What is a Roth 401(k)?

Darlene Finzer | June 21st, 2012

Understanding Employee Benefit Plan Types

In 2001, a new retirement plan option was created.  Although this option, known as a Roth 401(k), has been around for a few years now, there’s still some confusion about how it works and what makes it different from a traditional 401(k).  As a plan sponsor, you need to understand the Roth 401 (k) and its benefits so that you can be sure that you’re offering the right retirement plan options to your employees.

Roth 401(k) Benefits

Many people are familiar with other retirement investment options, including: a traditional IRA, Roth IRA and traditional 401(k). The Roth 401(k) is a combination of features from both the Roth IRA and the traditional 401(k), hence the name. The basic difference between a traditional 401(k) and a Roth 401(k) is the funding of these options.

A traditional 401(k) is funded with pre-tax contributions. This means contributions to the retirement plan are deducted from a taxpayer’s gross pay before any taxes are calculated. Contributions made to a traditional 401(k) are subject to income taxes when they are distributed upon retirement. The Roth version of the 401(k) is funded with after-tax contributions. This means that contributions to the retirement plan are deducted from an individual’s net, or take-home, pay after taxes have already been calculated. The benefit of making after-tax contributions is that, generally, distributions upon retirement are not subject to federal income tax.

2012 Roth 401(k) Contribution Limits

Individuals participating in an employer-sponsored retirement plan may contribute to the traditional 401(k), the Roth 401(k) or to both options. The only limit placed on the contribution is the total amount that may be contributed to the plan. The contribution limit for 2012 is $17,000; or $22,500 for those individuals age 50 or older who are eligible for a catch-up contribution. Therefore, a participant can defer up the $17,000 (or $22,500) into his or her retirement account for 2012. The Roth 401(k) option is not an opportunity to save additional money for retirement. It is simply an alternative savings option.

Adding a Roth 401(k) Plan Option

A Roth 401(k) is not automatically available for retirement plans. As the employer (or plan sponsor), you must elect to include the Roth 401(k) as an option under the retirement plan. Not only will you need to ensure the plan record keeper is able to account for the Roth 401(k) contributions, but you must also be certain that payroll records are being handled correctly for both pre- and post-tax contributions by employees.  This might sound like extra paperwork, but it could be worthwhile paperwork that could have a big impact on your employees.  And, you don’t need to do it alone, Rea’s benefit plan administration services can help.

As a plan sponsor, you want to offer the best retirement plan to your employees, at the best price to your company.  You want to make sure that you’re offering the right plan options to your employees — options that fit their needs now and in the future.  Could adding a Roth 401(k) option to your retirement plan benefit your employees?  Depending on your employees’ financial situations, the addition of a Roth option could help to increase their current retirement savings and decrease their future tax burden.

Rea’s Ohio Retirement Plan Design Services

Interested in exploring the addition of a Roth 401(k) option?  Contact Rea & Associates.  Our Ohio Retirement Plan Services team will review your plan to make sure that you’re providing your employees with the best possible options.  We’ll let you know what changes, be they the addition of a Roth option or a switch to a new service provider, could make a big difference to you and your employees.  To learn more, visit our Retirement Plan Design Services page.

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