Enter the retirement mutant hybrid: the Roth 401(k)

SupermanPhoto courtesy of Thomas Hawk

When people think of employer-based retirement accounts like 401(k) plans, people often think that that implies pre-tax contributions. It’s only your own self-directed retirement accounts (IRAs) that have the post-tax (Roth) option.

I used to be one of those people.

But these days, employers can offer what is known as a Roth 401(k) plan in addition to the regular 401(k) plan.

Because the plan combines some of the aspects of a 401(k) and some aspects of a Roth IRA, I call it the retirement mutant hybrid.

But like comic book characters, the mutants aren’t always the bad guys. And in this case, I believe this one can be pretty good.

I can give you the official definition of a Roth 401(k), but I won’t. First of all, even the IRS doesn’t go out of its way to tell you what a Roth 401(k) is. But secondly, it generally is as straightforward as it sounds.

  • With a regular 401(k) (or 403(b), etc.) contributions come out of the paycheck before tax. So a $125 contribution might result in only a $75 reduction in a paycheck, depending on the tax rate. You will need to pay income tax when withdrawing that money later.
  • With a Roth 401(k), contributions come out of the paycheck after tax. So a $125 contribution will result in a $125 reduction in a paycheck. No taxes need to be paid on that money ever again.

I’ve already talked about why I like Roth IRAs over Traditional IRAs. Put simply:

  • While I’m no clairvoyant, I suspect that tax rates will be higher in the future, so I’m paying taxes now.
  • There are no required minimum distributions. I can take the money out whenever I choose.

There are some downsides to Roth IRAs. One of which is the income limitations. If you make too much money ($117,000 as a single person, as an example) you can’t contribute to a Roth IRA. But many people won’t hit these limits, which is why Roth is such a good option for many people.

A sightly bigger issue is the contribution limits to a Roth IRA. As of right now it’s $5,500 if you’re under 50, $6,500 otherwise. And while that may seem like a lot of money, it’s not a lot for many people. If you adhere to the rule of thumb of saving 15% of your gross income for retirement, you’ll max that right out when you hit $37,000 in salary.

Enter the mutant

A Roth 401(k) doesn’t have any income limitations. You can contribute to a Roth IRA no matter how much money you make.

More excitingly, a Roth 401(k) has the same contribution limits as a regular 401(k). At the time of writing, that’s $18,000 a year if you’re under 50, and $24,000 otherwise. That’s a huge difference over $5,500!

A Roth 401(k) has a required minimum distribution just like a regular 401(k), but we don’t care about that, because you can easily rollover a Roth 401(k) into a Roth IRA. Problem solved!

So as far as I’m concerned, a Roth 401(k) has all the benefits of a Roth IRA and regular 401(k) rolled into one. It’s pretty awesome.

What about that match?

If you have an employee match, the match will always go into a pre-tax account.  That should make sense, as otherwise you’d be getting more money out of the employer just for choosing the Roth option. ($100 before taxes ends up being less money than $100 after taxes.)

Your 3% (or whatever) contribution might be able to go into the Roth, but you will want to make sure. Remember, don’t leave a 100% return on the table!

Ask your employer

You may have the option to contribute to a Roth 401(k) and not know it! That happened to me a few years ago. I assumed that the pre-tax option was the only option until one day when I asked. I found out that not only was there a Roth 401(k) an option, but I could elect to contribute to both if I wanted!

And that isn’t a bad idea either. Besides, isn’t it true that the mutants always join forces to defeat evil?

But enough about comic books. What do you think about the Roth 401(k)?

Mike Pumphrey

Mike Pumphrey

I'm the founder and author of Unlikely Radical, a site to help people succeed with money, achieve their goals, and live intentionally.

I offer a free phone consultation to anyone who is interested in changing their financial narrative. Are you ready? Click here for details.
Mike Pumphrey
Posted on July 28, 2016