4 Things You Should Know About Roth 401(k) Accounts

A Roth 401(k) is a powerful retirement savings tool that combines the benefits of a traditional 401(k) with the tax advantages of a Roth IRA. If you're considering contributing to a Roth 401(k) or already have one, it's important to understand how this type of account works and how it differs from other retirement savings options. Here are four key things you should know about Roth 401(k) accounts.

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1. Tax Treatment: Pay Now, Enjoy Later‍

One of the biggest benefits of a Roth 401(k) is its tax treatment. Contributions to a Roth 401(k) are made with after-tax dollars, meaning you pay taxes on your income before contributing. The major advantage comes in retirement: qualified withdrawals are completely tax-free, including any earnings on your investments. To qualify for tax-free withdrawals, you need to be at least 59½ years old and have held the account for at least five years.

This "pay now, enjoy later" structure is ideal for people who expect to be in a higher tax bracket when they retire, allowing them to enjoy their retirement savings without worrying about taxes.

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2. Contribution Limits: Generous Room to Save‍

Roth 401(k) accounts share the same contribution limits as traditional 401(k) plans, which means you can take full advantage of their higher limits compared to Roth IRAs. For 2024, you can contribute up to $23,000 if you're under 50. If you're 50 or older, you can make an additional catch-up contribution of $7,500, allowing for a total contribution of $30,500.

These higher limits make Roth 401(k)s an excellent choice for people looking to maximize their retirement savings with the added benefit of future tax-free withdrawals.

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3. Employer Matching: Separate from Your Roth Contributions‍

One unique aspect of a Roth 401(k) is how employer matching works. If your employer offers a matching contribution, it will be made to a traditional 401(k) account, not your Roth 401(k), even if all your personal contributions go into the Roth portion. This means that while your contributions grow tax-free, your employer’s match will grow tax-deferred, and you’ll owe taxes on those matched contributions when you withdraw them in retirement.

This separation of employer matching and personal contributions is important to consider when planning your retirement tax strategy.

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4. No Required Minimum Distributions (RMDs) Starting in 2024‍

A big update from the SECURE 2.0 Act: Starting in 2024, Roth 401(k) accounts are no longer subject to Required Minimum Distributions (RMDs). Previously, Roth 401(k) accounts had the same RMD rules as traditional 401(k)s, requiring you to withdraw a certain percentage of your savings each year starting at age 73. However, the new law eliminates RMDs for Roth 401(k)s, aligning them with Roth IRAs, which have never had this requirement.

This means you can leave your savings in the account to continue growing tax-free for as long as you like, without being forced to take distributions during your lifetime. If you want to preserve your Roth 401(k) for legacy purposes or for future tax-free growth, this change is a significant advantage.

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Conclusion‍

A Roth 401(k) is a flexible and tax-efficient retirement savings option that offers several key benefits, from tax-free withdrawals to high contribution limits and, starting in 2024, no required minimum distributions. Whether you're nearing retirement or just starting to plan, understanding how these features work can help you make the most of your Roth 401(k) and set yourself up for a more secure financial future.

By taking advantage of the Roth 401(k)'s unique tax treatment and employer matching benefits, you can build a tax-free retirement portfolio that offers you greater financial freedom when you retire. Check with your financial planner or CPA to see if this tool fits your retirement goals.