The Roth 401(k) combines some of the most advantageous aspects of both the 401(k) and the Roth IRA. Under the Roth 401(k), employees can decide to contribute funds on a post-tax elective deferral basis, in addition to, or instead of, pre-tax elective deferrals under their traditional 401(k) plans. An employee’s combined elective deferrals– whether to a traditional 401(k), a Roth 401(k), or to both– cannot exceed $18,000 (for tax year 2016) if a participant is under 50; if they are over 50, they may contribute an additional $6,000 (for tax year 2016). Employer’s matching funds are not included in the $18,000 elective deferral cap, but are considered for the maximum section 415 limit, which is $53,000 for 2016.
Employers are permitted to make matching contributions on employees’ designated Roth contributions. However, employers’ contributions cannot receive the Roth tax treatment. The matching contributions made on account of designated Roth contributions must be allocated to a pre-tax account, just as matching contributions are on traditional, pre-tax elective contributions. (Pub 4530)
In general, the difference between a Roth 401(k) and a traditional 401(k) is that the Roth version is funded with after-tax dollars while the traditional 401(k) is funded with pre-tax dollars. After-tax dollars represent money for which taxes are paid in the current year, and pre-tax dollars are those that do not represent federal taxable income in the current year. Typically, the earnings on Roth contributions will be tax free as long as the distribution is made at least 5 years after the first Roth contribution and the attainment of age 59 and one half, unless an exception applies.
A Roth 401(k) plan will probably be most advantageous to those who might otherwise choose a Roth IRA, for example, younger workers who are currently taxed in a lower tax bracket, but expect to be taxed in a higher bracket upon reaching retirement age. Higher-income workers who wish to save the maximum amount allowed may favor the Roth 401(k) because it effectively allows greater real contributions, as post-tax dollars are more valuable than pre-tax dollars; however, those near the Roth IRA income limits may prefer a traditional 401(k), since its pre-tax contributions lowers Modified Adjusted Gross Income (MAGI) and thus increases eligibility for Roth IRA contributions. Another consideration for those currently in higher tax brackets is the future of income tax rates in the U.S. (if income tax rates increase, current taxation would be desirable for a wider group). The Roth 401(k) offers the advantage of tax free distribution, but is not constrained by the same income limitations. For example, normal Roth IRA contributions are limited to $5,500 ($6500 if age 50 or order); whereas, up to $18,000 could be contributed to a Roth 401(k) account, provided no other elective deferrals were taken for the tax year (no traditional 401(k) deferrals taken).