Choosing the best mix of accounts to house your retirement funds can be challenging. You have individual retirement accounts, such as Roth and traditional IRAs, and employer-sponsored retirement plans like a 401(k) and 403(b). Also, about 90% of employers now offer Roth savings options within their 401(k) plans, according to a 2022 survey, adding another wrinkle to retirement planning.
Despite the increase in employers offering Roth 401(k)s, the number of employees contributing to these accounts hasn't budged much, with less than a quarter taking advantage of this option. However, a change to the required minimum distribution rule that goes into effect this year may entice more people to consider a Roth 401(k).
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How a Roth 401(k) works
Roth 401(k)s haven't been on the retirement scene for two decades yet, but they are already becoming a staple in many employer retirement plans. A Roth 401(k) allows employees to contribute after-tax dollars to their retirement accounts and, in return, receive tax-free income during retirement, similar to a Roth IRA. This differs from a traditional 401(k), where pre-tax dollars are contributed, lowering your taxable income for the year. While you miss out on that upfront tax deduction with a Roth 401(k), you'll reap the tax benefits later once you've turned 59 1/2 and met the requirements of the five-year rule.
One drawback to employer-sponsored retirement plans has been the required minimum distributions (RMDs). Before the SECURE 2.0 Act, individuals were required to start taking RMDs from all types of 401(k) accounts and similar retirement accounts at age 72, with the first RMD needing to be taken by April 1 of the following year.
The SECURE 2.0 Act has made significant changes, including raising the RMD starting age to 73 in 2023. However, a new rule is making Roth 401(k)s even more appealing by eliminating the RMD requirement altogether.
New RMD rule in 2024
Starting in 2024, RMDs are no longer required for savers who invest in designated Roth accounts, such as a Roth 401(k). This means you will not be forced to take distributions from your Roth 401(k) during your lifetime. This change aligns with Roth IRAs, which are not subject to RMDs during the account owner's lifetime.
Here are a few reasons this RMD change to Roth 401(k)s could be a big deal:
- Your money can grow tax-free longer. Since you don't have to worry about withdrawing money from your Roth 401(k) at a certain age, your investments can continue to grow tax-free for as long as you live. This is a good option for those who don't need to access their retirement funds immediately upon reaching retirement age and want to get closer to a million-dollar retirement.
- You have more flexibility. People who save money in a Roth 401(k) can choose to withdraw from their account when it makes sense for their financial situation, rather than worrying about RMD rules in their 70s.
- You can simplify your retirement planning. In the past, rolling over a Roth 401(k) to a Roth IRA was one way to avoid required minimum distributions. However, this could create another issue with the five-year rule, which requires you to have had your Roth IRA for at least five years before you can withdraw the earnings tax-free. This could get confusing. Now, savers can avoid the extra steps and planning required to ensure their money keeps growing.
It's important to note that while RMDs are no longer required for Roth 401(k)s starting in 2024, you must still take RMDs for 2023, including those with a required beginning date of April 1, 2024.
Choosing the best retirement plan for you
Retirement planning is highly personal, and the best accounts for you will depend on your finances, goals, and future expectations. If you're not completely sold on a Roth 401(k), you can still contribute to a traditional 401(k) or allocate a portion of your paycheck to both the Roth 401(k) and the traditional 401(k). However, with the new Roth 401(k) RMD rules, you can enter retirement with less stress, knowing that you aren't required to withdraw money at a certain age and can allow your investments to grow for as long as you want.
