How much can you contribute to roth 401 k

Many companies now offer employer-sponsored Roth 401(k) retirement accounts alongside traditional 401(k) plans, giving employees another way to save for retirement. What's the difference between the two accounts? And should you consider opening a Roth 401(k)?

Here, we'll take a look at how Roth 401(k) plans stack up against their traditional counterparts and what to consider before contributing to one.

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

Most people are familiar with how traditional 401(k) retirement plans work: An employee contributes pre-tax dollars and can choose from a variety of investment options. Then, contributions and potential earnings grow tax-deferred until they're withdrawn, usually in retirement. 

With a Roth 401(k), the main difference is when the IRS takes its cut. You make Roth 401(k) contributions with money that has already been taxed—just as you would with a Roth individual retirement account (IRA). Any earnings then grow tax-free, and you pay no taxes when you start taking withdrawals in retirement.1

Another difference is that if you withdraw money from a traditional 401(k) plan before you turn 59½, you pay taxes and may potentially owe a 10% penalty on the entire distribution.2 With a Roth 401(k), your non-qualified withdrawals are a pro-rata amount of your contributions and earnings, and you may potentially be subject to the 10% early withdrawal penalty on funds that are considered gross income.3

One similarity between Roth and traditional 401(k)s is that you must start taking required minimum distributions (RMDs) once you reach age 72 (70 1/2 if you turned 70 1/2 in 2019 or earlier) to avoid facing a penalty. However, you can get around this requirement when you retire by rolling your Roth 401(k) into a Roth IRA, which has no RMDs.4 This way, your assets have the opportunity to grow tax-free, and if you pass down your IRA to your heirs, they won't have to pay taxes on distributions either. 

"This flexibility is a significant difference between Roth and traditional 401(k)s or IRAs," says Rob Williams, managing director of financial planning, retirement income, and wealth management at the Schwab Center for Financial Research.

Choosing a Roth 401(k) or a traditional 401(k) might not be an either-or decision. If your employer offers both, you can contribute to a Roth 401(k) as well as a traditional 401(k). Your employer can also match both, but funds to your traditional 401(k) go directly into your account whereas with a Roth 401(k), they're deposited into a separate tax-deferred account. 

Also, keep in mind that your annual contribution limit would apply across the two accounts. For example, you can't contribute the 2022 salary deferral limit of $20,500 ($27,000 if you're age 50 or older) to each 401(k). Instead, you must divide the total amount between accounts—for instance, putting $10,000 in one and $10,500 in the other. The same goes for your total annual contribution amount ($61,000, or $67,500 if you're age 50 or older), which includes employer matches.

Which account is right for you?

Traditional 401(k)

• Taxes: You make pre-tax contributions and pay tax on withdrawals in retirement
• Salary deferral limits for 2022: $20,500 ($27,000 if you're age 50 or older)
• Employer match: Funds are added directly to your 401(k) account
• Total contribution limits for 2022: $61,000 ($67,500 if you're age 50 or older), includes salary deferral amount and employer matches
• RMDs
  • You must take RMDs starting at age 72 (70 1/2 if you turned 70 1/2 in 2019 or earlier)
  • Heirs are subject to RMDs and taxed on distributions

Roth 401(k)

• Taxes: You make after-tax contributions and don't pay tax on qualified withdrawals in retirement
• Salary deferral limits for 2022: $20,500 ($27,000 if you're age 50 or older)
• Employer match: Funds are deposited into a separate tax-deferred account
• Total contribution limits for 2022: $61,000 ($67,500 if you're age 50 or older), includes salary deferral amount and employer matches
• RMDs
  • You must take RMDs starting at age 72 (70 1/2 if you turned 70 1/2 in 2019 or earlier); however, you could roll over funds to a Roth IRA to avoid RMDs
  • Heirs are subject to RMDs but not taxed on distributions

Now that you have a better understanding of a Roth 401(k), you might be wondering how it differs from a Roth IRA. Contributions to either account type are made with after-tax dollars, and you won't pay taxes on qualified distributions. The differences between the two types of Roth accounts come down to contribution limits, income limits, and RMDs. 

