Being able to save for retirement in an employer-sponsored plan is among the most popular workplace benefits. For most who enjoy it, that means a traditional 401(k), with tax-deferred contributions taken out of every paycheck but a tax bite on the back end when you withdraw the money.
For a growing number of workers, there’s another option: a Roth 401(k), in which contributions are taxed going into the account but withdrawals in retirement are tax-free.
From 2013 to 2022, the share of retirement plans that give employees a Roth option grew from 58 percent to 89 percent, according to the most recent data available from the Plan Sponsor Council of America, a nonprofit trade association.
“Having Roth as an option has become standard — a best practice — the last few years,” says Hattie Greenan, director of research and communications for the association. “Allowing Roth contributions is often seen as a low-cost way for plans to offer choice to participants.”
As with Roth IRAs, Roth 401(k)s allow you to stash money after you’ve paid taxes on it, so your withdrawals in retirement are tax-free. They can also give you greater flexibility when you’re taking money out: As of 2024, the IRS no longer requires Roth 401(k) owners to withdraw a minimum amount each year once they reach a certain age, an exception previously limited to Roth IRAs.
One big difference is that you can save a lot more with a workplace Roth account. In 2024, you can contribute up to $23,000 to a 401(k) — $30,500 if you’re age 50 or older. The limit for IRAs is $7,000, $8,000 if you’re 50-plus.
Despite the wider availability, only about 1 in 5 retirement plan participants contribute to a Roth 401(k), according to the association. Here are some things to ask yourself if you’re thinking about enrolling in a Roth 401(k) or converting to one from a traditional retirement plan.
Do you want to pay Uncle Sam now or later?
In essence, the decision to save in a traditional or a Roth 401(k) comes down to one basic trade-off, says Scott Thoma, principal for client needs research at Edward Jones: “Do I want to save money on taxes today or do I want to save money on taxes whenever I retire?”
If you expect to be in a lower tax bracket when you retire, you might be better off with a traditional 401(k) that lets you put off taxes until then. But if you expect your income to be higher in retirement, you could go the Roth route and pay taxes on your contributions at your current, lower rate.
That’s why younger workers tend to be more likely to have a Roth 401(k), says Kirsten Hunter Peterson, vice president of thought leadership at Fidelity: “Right now, they probably have a lower tax rate, so it just makes sense for them to potentially pay that tax on their retirement contributions now.”
Where and how you choose to live in retirement can also come into play. For example, “if you live in a state now that has a lower income tax than the state you plan to move to, then you might want to consider contributing after-tax or on a Roth basis,” Hunter Peterson says.
Do you need more take-home pay?
When you save a portion of your salary in a Roth 401(k) plan, you pay the taxes up front. But with more of your money going to taxes, your take-home pay will be less than what you’d pocket if you saved the same amount of money in a traditional 401(k).
“For folks who might feel like they need every dollar in that paycheck right now, or don’t have that wiggle room in their budget to be able to pay the tax up front, that’s an important consideration,” Hunter Peterson says.
When will you need the money?
Are you counting down the days before you can tap your retirement account, or is enough coming in from other income streams, such as Social Security or a pension? If the latter, recent changes in retirement-saving rules could make a Roth 401(k) more attractive.
Most retirement plan owners must take a set amount out of their accounts each year, starting at age 73. As part of the SECURE 2.0 Act of 2022, a federal law aimed at expanding savings opportunities, Congress exempted Roth 401(k) plans from these required minimum distributions (RMDs), effective with the 2024 tax year.
Now, if you don’t need much money (or any money) from your Roth 401(k) in a particular year, you don’t have to take it — you can leave it where it is, earning returns or interest. That could provide a hedge against rising costs as you age (for health care, for example) or let you pass on more to heirs, if you intend to leave an inheritance.
Does your plan allow Roth conversions?
What if you’ve saved a sizable amount in a traditional 401(k) account and now want to move that money into a Roth 401(k)? A majority of workplace plans allow employees to convert from a traditional 401(k) to a Roth, but about 43 percent do not, according to an industry survey of plan sponsors. Check with your HR department or plan manager to see about your options.
Can you afford to convert?
If you can and do choose to make the switch, be sure to consider all costs involved. “Converting a traditional 401(k) to a Roth 401(k) means you’ll have to pay taxes on the converted amount,” says Derek Miser, a financial adviser and founder of Miser Wealth Partners in Knoxville, Tennessee. “You want to ensure you have enough cash on hand to cover any tax liability from the conversion.”
Keep in mind, too, that you must own a Roth account for five years before you can make qualified withdrawals (unqualified withdrawals carry a 10 percent tax penalty). If, say, you plan to retire in two years and will need to tap your account at that time, a Roth conversion might not make sense.
Indeed, when it comes to choosing between a traditional or a Roth 401(k), there’s no right or wrong answer — it all depends on which account type works best for your personal situation.
And you don’t necessarily have to choose one of the other. Suppose you have a traditional 401(k) and you change jobs. If your new employer offers a Roth 401(k), “you can do both, and you can diversify your tax strategy now and in retirement by doing so,” Hunter Peterson says. “That’s a third option.”