Roth 401(k): Definition, Basics, and Limits

By Motley Fool Retirement Team – Updated Nov 22, 2024 at 5:22 PM

Key Points

A Roth 401(k) allows tax-free withdrawals and no taxes on investment earnings if you wait until age 59 1/2.
Contributing to both Roth and traditional 401(k)s enables flexibility in managing future tax situations.
Roth 401(k)s are no longer subject to RMDs, enhancing their value as estate planning tools.

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Notebook open to Roth 401k and Traditional 401k on facing pages. — Image source: Getty Images.

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Benefits of a Roth 401(k)

To wrap things up, here are six appealing features of the Roth 401(k):

Tax-free withdrawals in retirement: Once you are 59 1/2 and your Roth 401(k) has been funded for at least five years, your withdrawals are tax-free.
Tax-free investment growth: As long as you don't withdraw earnings early, your realized gains, interest income, and dividend income in your Roth 401(k) are tax-free.
High contribution limits: 401(k) contribution limits are much higher than the contributions limits for IRAs. These 401(k) contribution limits apply to your total deposits across Roth and traditional 401(k)s. You have the option of maxing out the limit in your Roth or splitting it up between your Roth and a traditional 401(k).
No income restrictions: You can fund your Roth 401(k) up to the contribution limit at any income level.
No RMDs: The Secure Act 2.0 eliminates RMDs from Roth 401(k)s beginning in 2024.

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Roth 401(k) for tax diversity and estate planning

Because the Roth combines tax-free retirement withdrawals with high contribution limits and no income restrictions, it can be a powerful component of your retirement readiness plan. Saving in a Roth 401(k) and a traditional 401(k) gives you the flexibility to take taxable or tax-free withdrawals in retirement as needed.

And, if it turns out you don't need your Roth 401(k) funds to cover living expenses, you can roll them into a Roth IRA and pass them on to your loved ones as an inheritance.

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So if you contribute $5,000 to a Roth 401(k), that leaves $18,500 available to contribute to a traditional 401(k) in 2025.

Matching contributions. Matching contributions are deposits your employer makes to your retirement account based on your saving activity. If your 401(k) offers a matching program, you should get those matching contributions for any qualified Roth contributions you make. Matching contributions have historically been pre-tax and would go into your traditional 401(k) account and not the Roth one. Under the Secure Act 2.0, employers can now make post-tax Roth contributions, however, many plans haven't yet implemented this feature.

Withdrawals. Once you reach age 59 1/2 and it's been five years since you funded the Roth 401(k), you won’t pay penalties or taxes on Roth 401(k) withdrawals. You can avoid the taxes and penalties by qualifying for an exception or by waiting. If you become disabled, for example, the penalty for withdrawing earnings early is waived.

Unlike with a Roth IRA, you can’t withdraw your Roth 401(k) contributions whenever you want. If you withdraw money early, the IRS will use a pro-rata formula to determine how much of the distribution is taxable and subject to a 10% early withdrawal penalty. For example, if your account consists of 80% contributions and 20% earnings, you’d owe taxes and a penalty on 20% of the withdrawal.

Note that in a traditional 401(k), there's no tax distinction between contributions and earnings. Unless you qualify for an exception, you'll pay taxes and penalties on any early withdrawal.

Required minimum distributions. Traditional 401(k)s are subject to required minimum distributions, or RMDs. These are IRS-mandated withdrawals you must take after your 73rd birthday. (Previously, RMD age was 72). The Secure Act 2.0 eliminated RMDs for Roth 401(k)s in 2024 and subsequent tax years.

The big negative of RMDs is they force you to move the funds to another account where you won't get a tax deferral on your earnings. Another RMD downside is that these withdrawals limit your ability to bequeath your retirement funds to loved ones.

Roth 401(k): Definition, Basics, and Limits

Key Points

Benefits of a Roth 401(k)

Roth 401(k) for tax diversity and estate planning

Related Retirement Topics

Solo 401(k)

401(k) Basics

Roth IRAs

Retirement plans

Our Guides

Premium Investing Services

Solo 401(k)

401(k) Basics

Roth IRAs

Retirement plans

What is a Roth 401(k) and how does it work?

Roth 401(k) vs. traditional 401(k)

Can I contribute to both?

Benefits of a Roth 401(k)

Roth 401(k) for tax diversity and estate planning

Related Retirement Topics