A New Retirement Savings Option: The Roth 401(k)

[This article was originally published on November 3, 2005.  The links were updated on June 28, 2018.]

Some employees will soon have a new retirement savings option: the Roth 401(k). Passed into law in 2001, the new Roth 401(k) first becomes available on January 1, 2006. Not all employers will offer the plans as benefit to employees, however; a survey of employers by Hewitt Associates found that only 35 percent are considering it.

The Roth 401(k) differs from a traditional 401(k) the same way a Roth IRA differs from a traditional IRA. Contributions to a traditional 401(k) are made pre-tax, so while it reduces your taxable income in the year you contribute to it, you have to pay taxes on the money you withdraw during retirement. On the other hand, contributions to the Roth 401(k) are made after taxes. This means you won't have to pay any taxes when you withdraw the money. The Roth 401(k) has the same contribution cap as the traditional 401(k): a maximum of $15,000 a year or $20,000 a year if you are over age 50.

So if you have the option, which one is better? It is impossible to know for sure unless you can see into the future. But the general rule of thumb is that if you believe you will be in a higher tax bracket when you retire than the tax bracket you are currently in, the Roth 401(k) is better. Of course the tax system could change and taxes could go up or down, so predicting your tax bracket could be difficult. It is also unclear how long the Roth 401(k) will be available. Right now it is scheduled to expire in 2010 unless Congress extends it. If it expires, the account will stay, but you will not be able to make new contributions.

For more information on retirement planning, click here.

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