5 Things You May Not Know About Roth 401(k)s

I made the switch to Roth for my retirement savings years ago – and I have long counseled younger workers, who were likely paying the lowest tax rates of their working lives, to do so as well.

Pre-tax treatment has, of course, been the norm in 401(k) plans since their introduction in the early 1980s. On the other hand, the Roth 401(k) wasn’t introduced until the Economic Growth and Tax Relief Reconciliation Act of 2001, and even in that legislation wasn’t slated to become effective until 2006 (and at that time was still slated to sunset in 2010).

Despite that late start, according to a variety of industry surveys (Plan Sponsor Council of America, Vanguard, PLANSPONSOR), roughly 60% of 401(k) plans now offer a Roth 401(k) option, and PSCA data shows that 28.6% of 403(b) plans already allow for Roth contributions. Participant take-up, which just a few years ago hovered in the single digits, is now in the 15-20% range.

Here are five other things you may not know about the Roth 401(k):

To allow designated Roth contributions, a plan also has to offer traditional pre-tax 401(k) contributions. 

A plan can only offer designated Roth contributions if it also offers traditional, pre-tax elective contributions. Oh, and they can be offered by either a 401(k), 403(b) or 457 plan.

You can auto-enroll designated Roth contributions. 

The plan must state how the automatic contributions will be allocated between the pre-tax elective contributions and designated Roth contributions.

You can “catch up” on a Roth basis. 

Individuals can make age-50 catch-up contributions as a designated Roth contribution to a designated Roth account.

You have to include Roth contributions in the 401(k) plan annual nondiscrimination testing. 

Designated Roth contributions are treated the same as traditional, pre-tax elective contributions when performing annual nondiscrimination testing. Moreover, just like other elective deferral, they must be included when calculating the top-heavy ratio each year. You cannot allocate forfeitures, matching or any other employer contributions to any designated Roth accounts.

You can take loans from designated Roth accounts. 

As long as the plan permits, you can identify from which account(s) in your 401(k), 403(b) or governmental 457(b) plan you wish to draw your loan, including from a designated Roth account.

Retirement plan education has long had as a basic tenet that individuals will be paying lower tax rates in their retirement future. Of course, tax rates – and future income levels – are hard to predict. Both can rise more than anticipated in the future – and a Roth option can provide some essential flexibility to diversify tax treatment, as well as investments.

- Nevin E. Adams, JD

For more information, see Retirement Plans FAQs on Designated Roth Accounts from the IRS.