Roth 401(k) and 403(b)

A new generation of 401(k) and 403(b) plans – the Roth 401(k) and Roth 403(b) – were introduced in 2006.  While employers have been slow to offer it, you may become eligible at some point, in which case, you will need to decide between the old reliable 401(k) or 403(b) or switch to the new models.

Here are the differences between the two:

  • Contributions.  Contributions to a traditional 401(k) or 403(b) plan are made with pre-tax dollars while contributions to a Roth 401(k) or 403(b) plan are made with after-tax dollars.
  • Withdrawals.  Withdrawals from a traditional 401(k) or 403(b) plan are taxable while withdrawals from a Roth 401(k) or 403(b) plan are tax free.

The crux of the decision is whether to take the tax break now in the form of, in effect, a tax deduction for your contribution or forego today's tax break in exchange for being able to withdraw the money tax free when you're retired.  While most of us like immediate gratification, postponing the joy of avoiding taxes may be more advantageous.

Here are some points to consider when considering a Roth 401(k) or 403(b) contribution:

  • Much larger contribution limits than Roth IRA.  If you like the Roth IRA, you'll adore the Roth 401(k)/403(b) because the annual contribution limits are much higher.
  • No income limits.  Has your income been too high to qualify for a Roth IRA?    There are no income limits for making contributions to Roth 401(k) or 403(b) plans.
  • Employer match doesn't qualify.  You can't put any employer matching contributions into the Roth.  The match can still be put in a traditional 401(k), so you don't lose it, but later withdrawals will be taxable.
  • Rollover to a Roth when you leave your job.  You can roll your Roth 401(k)/403(b) account into a Roth IRA when you change jobs or when you retire.
  • Favorable distribution rules.  In addition to the primary allure of a Roth, the ability to withdraw money tax free, as opposed to a traditional 401(k), you won't have to make minimum distributions beginning at age 70 ½, so the tax deferral and estate planning advantages can be enormous.