how roth 401 k s work
investors have many options when it comes to saving for retirement one of the most common ways to put money aside is through employer sponsored plans like the 401 k participation is voluntary and those who take part agree to automatic payroll deductions that are transferred into a special retirement account some employers even match employee contributions up to a certain amount 1there are several varieties of 401 k s the roth 401 k option became available at the beginning of 2006 while the traditional 401 k has been around since 1978 both were authorized by congress as tax advantaged retirement plans to encourage employees to save for their retirement 234their tax advantages are different 5the number of plan sponsors that offer a roth 401 k option as surveyed by the transamerica institute at the end of 2022 6roth 401 k contribution limitsa roth 401 k is subject to contribution limits based on the individual s age these limits are adjusted annually for inflation and released by the internal revenue service irs the contribution limit for individuals is 23 000 in 2024 individuals 50 and older can contribute an additional 7 500 as a catch up contribution in 2023 the contribution limit was 22 500 and the catch up contribution was 7 500 unlike other plans there is no income limit to participate 75note that you cannot contribute more than your taxable income for the year roth 401 k withdrawal ruleswithdrawals of any contributions and earnings are not taxed as long as the withdrawal is a qualified distribution which means certain criteria must be met this means that 8the irs has updated the rules for required minimum distribution rmd s for 2024 keep in mind that individuals can withdraw more than the rmd but there is a penalty if you miss an rmd or if your withdrawal is less than outlined during a calendar year previously 50 of the value of the missed withdrawal this penalty is now 25 of the missed withdrawal s value you can reduce the amount of the penalty to 10 if you fix the mistake before the date that the penalty is imposed which is known as the correction window 9advantages and disadvantages of roth 401 k sa roth 401 k may have the greatest benefit for employees currently in a low tax bracket who expect to move into a higher one after they retire contributions made to a roth 401 k are taxed at the lower tax rate distributions are tax free in retirement making them the greatest single advantage no matter how much the account grows over the years that money is still exempt from income taxes after the account holder retires the downside is a little more immediate financial pain because contributions to a traditional 401 k are not taxed immediately but effectively reduce the amount of your gross income the impact on your take home pay is reduced and your tax break for the year is maximized but there s no such deal with a roth 401 k this means that you are out of pocket for and taxed on the deposits you make in the year you make them 10helps people who believe they ll be in a higher tax bracket later in lifedistributions are tax free during retirementearnings grow tax freecontributions are made using after tax dollarscontributions don t reduce your taxable incomeroth 401 k s vs other retirement accountsa roth 401 k is an employer sponsored plan that helps people prepare for retirement but it s not the only option available to investors like its roth equivalent the traditional 401 k is an employer sponsored plan this means you can t set one up on your own money is taken out of your paycheck through automatic deductions and transferred into a special account the money is then invested in a series of mutual funds that you choose the irs sets limits on how much you can contribute to the plan each year this figure is adjusted annually for inflation 7employers can also contribute to their employees plans so long as the total contribution does not exceed the employee s annual salary the 2023 limit for employer and employee contributions together is capped at 69 000 in 2024 or 76 500 including the catch up contribution for 2023 those limits were 66 000 and 73 500 respectively 11this plan is a defined contribution plan which means your contributions determine the account balance and how well your account performs contributions are made using pretax dollars reducing the income tax you pay withdrawals made during retirement are subject to income tax 12if you don t have the option to invest in an employer sponsored plan you may want to consider an individual retirement account ira this kind of account can be set up by anyone through a financial institution or investment firm which means anyone who has earned income is entitled to one unlike a roth 401 k a roth ira is not subject to required minimum distributions you can invest in a variety of investments under an ira including stocks bonds exchange traded funds etfs mutual funds and real estate investment trusts reits just like the 401 k there are several types of ira options available 13you can also choose a simplified employee pension sep ira or a savings incentive match plan for employees simple ira if you re self employed or work for a small business these plans are just like the 401 k but are sponsored by employers for individuals who work in schools and other tax exempt organizations this includes teachers professors clergy people government employees and librarians 403 b s come with regular payroll deductions and potentially additional contributions by the employer 15these plans have the same contribution limits as 401 k plans you can contribute a maximum of 22 500 in 2023 and 23 000 in 2024 people over 50 can make an additional contribution of 7 500 in 2023 and in 2024 7