How Roth 401(k)s can help participants tackle taxes in retirement

Plan sponsors are always looking for ways to positively impact retirement savings for participants. One strategy is to offer both a pre-tax (traditional 401(k)) and post-tax (Roth 401(k)) options to save for retirement within the 401(k) plan. This gives participants the choice and flexibility they want, and also provides a significant retirement planning opportunity. Just as plan sponsors have promoted the importance of diversifying their investment mix, participants should next consider diversifying their retirement savings tax liability.¹

The rise of the Roth 401(k)

The adoption of Roth 401(k) has become mainstream. In 2020, 86% of plans allowed a Roth 401(k) option.² As Roth 401(k) availability has increased, so too has participant usage.

What’s the difference?

In general, when participants make Roth 401(k) contributions (taxed at the time of deferral) into their Roth 401(k) account, withdrawals in retirement from that “bucket” are tax free because taxes have already been paid on those contributions. This differs from the traditional 401(k), where they get a break from paying taxes up front, but must pay taxes later, on both the original contribution and any investment growth.

Who benefits from a Roth 401(k)?

Offering both types of contributions gives participants the ability to personalize their retirement savings approach. Depending upon their specific life stage or financial situation, participants have the flexibility to contribute to either a traditional (pre-tax) 401(k) or Roth (after-tax) 401(k) account, or they can split their contributions between the two, alternating back and forth as they see fit.

For many participants, it makes sense to use a Roth 401(k) early in their career and then contribute to a traditional 401(k) later as earnings increase. This helps them avoid paying taxes at the higher tax brackets during the highest earning years and provides flexibility when making retirement withdrawals.

Early career and/or lower-wage employees who:

• Are likely in a lower tax bracket now than when they retire
• May need to tap savings for financial emergencies

Highly compensated employees who:

• Aren’t eligible for Roth IRA but want to save some tax-free money
• Don’t want to pay high(er) taxes on a Roth IRA conversion

All employees who:

• Don’t want retirement distributions to impact the taxes they owe on Social Security

Learn more about what type of participants would benefit from contributing to a Roth 401(k), and how considering a segmented auto-enroll strategy could help participants better diversify their tax liability.