You just got an email or letter from your 401(k) plan telling you that they are adding a Roth 401(k) option to your existing 401(k) plan. Now you’re wondering if this new option is right for you.
Most investors are familiar with Roth IRAs, which date back to 1998.
Roth 401(k)s are still relatively new, first becoming an option for employees in January of 2006.
Given the favorable tax treatment that Roth IRAs receive, Roth 401(k)s are becoming increasingly popular as an employer offering that allows high income earners to access some of the benefits of a Roth style plan within their 401(k).
Mechanics of a Roth 401(k)
When your employer adds a Roth 401(k) option to your existing 401(k), what they are doing is giving you the opportunity to set aside your salary in a Roth style savings vehicle.
That means:
- what you set aside in your new Roth 401(k) will be subject to income tax in the year that you earn the income.
- what you set aside in your Roth 401(k) will grow tax deferred.
- what you set aside and the growth on those funds will be free of taxation when you make qualified distributions in retirement. [1]
Having a Roth 401(k) can be a powerful planning tool when considering how to use your wealth in retirement.
As with all things though, there are pros and there are cons.
Roth 401(k) Pros
No income restrictions
Roth IRAs were the first account of its kind, offering the one-two punch of tax-free growth and tax-free distributions.[2] But Roth IRAs come with strings attached.
There are limits on the income you can earn and still be eligible to contribute to a Roth IRA.
There are no such limits with a Roth 401(k). That makes the Roth 401(k) offering potentially attractive to someone earning too much to contribute to a Roth IRA directly.
Higher contribution limits
Another limitation of Roth IRAs (as well as Traditional IRAs) is the relatively modest contribution limits. As of 2025, an investor may only contribute up to $7,000 a year to an IRA each year.
A Roth 401(k) allows an investor to contribute as much as $23,500 each year.[3]
Matching
Because they are not tied to an employer, Roth IRAs and Traditional IRAs do not receive matching funds. But Roth 401(k)s may be eligible for an employer match.
If your employer offers both Roth 401(k) and matching, those matching funds would be pre-tax, not Roth.
Tax-free distributions
When an investor retires and starts to live off their savings, qualified distributions from their Roth 401(k) are tax-free.
To be deemed a qualified a distribution must be:
- made at least five years after the first day of the calendar year in which the account owner first made a Roth contribution.
- made at or after the account owner attains age 59 ½ or the distribution is being made on account of death or disability.
Nothing in this world comes without downsides, and Roth 401(k)s are no different.
Roth 401(k) Cons
Taxable today
Unlike your regular 401(k) contributions, the amounts you save in a Roth 401(k) are included in your taxable income and subject to taxation in the year you earned the money.
Many investors use their 401(k) contributions to manage their tax liability during high earning years. Choosing a Roth 401(k) means forgoing this benefit.
Limits on distributions
Roth 401(k) balance are subject to the five-year waiting period described above; regular 401(k) balances are not.
If you are nearing retirement and are considering a Roth 401(k), consider also the five-year rule and how it might hinder ability to take distributions from your 401(k) in the early years of your retirement.
Subject to RMDs
Unlike Roth IRAs, Roth 401(k)s are subject to Required Minimum Distribution rules. When the account owner turns 73, they must commence Required Minimum Distributions or face steep penalties.
While those distributions won’t be taxable at distribution, it does mean you will have to take money out of a tax-deferred account and either spend it or re-invest it in a non-tax-deferred account.[4]
What’s best for me?
Which is better; the 401(k) or the Roth 401(k).
If you are a loyal reader, you’ll know that the answer is “It depends.”
The choice you have here is whether or not you want your tax goodies today or tomorrow.
If you want your tax goodies today, the 401(k) is a good option.
If you can wait and get your tax goodies tomorrow, the Roth 401(k) is a good option.
And you don’t have to choose one or the other. It is possible to make some contributions to your regular 401(k) and some to your Roth 401(k).
Be aware that the $23,500 limit on contributions is cumulative between 401(k) and Roth 401(k) – no double dipping by putting $23,500 into each.
The Roth 401(k) can be a powerful wealth building and tax planning tool when used wisely. When choosing for yourself, it’s wise to consult with your tax advisor and Financial Advisor. They can help you work through how the pros and cons of Roth 401(k)s apply to you.
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The information offered is provided to you for informational purposes only. Robert W. Baird & Co. Incorporated is not a legal or tax services provider and you are strongly encouraged to seek the advice of the appropriate professional advisors before taking any action. Please update and resubmit for review.
[1] Roth 401(k) distributions must be “qualified distributions” in order to avoid taxation. We’ll discuss this more later in the article.
[2] Only “qualified distributions” avoid taxation.
[3] The figures quoted above do not include the catch-up contributions which are available to workers who are aged 50 or older.
[4] That may be avoided by executing a rollover of your Roth 401(k) to a Roth IRA. Carefully consider cost, limitations, and your goals before executing a rollover of any kind.
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