• IRA contributions are capped at $6,000 per year—$7,000 if you're 50 or older.
• For 2022, you can contribute to a Roth IRA only if your modified adjusted gross income (MAGI) is less than $144,000 for single filers or $214,000 for married couples filing jointly or a qualified widow(er).
• With a Roth IRA, you won't be required to take RMDs. Your heirs, on the other hand, must take RMDs, but as with a Roth 401(k), they won't be taxed on withdrawals.

Finally, a Roth 401(k) is only available through an employer plan. If your employer offers only a traditional 401(k) and matches contributions, you'll be passing up free money by not participating. As long as you meet the above MAGI income requirements, you can open a Roth IRA on your own as part of your retirement strategy.

When a Roth 401(k) can make sense

Taxes are a key consideration when it comes to deciding on a Roth 401(k) over a traditional 401(k). 

If you're young and currently in a low tax bracket but you expect to be in a higher tax bracket when you retire, then a Roth 401(k) could be a better deal than a traditional 401(k). Think of it this way: With a Roth 401(k), you can get your tax obligation out of the way when your tax rate is low and then enjoy the tax-free earnings later in life.

The same argument can apply to mid-career workers as well, especially those concerned about the prospects for higher tax rates in the future. After all, current tax rates are fairly low by historical standards. The top rate for married couples filing jointly is 37% in 2022, but it was 70% in 1981 and an eye-watering 91% back in 1963.5 

"On the flip side, it may make less sense to contribute to a Roth 401(k) if you think your tax bracket will be lower in retirement than it is now," Rob says.

And high earners who expect to maintain their income and spending standards into retirement could consider using Roth 401(k)s to simplify their taxes by paying them up front while they're still working. Doing this would mean that you would still take RMDs from your Roth 401(k) but with less of a tax impact since distributions are tax-free. RMDs from a traditional 401(k), however, would be treated as taxable income.

Covering your bases through tax diversification

If you're not sure where your tax rate, income, and spending will be in retirement, one strategy might be to contribute to both a Roth 401(k) and a traditional 401(k). The combination will provide you with both taxable and tax-free withdrawal options. As a retired individual or married couple with both Roth 401(k) and traditional 401(k) accounts, you could determine which account to tap based on your tax situation. 

"You can't really know what future tax rates will look like, so building in the flexibility to use multiple accounts to manage taxes is important and helpful," says Rob.

For example, you could take RMDs from your traditional account and withdraw what you need beyond that amount from the Roth account, tax-free. That would mean you could withdraw a large chunk of money from a Roth 401(k) one year—say, to pay for a dream vacation—without having to worry about taking a big tax hit.

Besides the added flexibility of being able to manage your marginal income tax bracket, reducing your taxable income in retirement may be advantageous for a number of reasons, including lowering the amount you pay in Medicare premiums, paring down the tax rate on your Social Security benefits, and maximizing the availability of other income-based deductions. Be sure to weigh all your available options to maintain your retirement goals.

1Individuals must have the Roth 401(k) account established for five years and be over the age of 59½ for tax-free withdrawals.

2Individuals separating from service on or after the year that they turn 55 are exempt from the 10% penalty.

3To be a "qualified distribution" the following rules must be met: 1) You have reached age 59½ (or have died or become disabled), and 2) At least five years have passed since the first day of the calendar year in which you first made a Roth contribution to the retirement plan.

4Rolling over a Roth 401(k) balance to a new Roth IRA may restart the five-year qualification period. The qualification period would then be calculated from the initial deposit into the IRA and the rollover will be eligible for tax-free withdrawals when that five-year period has ended (and the age qualifier has been met).

5The Tax Foundation, 3/22/2017.