A Guide to Your Roth 401(k)

Saving for retirement in a Roth 401(k) will give you a tax-free source of retirement income. You also won’t need to pay income tax on the investment growth within the account.

Here’s why you should consider using a Roth 401(k) to save for retirement:

— You can avoid paying income tax on investment gains.

— Withdrawals in retirement are often tax-free.

— You can pay your current tax rate on your retirement savings instead of an unknown future tax rate.

— Your employer may provide a pretax 401(k) match.

What Is a Roth 401(k)?

A Roth 401(k) is a workplace retirement account that provides tax advantages to participants. When you contribute after-tax dollars to a Roth 401(k), you become eligible to accumulate tax-free investment growth and to take tax-free withdrawals after age 59 1/2 from an account that is at least five years old.

[Read: How Much Should You Contribute to a 401(k)?]

What Is the Difference Between a Roth 401(k) and a Traditional 401(k)?

A traditional 401(k) allows you to defer paying income tax on your retirement savings until you withdraw the money from the account. A Roth 401(k) only accepts after-tax contributions, but the money will grow tax-free and you can take tax-free withdrawals in retirement.

If your employer offers both a traditional and Roth 401(k), you can decide when to pay tax on your retirement savings. “The decision between contributing to a traditional 401(k) or a Roth 401(k) ultimately comes down to deciding whether you want a tax break now when you contribute or in the future when you withdraw,” says Ryan Moore, a certified financial planner for Jato Wealth Advisory in Atlanta. “Roth 401(k)s are great for individuals who are currently making less money per year than they think that they will in the future.”

If you aren’t sure whether you will pay a higher tax rate now or in the future, you can hedge your bets by saving in both accounts. You can contribute to a traditional and Roth 401(k) in the same year as long as your contributions to both types of accounts don’t exceed the IRS 401(k) contribution limit for that year.

“A Roth 401(k) makes a lot of sense for a younger person, especially someone that is in the lower tax brackets. The compounded, tax-free growth and withdrawals are the biggest benefit,” says Michael Hakimi, a certified financial planner and owner of Black Dog Financial Planning in Mount Pleasant, South Carolina. “I would consider sticking to traditional 401(k) contributions if the employee is a high earner.”

[READ:10 Strategies to Maximize Your 401(k) Balance.]

What Are the Roth 401(k) Contribution Limits?

The Roth 401(k) contribution limit is $19,500 in 2021. Employees age 50 and older can make additional catch-up contributions of up to $6,500 for a maximum possible Roth 401(k) contribution of $26,000.

Is There a Roth 401(k) Match?

Some employers match Roth 401(k) contributions, but the company contribution won’t be put in the Roth account. The 401(k) match will be deposited in a traditional 401(k) account, and you will owe income tax on the employer contributions and the investment earnings when you withdraw the money from the account.

“It is important to remember that contributions made by an employer will still be taxable upon withdrawal even if the employee contributions were made to a Roth 401(k),” Moore says. “The distribution during retirement would be split between tax-free Roth contributions and taxable employer contributions if your employer has been matching the money you have been putting towards a Roth 401(k).”

Do You Have to Take Roth 401(k) Withdrawals in Retirement?

Distributions from Roth 401(k)s are typically required each year after age 72 unless you are still working. However, you could also roll your Roth 401(k) balance over to a Roth IRA, which doesn’t have any withdrawal requirements in retirement.

“You can avoid having to take required minimum distributions on your Roth 401(k) balances during your lifetime, as long as you roll your Roth 401(k) into a Roth IRA when you’re no longer employed,” says Joseph A. Piela, a certified financial planner for Sax Wealth Advisors in Parsippany, New Jersey. A Roth IRA balance can continue to grow tax-free until you withdraw the money or pass it on to your heirs.

[Read: How to Open a Roth IRA.]

What Is the Difference Between a Roth 401(k) and a Roth IRA?

You can only participate in a Roth 401(k) if your employer provides one. Roth IRAs are available to people with earned income whose adjusted gross income is less than $140,000 as an individual or $208,000 as a married couple in 2021. Eligibility to contribute to a Roth IRA is phased out for those who earn more than $125,000 as an individual and $198,000 as a married couple in 2021.

“If your income is too high and you’re unable to contribute to a Roth IRA but would like to, you can still contribute to a Roth 401(k), as they are not subject to income limitations,” Piela says.

Roth 401(k)s have a much higher contribution limit than Roth IRAs. You can save as much as $19,500 in a Roth 401(k) and make catch-up contributions worth an additional $6,500 if you’re age 50 or older. Savers can only contribute up to $6,000 to a Roth IRA, and the catch-up contribution is limited to another $1,000.

Roth 401(k)s have an earlier contribution deadline than Roth IRAs. Roth 401(k) deposits generally need to be made by the end of the calendar year, but you have until your tax filing deadline to make Roth IRA contributions.

More from U.S. News

9 Ways to Avoid the 401(k) Early Withdrawal Penalty and Other Fees

Are Your Retirement Savings Ahead of the Curve?

How to Set Up Your First 401(k)

A Guide to Your Roth 401(k) originally appeared on usnews.com

Update 04/26/21: This story was published at an earlier date and has been updated with new information.

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