The Basics of Roth 401(k)s
Contribute after-tax money, and all future earnings on the contributions will be tax-free.
If your employer offers a Roth 401(k) plan, you can sock away a lot more money. And there are no income limits on who can contribute to this type of tax-advantaged account.
Employees may direct either some or all of their 401(k) contributions to a Roth. In 2013, the total amount you may contribute to your 401(k) accounts—traditional, Roth or a combination of the two—is $17,500, or $23,000 if you’re 50 or older. Unlike a regular 401(k), contributions to a Roth will not reduce your taxable income. Any matching funds from your employer will go into a regular pretax 401(k) plan. If you're a super saver (and a big Roth fan), you can contribute to both a Roth 401(k) and a Roth IRA.
Because there are no income limits on Roth 401(k)s, these plans offer a way for high-income workers to invest in a Roth without converting a traditional IRA. And starting this year, the law allows you to convert some or all of the money in your 401(k) to a Roth 401(k) while you're still on the job, as long as your employer offers that option.
As with traditional IRA conversions, you'll have to pay taxes in the year you convert—but all future earnings in the Roth account will be tax-free. Make sure you have the money to pay the tax bill, because once you've made the conversion, you can't change your mind. The option you have to "recharacterize" an IRA conversion and undo the tax bill isn't available for Roth 401(k) conversions, says Ed Slott, a CPA and IRA expert based in Rockville Centre, N.Y. "Once you're in, you're in."
Another drawback to Roth 401(k) plans is that you'll be required to take minimum distributions from your plan when you turn 70 1/2 unless you're still working for the employer that sponsors your plan. But that problem is easy to fix, Slott says. Just roll your Roth 401(k) into a Roth IRA before you're required to start taking distributions.
Although Roth 401(k) plans have been around since 2006, they've been slow to catch on. About half of large employers now offer them, according to a survey conducted by Aon Hewitt earlier this year. The survey also found that 29% of employers that didn't offer the option were likely to add a Roth 401(k) within the next 12 months. Most employers that offer Roth 401(k) plans intend to allow workers to make in-plan conversions, Aon Hewitt says.