Roth 401(k) is a retirement savings plan which combines the features of Roth IRA and a traditional 401(k). If you are expecting an increase in tax rate when you retire, then Roth 401(k) plan is likely to be beneficial as the tax distributions after the maturity age will not be taxable. Also while switching employers, Roth 401(k) plans can be rolled over to a Roth IRA or to another Roth 401(k), which is a great flexibility that you can use.
Compared to the traditional 401(k) and Roth IRA, Roth 401(k) has many advantages. Roth 401(k) allows up to USD 15,000 as annual contribution, and for those who are 50 years and older, USD 20,000 is the allowed maximum limit. These limits are much higher than the contribution limits in a Roth IRA – USD 4,000 if you are aged less than 50 years and up to USD 5,000 if you are 50 or above.
You can also combine your Roth 401(k) plan with your spouse’s and file a joint return. In contrast, Roth IRAs are limited to single taxpayers with USD 110,000 as the upper income limit and married couples with combined income of USD 160,000 or less in adjusted gross income. Roth 401(k) provides the facility of tax-free distribution after maturity without any income limitation to participate. Withdrawals of contributions and earnings under a Roth 401(k) are not taxed provided it is held for a minimum 5 years unlike traditional 401(k), where earnings are subject to Federal and several State income taxes.
But everything comes at a cost and Roth 401(k) is no exception. Once an account is converted to Roth 401(k), it cannot be converted to a regular 401(k) account. Also in order to be eligible for the tax benefit, money should be invested for a minimum period of 5 years. You contribute taxed income towards Roth 401(k) unlike pre tax income in case of traditional 401(k), which helps you save on income taxes presently.
For Roth 401(k), employers have the discretion to restrict individuals with less than 1 year of service tenure, union members, non US citizens, part-time workers and few others, from participating in the plan.
Adoption of Roth 401(k) plans has been relatively slow, on account of these disadvantages. These accounts require additional administrative recordkeeping and payroll processing, so the employers are not too excited about adopting them. However, with the adoption of Roth 401(k) plans by a few large firms lately, several other firms, even some smaller ones are expected to participate and allow their employees the choice and benefit.