The Secure Act made many important changes that benefit retirement investors. One often-overlooked change enhances the appeal of Roth 401(k)s — which are themselves a retirement planning vehicle that are often overlooked in favor of Roth IRAs.
Historically, the primary advantage of a Roth IRA as opposed to a Roth 401(k) was the ability to allow Roth IRA funds to continue growing tax-free even after the client became subject to the required minimum distribution rules. Now that the Secure Act has removed the lifetime RMD requirements for Roth 401(k)s starting in 2024, clients may want to take a closer look to determine whether a Roth 401(k) fits within their planning needs.
Roth 401(k)s: Basics and Background
Roth 401(k)s are very similar to Roth IRAs. They're funded with after-tax dollars, and distributions are tax-free to the client during retirement.
There are, however, some key differences. Roth 401(k)s have higher annual contribution limits. They're subject to the same limits that apply to traditional 401(k)s: $22,500 per employee in 2023 ($30,000 for those 50 and older) and $66,000 for combined employer-employee contributions. Direct Roth IRA contributions are limited to $6,500 in 2023 ($7,500 for those 50 and older).
Roth IRAs also come with an income limit. Taxpayers who exceed annual thresholds cannot contribute directly, although they are permitted to use a conversion strategy to convert traditional IRA dollars to a Roth. Roth 401(k)s do not have an income limit, so even high-earning taxpayers can contribute directly.
A 10% penalty will apply to Roth 401(k) withdrawals before age 59.5 unless an exception applies. After five years pass, investors can access Roth IRA contributions without penalty even before age 59.5.
Roth 401(k) contributions can be taken directly from the employee's paycheck, just like traditional 401(k) contributions. One key advantage is the ability of the employer to make matching contributions based on the employee's contribution to the Roth 401(k).
