What is a Roth 401(k)?

By Sabrina Karl

Many Americans have become familiar with 401(k) plans offered at work, which have for decades offered employees the opportunity to contribute directly from their paycheck to a retirement savings account with pre-tax dollars.

But an additional retirement plan was made available to employers in 2006: the Roth 401(k). And its recent growth has been surging. In fact, the Plan Sponsor Council of America reports that in 2020, 86% of workplace retirement plans offered a Roth 401(k) option, vs. just 49% in 2011.

So what is a Roth 401(k)? Anyone already familiar with a Roth IRA will have a good guess that it primarily boils down to when your money will be taxed.

With traditional 401(k)’s, your contributions come directly from your paycheck pre-tax, meaning contributions are subtracted from gross pay and therefore aren’t counted as taxable income. The trade-off, of course, is that you’ll pay tax on the 401(k) dollars when you withdraw them in retirement.

Roth 401(k)’s flip that around, with contributions from your paycheck being made after-tax. This means they won’t immediately reduce your tax bill like traditional 401(k) contributions would, but they will grow tax-free and you won’t owe any tax when withdrawing the funds in retirement, since you’ve already been taxed.

This means that choosing a 401(k) plan comes down to whether you think you’re in a higher tax bracket now than you will be when you’ve retired, in which case a traditional 401(k) would be best. But if you think your tax bracket now is lower and will be higher in retirement, you’re better off paying taxes today and putting the funds in a Roth 401(k) to avoid the future tax hit.

Unsure of that tax answer? You’re in luck, as most employers allow you to contribute to both plans at the same time.