Roth 401(k)

A Roth 401(k) contribution is an increasingly popular option for retirement savings, offering unique tax advantages and benefits for those looking to secure their financial future. As an optional provision (because technically it is an optional provision in a 401(k) plan, not a type of 401(k) plan), in an employer-sponsored retirement savings plan, a Roth 401(k) contribution allows employees to contribute a portion of their income to an account with significant tax advantages, helping them save for retirement while potentially reducing their tax burden in the long run.

Roth 401(k) contribution limits 

For 2025, employees can contribute up to $23,500 to a Roth or traditional 401(k). Participants age 50 and older can make catch-up contributions of $7,500. Those aged 60-63 are eligible for enhanced catch-up contributions of up to $11,250, bringing their total contribution limit to $34,750. The total combined limit for all contributions, including employer matching and profit sharing, cannot exceed $70,000 per year, or $77,500 for those eligible for standard catch-up contributions. For those aged 60-63 eligible for the enhanced catch-up contribution, the total combined limit is $81,250.

Roth 401(k) vs. Traditional 401(k): Understanding the key differences 

The primary distinction between a Roth 401(k) and a pre-tax 401(k) lies in how contributions and withdrawals are taxed:

• Contributions: Roth 401(k) contributions are made using after-tax dollars, meaning you don't receive an immediate tax benefit. Traditional 401(k) contributions use pre-tax dollars, reducing your current taxable income.

• Withdrawals: Qualified withdrawals from a Roth 401(k) source in retirement are tax-free, including both contributions and earnings. To meet the qualifications for a Roth withdrawal, an individual must be 59 ½ years of age or older and have at least five years invested in their Roth account. Note that Roth contributions are always free from taxation when withdrawn.

What are the tax advantages of a Roth 401(k)?

A Roth 401(k) provision offers distinct tax benefits that can enhance your retirement strategy:

• Tax-free growth (with conditions): Money in the account benefits from tax-free growth, meaning any investment gains, interest, or dividends accumulate without being taxed annually. However, taxes may apply when withdrawals are made, depending on whether they are qualified or non-qualified withdrawals. Qualified withdrawals allow participants to withdraw earnings on their Roth contributions tax-free, while non-qualified withdrawals from earnings are taxable and may incur early withdrawal penalties.

• Tax-free qualified withdrawals: After age 59½ and holding the account for five years, withdrawals of both contributions and earnings are tax-free.

• Tax diversification: Combining a Roth 401(k) with traditional retirement accounts allows for strategic tax management in retirement, helping optimize your overall tax situation based on your income levels and tax brackets.

Who can contribute to a Roth 401(k)?

Any employee whose employer offers a Roth 401(k) option can contribute. Unlike Roth IRAs, there are no income limits restricting who can participate. Employers can also make matching contributions, and due to SECURE Act 2.0, plans can choose Roth employer contributions. 

Understanding Roth 401(k) Withdrawals

Qualified withdrawals from a Roth 401(k) can be made without penalties or taxes on earnings when you reach age 59½ and have held the account for at least five years. Additionally, qualified withdrawals are allowed if you become disabled or pass away (with distributions going to beneficiaries). Early withdrawals before age 59½ may be subject to a 10% penalty and taxes on earnings.

However, there are specific exceptions that allow for penalty-free early withdrawals.