The Roth 401(k) is an employer-sponsored plan where contributions come from after-tax wages through payroll deduction. This retirement plan allows you to grow your account potentially tax-free and qualified withdrawals are not taxed. Some of the Roth 401(k) benefits include tax-free withdrawals and higher contribution limits.
Another great benefit of Roth 401(k) is that your employer could match your contributions which is free money to boost your retirement savings. While you might get an employer match, employer contributions are considered after-tax funds. As a result, you will pay tax on these contributions and associated earnings during retirement.
Here are the top 6 Roth 401(k) benefits that you should know.
1. You can avoid RMDs by rolling over your Roth 401(k) into a Roth IRA
The Roth 401(k) is a retirement plan that comes with required minimum distributions(RMDs) when you turn 73. RMDs are distributions you must take from your plan after the age of 73. Failure to take RMDs might result in a 50% tax on the money you did not distribute. When it comes to RMDs, however, the Roth 401(k) plan differs from other retirement plans due to the option of rolling over your funds into a Roth IRA to avoid RMDs.
Once your Roth 401(k) funds are rolled into a Roth IRA, you will not be required to take RMDs. According to Kiplinger, the rollover process must be complete before the year you turn 72 to avoid RMDs.
2. You might get a match from your employer
Like the pre-tax 401(k) plan, your Roth 401(k) is offered and sponsored by your employer. Some employers do not offer this plan and those who do are not required to make contributions.
If you are lucky, your employer might match your contributions up to a certain percentage. Usually, most employers match employee contributions about 3 to 6% of their gross income. Your employer match is like free money to your account but it might be subjected to vesting schedules. Vesting schedules refer to the timeline that dictates when you can claim ownership of your employer match. When you are fully vested, it means you can claim 100% of your employer match the plan. If you are partially vested, you can only claim the percentage of your employer match that is vested.
3. You will grow your account potentially tax-free
One of the greatest tax benefits of a Roth 401(k) plan is that contributions and earnings from investments will grow tax-free and you will pay no tax on qualified withdrawals. This is because your contributions are already taxed and the Roth 401(k) has similar benefits to the Roth IRA when it comes to withdrawals.
Keep in mind that unqualified distributions might be subjected to a penalty and potential tax liability.
For example, if you withdraw the money from the account before you turn 59½; you may pay a 10% penalty on the non-contribution portion, and taxes may apply to the same portion of the withdrawal if your account is not at least 5 years. You can take out your contributions tax-free and without a penalty.
Contributions from your employer to the account will be grown on a tax-deferred basis. Tax-deferred means that employer contributions and earnings from them are not taxed until you are taking distributions.
4. Contribution limits to Roth 401(k) are much higher than IRA limits
When it comes to retirement savings, how much you can contribute makes all the difference. The more you can contribute, the faster you can boost your retirement savings. Another Roth 401(k) benefit that most people don’t know about is that it comes with higher contribution limits compared to IRA limits.
For 2024, the contribution limits to Roth 401(k) are $23,000 or $30,500 if you are 50 or older while the Roth IRA limits are $7,000 or $8,000 if you are 50 or older. Based on these contribution limits, you can see that a Roth 401(k) plan will help you save more money and reach your retirement savings faster than having a Roth IRA.
Another benefit of Roth 401(k) is that you can still make after-tax contributions to the plan If you are a high-income earner. Typically, the Roth IRA comes with income limits that determine your eligibility to make contributions. Having a Roth 401(k) will be your only option to make after-tax contributions when you are ineligible to make IRA contributions.
5. Qualified distributions will be tax-free
Paying no tax on qualified withdrawals is one of the Roth 401(k) benefits that you probably did not know about. For your distributions to be qualified for tax benefits, you must be at least 59½ and your account must be at least 5 years old.
Any distributions you take before you turn 59½ will be considered early withdrawals and you may be subjected to a 10% penalty and applicable tax.
Some exceptions apply when a beneficiary takes the money out after the account owner dies or when you become disabled. In these cases, the 10% penalty will not apply to your withdrawals.
6. Your income level does not affect your eligibility
Unlike a Roth IRA where eligibility to contribute is based on your income level, your eligibility to contribute to a Roth 401(k) does not depend on your income. There is no income level to make contributions to Roth 401(k). This is why the Roth 401(k) is a great option for people who want to make contributions with after-tax money but do not qualify for a Roth IRA.
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