How to Open a Roth 401(k)

Fact checked by Jiwon MaReviewed by Ebony HowardFact checked by Jiwon MaReviewed by Ebony Howard

A Roth 401(k) is a relatively recent alternative to a traditional 401(k) retirement plan, with different tax advantages to a 401(k) or traditional IRA account. Not all employers offer them, but it is worth investigating as a retirement vehicle option.

Key Takeaways

• With a Roth 401(k), you don’t get a tax break for your contributions. But as long as you’ve had the account for five years and are age 59 ½ or older, your withdrawals will be tax- and penalty-free.
• Unlike Roth IRAs, there are no income limits for Roth 401(k)s.
• You can contribute to both a Roth 401(k) and a traditional 401(k) if your employer offers them.

How a Roth 401(k) Works

Like Roth individual retirement accounts (IRAs), Roth 401(k)s are funded with after-tax dollars. You don’t get any tax benefit for the money you put into account. When you begin to take distributions from the account, however, your withdrawals will be tax- and penalty-free, as long as you’ve held the account for at least five years and are age 59½ or older.

Traditional 401(k)s, on the other hand, are funded with pretax dollars, providing you with an upfront tax break. When you begin to take distributions from the account, your withdrawals will be taxed as ordinary income.

This basic difference can make the Roth 401(k) a good choice if you expect to be in a higher tax bracket when you retire than when you opened the account. That could be the case, for example, if you’re relatively early in your career or if tax rates shoot up substantially in the future.

If You’re an Employee

You can fund a Roth 401(k)—sometimes referred to as a designated Roth—if your employer offers one as part of its retirement plan options. Not all employers do, but their numbers are growing, especially among large companies. If your employer matches your contributions, or some percentage of them, that money, unlike your own Roth 401(k) contributions, is considered a pretax contribution and is therefore taxable when you withdraw it.

Unlike Roth IRAs, which have income limits, you can open a Roth 401(k) regardless of how much money you earn. Be mindful that there are contribution limits that restrict the amount of money both you and your employer can contribute to the account. For individuals, the 2023 contribution limit is $22,500, and the 2024 contribution limit is $23,000. Individuals 50 years or older may also contribute a catch-up contribution of $7,500 in both 2023 and 2024.

Steps to Setting Up Your Roth 401(k)

Step 1: Sign up. When you start a job with a company that offers a Roth 401(k) plan, you have the option of enrolling in the retirement plan. You are not obligated to do so, and you are not automatically enrolled or have investments withdrawn from your paycheck.

Step 2: Choose your account type. As mentioned below, you may have the option of choosing between a Roth 401(k), a traditional 401(k), or both. Consider the tax implications of all options. If you’re unsure about which to choose, your human resources department may have a contact at the brokerage firm you have your plan through to help with investing questions.

Step 3: Choose your investments. With the actual account(s) now set up, it’s time to choose your investments. A 401(k) plan will often come with a limited number of fund options to choose from. You may set up automatic payroll deductions that contribute and invest in funds of your choosing at the allocation of your choice.

Important

As of 2024, Roth IRAs and Roth 401(k)s are not subject to required minimum distributions (RMDs).

If You’re an Employer

If you already offer a 401(k) plan to your employees and would like to add a designated Roth 401(k) option to it, your plan’s service provider or custodian should be able to help. The Internal Revenue Service (IRS) also has information for employers on its website, irs.gov, including Publication 4222, 401(k) Plans for Small Business and Publication 4530, Designated Roth Accounts Under 401(k), 403(b), or Governmental 457(b) Plans.

The IRS does place a limit on the total allowable annual employee and employer contributions to a retirement account. In 2023, this aggregated contribution limit was the lesser of 100% of the employee’s compensation, or $66,000. In 2024, this aggregated contribution limit was the lesser of 100% of the employee’s compensation, or $69,000. There is one exception: if the employee qualifies for a catch-up contribution, which is allowed for people 50 or older (it’s an additional $7,500 in both 2023 and 2024).

Special Considerations

You don’t need to choose between a traditional and a Roth account: you can have both, and split your contributions between them. Just pay attention to the annual limits set by the IRS. The maximum total you can contribute to the two accounts is the same as if you just had one account.

With a 401(k) plan, you likely don’t have much of a say about investing fees. You don’t have control over which brokerage firm your company uses, though you can change the fees you pay by selecting lower-fee fund options. The concept of portfolio fees becomes more important should you leave the company and consider transferring your retirement portfolio to a lower-cost provider.

Lastly, many investors try to contribute enough to their 401(k) to receive the full match from their employer. For example, if your employer awards a dollar-for-dollar match on 4% of your salary, investors are often wise to take full advantage of the match by contributing at least 4% of their salary.

Can I Start a 401(k) if I’m Self-Employed?

Yes, if you’re self-employed and don’t employ others, you are eligible to open a solo 401(k). You can contribute as an employer and employee, choose between a traditional or Roth plan, and may still qualify if the business is run with a spouse.

How Much Should I Start a 401(k) With?

There are no minimum balances for your 401(k), and most if not all of the investment options will have no minimum requirements either. A 401(k) is built slowly over time, so don’t worry if you’re not able to contribute much when you first start your plan.

Is Starting a 401(k) a Good Idea?

Individuals looking to have strong financial health in retirement may strongly benefit from starting a 401(k). Not only are there tax incentives for doing so, you may receive matching funds from your employer to help you save. But it’s not your only option. There are several other ways to save for retirement, including IRAs and taxable brokerage accounts.

The Bottom Line

Though not all companies offer a Roth 401(k), the account usually helps many on their path to retirement. Though there are no immediate tax deductions to be had with a Roth 401(k), earnings accumulate tax-free and can be withdrawn upon retirement with no tax liability, as long as you’ve had the account for five years and are 59 ½ or older. To get started, sign up for an account through your company’s human resources department and consider your investment options.

Read the original article on Investopedia.