When thinking of retirement, most workers (and their employers) probably associate the name “Roth” with the letters “IRA.” After all, the Roth IRA has been around since the 1998 tax year and has been widely embraced by many individuals seeking to maximize their retirement income.
However, for high-income professionals and business owners — especially those nearing retirement or those who have seen their retirement savings shrink in recent years due to stock market instability — it’s probably more important to know about the Roth 401k.
That term might sound like a whole new kind of 401k, but it’s not: Since the beginning of 2006, the IRS has allowed U.S. employers to amend their 401k plan document to let employees choose Roth IRA tax treatment for all or part of their future 401k contributions.
For company owners, partners, and high-earning employees, the Roth 401k option offers three key advantages:
- No maximum-income limit: High-income earners may contribute to a Roth 401k no matter how much they make in a year. In contrast, funding a traditional Roth IRA is an option only for individuals making $120,000 or less ($179K for joint accounts).
- Higher contribution amounts: Workers under age 50 may contribute up to $17,000 per year to a Roth 401k (those 50 and over may put in as much as $22,500), but the maximums are much lower for a Roth IRA: $5000 if you’re under 50, $6000 for those 50 and up.
- Tax-free distributions: Because Roth 401k contributions consist only of after-tax dollars, account owners pay no taxes when they withdraw their funds from them. As with a Roth IRA, the money in a Roth 401k grows tax-free.
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Given these points, it might seem like a “no-brainer” for business owners and other high-income earners to choose the Roth option over a traditional 401k or Roth IRA. However, given the many variables involved in maximizing retirement income while minimizing income taxes, it’s not that simple. We’ll talk about some of the key considerations in our next blog post.
