Adding a Roth feature to a 401(k) plan allows business owners and employees the option to pay taxes now contributions and at today’s tax rates. Unlike traditional pretax 401(k) contributions, Roth 401(k) contributions are made with after-tax dollars.

If you make Roth 401(k) contributions, when you take money out of your 401(k), the Roth contributions and the investment earnings will be distributed tax-free if you meet specific requirements.

Roth 401(k) is a significant advantage for those who are concerned about tax changes that may occur in the future that involves a different political landscape. With a Roth 401(k), individuals and employers will not be taxed on an uncertain tax future.

What is a Roth 401(k)?

Traditionally, the key tax incentive for employees to save in a 401(k) has been that the portion of their pay contributed to the 401(k) plan is not included in taxable income, lowering the amount of taxes they owe each year.

These contributions are referred to as pre-tax salary deferrals because they are made from earnings that have not yet been taxed. Investment earnings on 401(k) contributions are not taxed until withdrawn from the plan.

This allows you to delay taxation on your 401(k) savings until you take distributions from the plan–ideally in retirement.

Many employers have added a Roth contribution feature to their 401(k) plan to accompany the pretax deferral option. Like pretax deferrals, Roth 401(k) contributions are made to the plan by employees through payroll deduction. However, Roth contributions are deducted from wages after payroll taxes have been calculated.

This means they are deducted from your net pay and do not reduce your taxable income in the year contributed. The investment earnings on Roth contributions grow tax-deferred while held in the plan, just like pretax deferrals.

Since you don’t get a tax break for your Roth contributions, you may wonder why anyone would want to make Roth contributions rather than pre-tax deferrals.

The answer is because of the potential for entirely tax-free withdrawals in retirement.

Young business owners.

How are Roth 401(k) deferrals taxed when withdrawn?

When Roth 401(k) contributions are distributed, you do not have to include this money in your taxable income because you already paid taxes in the year you made the contribution.

Two requirements must be met for a Roth distribution to be qualified:

  • You must have had a Roth 401(k) account for at least five years, and
  • You are age 59½, have become disabled, or have died

If a distribution from a Roth 401(k) is not qualified, the earnings portion of the distribution (but not the Roth contributions) will be taxable. The earning may also be subject to a 10% early distribution tax if you are younger than age 59½ unless a penalty exception applies. Aside from the special taxation rules, Roth contributions are subject to the same distribution rules that apply to your pretax money.

That is, you generally cannot access your 401(k) savings until you have a distributable event (such as no longer working for the employer).

If you keep money in your 401(k) after you retire, you will be required to take required minimum distributions (RMDs) from your Roth 401(k) account as well as your pretax 401(k) account.

Is a Roth 401(k) right for me?

You should get professional tax advice to understand whether pretax or Roth or some combination of the two are best for you.

Some of the factors that cause people to choose the Roth option include:
  • Anticipating their 401(k) savings will grow significantly in value before they retire and wanting to take advantage of the tax-free growth on earnings
  • Expecting their tax rate will be higher in the future and can afford to save with the after-tax option, now
  • Wanting some of their income in retirement to be tax-free
  • Desiring tax-free assets for their beneficiaries after they die
  • Earning too much money to be eligible to contribute to a Roth IRA

Roth 401(k) contribution limits

Roth 401(k) contributions are subject to the same limits as pretax 401(k) contributions. If a plan allows Roth contributions, your total salary deferral contributions – Roth, pretax, or a combination of both – are limited to $23,000 for 2024. If you are age 50 or older, you can also contribute up to $7,500 more as a catch-up contribution, for a total of up to $30,500 for 2024.

Maximum employee elective contribution (age 49 and younger)

$23,000

Maximum employee elective contribution (age 50 and older)

Additional $7,500

Maximum employee elective deferral plus catch-up contribution (age 50 or older)

$30,500

Defined contribution maximum limit, employee + employer (age 49 or younger)

$69,000

Defined contribution maximum limit (age 50 or older), all sources + catch-up

$76,500

Highly compensated employees’ threshold for nondiscrimination testing

$155,000

Key employee officer compensation threshold

$220,000

Annual compensation limit for HCEs and key employees

$345,000

What is an in-plan Roth rollover?

Business owners and employees who participate in a 401(k) that accepts both pretax and Roth 401(k) contributions may be able to turn some of their previous pretax 401(k) contributions into Roth contributions.

If your plan allows for in-plan rollovers, you may move some or all of your vested pretax assets to a Roth account within the plan. There is no limit regarding how much you can roll over to the Roth account, but you may want to consult with a tax professional to weigh the tax consequences of an in-plan rollover and evaluate whether it fits into your overall tax and savings strategy.

In the year of the rollover, you will have to pay tax on the amount of savings converted from a pretax account to a Roth account.

Once assets are in the Roth account, any additional investment earnings will grow tax-deferred, and potentially tax-free if you meet the requirements for a qualified distribution. By including a Roth feature in a 401(k), business owners can diversify the tax impact of their retirement savings all within one plan, and allow their employees to do the same.