then consider contributing to your Roth 401k.

Any other reasons a high income and/or high net worth person might want to use the Roth 401k?  Yes.  If you are maxing out your regular 401k and would like to save even more money for your retirement, then consider moving your contributions to your Roth 401k.  The contribution limits of $22,500 and $30,000 remain the same, but in retirement, you'll have more after-tax money to spend if the money is in your Roth 401k versus your regular 401k.  That's because the taxes have already been paid on the money in your Roth 401k, unlike with a regular 401k.  And you are reducing the unknown risk of what tax brackets might look like several years from now.

Another Roth 401k benefit:  Unlike with a regular 401k, money in your Roth 401k will not be subject to Required Minimum Distributions (RMDs) when you reach age 70 ½.  Basically, you won’t be forced to withdraw money from your retirement funds when you turn 70 ½.  Note:  There is one exception to the RMD rule with a regular 401k, assuming your plan allows for this exception (most plans do).  If you are still working for the employer who is providing the 401k, you can delay your RMDs from that specific regular 401k account until you stop working for that employer (unless you or certain family members own more than 5% of the company providing the plan, then this exception doesn’t apply).  With money in your Roth 401k, you just don’t have to worry about RMDs.

Matching Contributions:  Regardless of whether you contribute to your regular 401k or your Roth 401k, all employer matching contributions will go into your regular 401k.

Splitting Contributions:  If you're still not sure what to do, you could split your contributions evenly between your regular 401k and your Roth 401k.  For example, if you want to contribute 6% of your total income, then consider putting 3% in your regular 401k and 3% in your Roth 401k.  FYI, the combined total can't exceed the contribution limits mentioned above.

When does a Roth 401k probably NOT make sense for you?  If you are extremely confident you will be in a lower tax bracket in retirement, then you should probably contribute to your regular 401k (not Roth 401k).  Take the tax deduction now while you're in a higher tax bracket, and pay the taxes in the future when you think you'll be in a lower bracket.

Want to run the numbers on your situation?  Bankrate has a very helpful calculator that will help you decide between the Traditional 401k or Roth 401k.  You have to make some assumptions, but play with the inputs/numbers to see how it changes the outcome.  Pro tip:  Make sure to expand the 'Investment return and taxes' section so you can play with those numbers too.  Here is the link to this calculator:  Traditional 401k or Roth 401k Calculator (Click here).

Business Owners / Employers:  Does your retirement plan (401k, etc) offer the Roth 401k option?  You and/or some of your employees would probably benefit from being able to invest in a Roth 401k, especially any younger employees.  The Roth 401k has been around since 2006 (over 15 years!).  If you’re not offering the Roth 401k as an option in your retirement plan, it’s probably time to start.  If you currently have a retirement plan without the Roth 401k and decide to add it, there would likely be a one-time cost (probably $500 - $1000) to amend your plan document and add this option.  That’s pretty standard.  Other than the one-time cost to amend your plan document and add the Roth 401k, there should be no additional ongoing cost to having this option.  Btw, if you’re not happy with your current plan provider and move your plan to me, I’ll be sure to include the Roth 401k.

HyLine Bottom Line:  Even if you are close to retirement or in the highest tax bracket, the Roth 401k might still be a better option for you than the regular 401k.

What can I do at HyLine Wealth to help you with your Roth 401k?  Not much.  Unless I am the advisor for your 401k plan, I can just pass along information to help you make your decision.  This tip is on me!

Want more investment "tips"?  We have a lot more great ideas and suggestions to help you be smarter with your money.  CLICK HERE to get these "tips".

CLICK HERE to Get More "Tips"

Questions?  Don’t hesitate to reach out.  If you have questions on anything, feel free to email me at brock@hylinewealth.com or call me at (605) 275-2343.

Think some of your friends might benefit from contributing to their Roth 401k?  Great!  Use the social media links at the bottom of the page to share this with them.

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Brock Hyde
Investment Adviser

HyLine Wealth
221 S Phillips Ave, Suite 207
Sioux Falls, SD 57104
Office (605) 275-2343

Location-Independent:  Pretty much wherever you are located, we can work together.  I am registered in the state of South Dakota and have an office in Sioux Falls.  The “de minimis exemption” allows me to do business in most other states (with only a few exceptions).  I consider myself "location-independent" as I use a heavy dose of technology to communicate and serve you.  This includes screen sharing technology, electronic signatures when possible, and shared client portals so we can view the same information at the same time.  Frankly, I can probably offer you better service than your "local" financial advisor.

HyLine Wealth is an investment advisor firm registered in the State of South Dakota. We do not provide tax or legal advice. Past performance is no guarantee of future results.  Always consult your financial advisor, tax advisor, attorney, and/or insurance agent before implementing any specific strategy to make sure it is right for you and your unique situation.  We are not responsible for the accuracy or upkeep of information on the links we provide to outside websites.  If/when we provide a link to an outside website, be sure to independently confirm the accuracy of any information.