You probably know there are two commonly used types of retirement plans: Individual Retirement Plans (IRAs) and 401(k)s/403(b)s offered by employers. Further, they come with different tax treatment choices, Traditional and Roth. In short, the Traditional option is funded with pre-tax dollars and withdrawals (contributions and growth) are taxed as ordinary income. The Roth option is funded with after-tax dollars and withdrawals are generally tax-free.
Roth 401(k) Overview
Prior to the SECURE Act 2.0 (enacted in late 2022), Roth 401(k) contributions and taxation treatment differed between employee and employer contributions in that employee contributions went to the Roth option, but employer contributions were required to go the Traditional option. This act really simplified things by allowing both employee and employer contributions to be deposited to the same option. Let’s take a look at some of these changes.
Employee Contributions
No changes here. Employee contributions to a Roth 401(k) are considered ‘after-tax’ and are not deductible by the employee.
Employer Contributions
Under the SECURE Act 2.0, employers can now make matching or non-elective contributions to Roth 401(k) accounts. However, these contributions must be included in the employee’s taxable income in the year they are made, which differs from the previous rule where all employer contributions were pre-tax and allocated to traditional 401(k) accounts. As a consequence, the employee’s Adjusted Gross Income will increase by the amount of the employer’s contribution leading to a somewhat higher tax bill.
This change allows for Roth treatment of employer contributions, making future withdrawals of these contributions tax-free, provided other Roth requirements are met (e.g., holding the account for at least 5 years and reaching age 59½).
Required Minimum Distributions (RMDs)
The SECURE Act 2.0 eliminated the RMD requirement for Roth 401(k) accounts starting in 2024. Previously, Roth 401(k) account holders had to take RMDs during their lifetime, just like traditional 401(k) holders. This change aligns Roth 401(k) accounts with Roth IRAs, which do not have RMDs during the account holder’s lifetime.
Is a Roth 401(k) Right For You?
This really depends on your circumstances. If you expect your tax rate to be lower in retirement, this may not be the best choice. If your tax rate might be higher than it is now, this could be the perfect way to go. Since it’s hard to see the future and since tax laws change, many people opt for a stream of tax-free income.
So, in summary, the SECURE Act 2.0 introduced significant changes that provide more flexibility and potentially more tax benefits for Roth 401(k) account holders by allowing employer contributions to Roth 401(k)s and eliminating RMDs. We can discuss whether a Roth 401(k) plan is right for you, or any other financial matters, in a no-charge, no-obligation initial meeting. Please visit our website or give us a call at 970.419.8212 to set up an in-person or virtual meeting.
This article is for informational purposes only. This website does not provide tax or investment advice, nor is it an offer or solicitation of any kind to buy or sell any investment products. Please consult your tax or investment advisor for specific advice.