Benefits of a Roth 401(k)

Benefits of a Roth 401(k)

A Roth IRA can be a great vehicle for retirement savings.  Taxpayers make after-tax (non-deductible) contributions to a Roth IRA.  Contributions accumulate along with earnings in the Roth IRA and can be withdrawn TAX FREE once the taxpayer reaches 59 ½ years old.  Contributing to a Roth IRA forgoes a current tax deduction for tax-free withdrawal of contributions and related earnings in retirement (after 59 ½ years old).

A drawback of Roth IRAs is the potential for taxpayers being excluded from making contributions as their income grows.  Taxpayers cannot contribute to a Roth IRA once their adjusted gross income reaches $133,000 (single filer) or $194,000 (married filer).

Taxpayers that participate in 401(k) plans at work or are self employed can avoid the Roth IRA contribution adjusted gross income phase outs ($133,000/single, $194,000 married) described above by making Roth contributions within a 401(k) plan.  Most 401(k) plans allow for employee Roth contributions and these contributions are NOT subject to the adjusted gross income limitations described above for taxpayers contributing to Roth IRAs.  Further sweetening the Roth 401(k) deal is ability to make larger employee contributions to a 401(k) than to a Roth IRA.  Roth IRA contributions are limited to $5,500 ($6,500 if 50 years or older) while Roth 401(k) contributions are limited to $18,000 ($24,000 if 50 years or older).

Consider this example:

  • Married couple in their 30s with an adjusted gross income of $320,000
  • Roth IRA contributions allowed = ZERO
    • Contributions allowed are “phased out” when adjusted gross income reaches $194,000 for a married couple
  • Roth 401(k) contributions allowed = $36,000 ($18,000 each)

A Roth 401(k) makes PERFECT sense for a high-income, young taxpayer.  Why?  Consider a taxpayer that would normally be excluded from making Roth IRA contributions because their adjusted gross income exceeds the phase out thresholds.  Not only can that taxpayer contribute to a Roth 401(k), he can contribute over three times the amount ($18,000 vs. $5,500) that could be contributed to a Roth IRA.

The reason being “young” is a big factor in this example is the time horizon for earnings growth.  Roth IRAs are popular to young taxpayers because of the length of time earnings grow that will ultimately be distributed tax free assuming distributions after 59 ½ years old.

A Roth 401(k) option is available even if you’re self-employed.  Consult your financial adviser about setting up a “Solo K” plan that allows for employee Roth contributions.

For taxpayers that fit the right criteria (high income, young), Roth 401(k) contributions make a TON of sense.

Sincerely‚
Marcus Mire
Marcus A. Mire, CPA is a PRM partner based out of the Lafayette, LA office. Marcus’s practice consists of tax planning and consulting for individuals and businesses in a variety of industries. Marcus can be reached via email at marcus@prmcpa.com or 337-406-1099 x 115

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