The Definition for a Roth 401(k)
Roth 401(k) plans offer an after-tax savings option for employees of any income level. Unlike Roth IRAs, Roth 401(k) plans do not restrict participation based on the employee's income level. Only companies that offer traditional 401(k) plans can offer Roth 401(k) plans. Knowing how Roth 401(k) plans work can help you decide if the account type is right for you.
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History
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Roth 401(k) plans were introduced by the Economic Growth and Tax Relief Reconciliation Act of 2001, but could not be offered until the 2006 tax year. These plans were only guaranteed to be available until 2010, but the Pension Protection Act of 2006 made them permanent. Once made permanent, more companies were willing to create them for their employees.
Contributions
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Roth 401(k) plans restrict the amount that employees can contribute each year. The limit may change each year for inflation. As of 2010, an employee can contribute up to $16,500. If the employee is 50 or older, the limit increases to $22,000. The limit for contributions is cumulative with traditional 401(k) plans, so employees must choose how to divide their 401(k) plan contributions between traditional and Roth plans. Employers can match contributions an employee makes to a Roth 401(k), but the money must be placed in a traditional 401(k) plan, it cannot go directly into the Roth 401(k).
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Tax Treatment
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Contributions made to a Roth 401k) plan are not deducted from your taxable income like traditional 401(k) plan contributions. Once in the account, the money grows tax-free and qualified withdrawals from the account do not count as taxable income. This makes Roth 401(k) plans optimal for people who expect to have to pay a higher income tax percentage at the time they take withdrawals rather than when they make contributions.
Time Frame
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Roth 401(k) plans follow similar withdrawal rules as traditional 401(k) plans. In order to take a qualified withdrawal from a Roth 401k plan, you must have had your account open for at least five tax years and you must be either 59 1/2 or permanently disabled. Your heirs also may make tax-qualified withdrawals from your Roth 401k plan if you die and the account has been open for at least five years. Early distributions only can be taken due to disability, leaving your job or a financial hardship and are subject to a 10 percent early withdrawal penalty on the portion of the withdrawal that comes from earnings.
Features
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Roth 401(k) plans allow account holders to take loans from the plan without taking a distribution from the plan. The loan can be up to $50,000 or 50 percent of the value of the account, whichever is smaller. These loans must charge interest, but the interest is paid back into your Roth 401(k) account. In addition, these loans do not require a credit check and have no tax implications as long as the money is repaid. If you fail to repay the money, the IRS will consider any unpaid amount as a distribution, subject to taxes and penalties.
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References
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