Roth 401(k)

The after-tax version of a 401(k): contributions are taxed now, but qualified withdrawals of both contributions and earnings are tax-free in retirement.

What it means

A Roth 401(k) is an option inside many workplace 401(k) plans. Instead of lowering taxable income today, employee contributions come out of pay after income tax. In exchange, qualified withdrawals, generally those taken after age 59½ once the Roth account has been open at least five years, are completely free of federal income tax.

Roth and traditional contributions share a single annual employee limit set by the IRS, and many workers split money between the two. Unlike a Roth IRA, a Roth 401(k) has no income limit for contributing. Employer matching contributions have traditionally gone into the pre-tax side, though plan rules vary.

Example

For example, a worker in a hypothetical 22% bracket puts $5,000 into a Roth 401(k), paying about $1,100 in tax on that income now. If the money grows to $40,000 by retirement, the entire $40,000 can come out tax-free in a qualified withdrawal.

How it’s used

Workers who expect a higher tax rate in retirement
Younger savers in lower brackets today
Building tax-free income alongside pre-tax savings

Strengths and weaknesses

Strengths

Qualified withdrawals, including growth, are tax-free
No income limit to contribute, unlike a Roth IRA
Adds tax diversification to retirement income
Can be rolled into a Roth IRA after leaving a job

Weaknesses

No up-front tax deduction, so take-home pay drops more per dollar saved
Benefit depends on future tax rates, which are uncertain
Early withdrawal of earnings can trigger tax and the 10% additional tax

Good to know

If unsure whether tax rates will be higher or lower later, splitting contributions between Roth and traditional is a common hedge.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.