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Ask Alight: What is a Roth 401(k) and why do I need one?

Written by Rob Austin, FSA, Vice President Head of Research Wealth Solutions & Strategy

How will your taxes in retirement compare to what they are today? A Roth 401(k) may provide some much-needed relief.

For most of us, there are many unknowns—Will tax brackets change in the future?  How much will I spend in retirement?  Will I move to a state that has a different income tax structure than where I live now?  The answers to these questions will impact your future taxes, but it’s nearly impossible to arrive at a reasonable degree of certainty.

There is good news, however. If you work for a large employer, you likely have an option within your 401(k) that can help diversify your tax situation in retirement. Let’s talk about these so-called Roth 401(k)s:

  • how they are like traditional 401(k)s
  • the maximum you can contribute to a Roth 401(k)
  • why saving to a Roth 401(k) might be a smart move

Roth 401(k) vs. Traditional 401(k)

Contributions to a 401(k) typically reduce your taxable income now, but you pay taxes on the money as you make withdrawals to cover your expenses in retirement. For Roth 401(k)s, it’s just the opposite. Your tax burden is higher now, but your retirement income is tax free1.  Everything else—the investment options, the match you get from your employer, the loan and withdrawal options—are the same as the rest of your 401(k).  And you can contribute to both at the same time.

How much can you save to a Roth 401(k)?

Each year, the IRS sets maximum amounts that can be contributed to 401(k) plans. These amounts apply to the combined total of Roth 401(k) and pre-tax 401(k) contributions. In 2023, the annual contribution is capped at $22,500 for people under age 50. Those over 50 are usually eligible for catch-up contributions, bringing their total to $30,000. So, for example, if you’re under 50, and you want to contribute $10,000 to your pre-tax 401(k), the most you can contribute to your Roth 401(k) would be $12,500.

For 2023:

Under age 50Pre-tax 401(k) + Roth 401(k) must not exceed $22,500
Age 50+Pre-tax 401(k) + Roth 401(k) must not exceed $30,000

What is a Roth 401(k) conversion?

Some 401(k) plans allow you to convert your pre-tax 401(k) balance to a Roth 401(k). The catch? Any amount that is converted now will be added to your taxable income this year. Therefore, any dreams of not paying taxes in your golden years could be seriously offset by your tax bill next April 15th.

When is saving to a Roth 401(k) a good idea2?

If your current tax rate and your retirement tax rate are likely to be the same, it won’t really matter if you save on a pre-tax basis or a Roth basis. However, if you expect that your taxes in retirement will be higher than what they are now, Roth 401(k) contributions are generally a good idea. Conversely, if your taxes in retirement are expected to be less, then pre-tax contributions are probably better.

Deciding to contribute to a Roth 401(k) may seem like a simple question of, “Do I want to pay more taxes now or later?” However, there are many details to consider. Before starting to save to a Roth 401(k), be sure to read up on the specifics for your employer’s 401(k) and talk to a professional who understands your specific financial situation and goals.

1 Not all Roth withdrawals are tax-free, but to keep this blog at a high level, we’ll not discuss those nuances here.  Before deciding to save to a Roth 401(k), be sure to review the requirements to receive tax-free withdrawals.

The content of this blog is for general informational purposes only and should not be considered an individualized recommendation or tax, investment, financial or legal advice. Each individual’s circumstances are unique, and therefore, you need to assess your own situation and consider consulting with your tax, financial or legal advisor before making a decision. The information contained herein is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability is not guaranteed. Alight Solutions LLC and its’ subsidiaries and affiliates are not responsible for any errors or omissions or for the results obtained from the use of this information.

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