Contribution rates to 401(k) savings plans hit an all-time high in 2021 with a combined average savings rate of 13.9%, according to a report by the Plan Sponsor Council of America (PSCA).
Nearly 88% of 401(k) plans allowed employees to contribute to a Roth 401(k) option in 2021, up from just over 86% in 2020 and only about half of all plans in 2012. The PSCA also found that nearly 28% of workers who participated in a 401(k) plan made Roth contributions in 2021.
“As the nation emerged from the impact of the COVID-19 pandemic, benefit programs generally, and retirement savings programs particularly, were seen as a key employment differentiator,” Hattie Greenan, PSCA director of research and communications, said. “With the support and encouragement of employer contributions, workers responded in kind, enhancing their long-term retirement security.”
Unlike a traditional 401(k), a Roth 401(k) allows employees to make tax-free qualified withdrawals in retirement. To qualify, workers need to be at least 59.5 years old and have been contributing to their Roth 401(k)s for at least five years.
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What is a Roth 401(k) and how does it work?
A Roth 401(k) is an after-tax retirement account. Unlike with a traditional 401(k), your contributions to a Roth 401(k) are not tax-deductible. This means contributions won’t lower one’s total taxable income for the year.
However, money invested in a Roth 401(k) grows tax-free. And a Roth 401(k) allows for qualified tax-free withdrawals. But there’s no rule stating employees can’t enroll in both a traditional 401(k) and a Roth 401(k) if their employers offer both.
The 401(k) contribution limit applies to both savings types combined: limits must be divided across traditional and Roth 401(k) accounts. For 2023, the 401(k) contribution limit is $22,500, up from $20,500 in 2022. Employees who are at least 50 years old may contribute an additional $7,500 in 2023.
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Who should invest in a Roth 401(k)?
Many financial advisors say Roth 401(k)s are best suited for younger investors who have their highest earning years ahead of them. The rationale is that they can pay taxes on their contributions now at a lower rate and take tax-free withdrawals at retirement.
But if the opposite is true and an employee retires at a lower tax bracket, it may make sense to enroll in a traditional 401(k).
For Roth 401(k) accounts, employees must begin taking out required minimum distributions (RMDs) at age 72. However, one option workers can take is rolling over their Roth 401(k)s into Roth IRAs, which require no RMDs.
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