Roth 401ks are an employer-sponsored retirement plan available to both small and large businesses that combines features from traditional 401K plans and Roth IRAs. The Roth portion of the 401K plan allows you to invest money on a post tax basis, which grows tax free and withdrawals are not taxed as long as they are a qualified distribution.
They make a strong retirement plan for businesses of all sizes as they allow business owners & employees to save significant money on a post tax basis without any income limits. Roth 401K’s maybe an advantage to people who are in lower tax brackets now and expect to be in a higher tax bracket in the future or expect taxes to increase. They are also a benefit to people who cannot qualify for a Roth IRA.
Roth 401K Employee Contribution Limits 2020 & 2021
For this tax year 2021 the employee contribution limit has increased to $19,500 from $19,000 in tax year 2020. If you are over the age of 50 you may contribute an additional $6,500 bringing your total contribution up to $26,000 for tax year 2021. You can use this handy 401K Save the Max Calculator to determine how much you need to save each pay period to “max out” your 401K.
How Employer Contributions Works on a Roth 401K
Just like a traditional 401K the Company (aka Employer) has the opportunity to contribute to an employees Roth 401K retirement. However, the company’s contributions are made into the traditional or pre-tax portion of the 401K plan as it is a tax deduction to the business. The maximum contribution of both employee and employer contributions for tax year 2020 is $57,000 ($63,500 over 50) and in 2021 is $58,000 ($64,500 over 50).
Roth 401K vs Traditional 401K
Roth and Traditional 401Ks are very similar to each other except that a Roth 401K allows you to make contributions on a post tax basis and make qualified withdrawals tax-free. Many 401K plans offer employees the option to save into either the Roth or Traditional 401K side of the plan with all employer contributions occurring in the traditional pre-tax portion.
Roth IRA vs Roth 401K
Roth 401Ks offer some tremendous savings benefits over their Roth IRA counterparts plus there is no income limits to participate. Roth IRAs only allow to you contribute $6,000 per year for 2020 and 2021 with a $1,000 catchup if you are over 50. Additionally, Roth IRAs have a max income limit for year 2021 of $208,000 if you are filing married and $140,000 filing single. Post tax contributions, tax deferred growth, and tax free qualified distributions work the same across both Roth 401Ks and IRAs.
Roth 401K Withdrawal
In order for a Roth 401K earnings to be withdrawn tax-free two qualifications must be met. First, the 401K account must have been held at least for 5 tax years. A tax year is from January 1st of when the first contribution was made to the account. Second, the account owner must be older than 59 1/2, taking withdraws from a beneficiary IRA, be permanently disabled, or taking up to $10,000 as a qualified first time home buyer. If you make a non-qualified distribution you may be subject to a 10% penalty and/or income taxes. Your post-tax contributions (not the earnings) can be withdrawn at anytime without penally but you should consult your tax advisor first. Here is a good article about early withdrawal penalties for Traditional and Roth IRAs.
Roth 401K Investment Options
Just like traditional 401Ks, Roth 401Ks offer lots of different investment options and strategies depending on the plan provider. Being a business owner you have to decide which Roth 401K plan provider is best for your business and investing needs. Generally speaking most 401K plans offer a slew of different underlying investments from ETFs to Mutual Funds to Target Date Retirement Funds. Some 401K plans even offer institutional money managers and professionally managed portfolios over the do-it-yourself approach of many plans. We’re happy to help you find a plan that fits your business wants and needs.
Should I Rollover a Roth 401K?
Yes, if you have an old 401K from a company no longer work at, you should probably roll it over into a Roth IRA or into another qualified retirement plan if you own or having controlling interest in the company. Your Roth portion of the 401K will roll over into a Roth IRA and the traditional portion will roll over into a traditional IRA. Putting your assets into accounts you have direct control over helps gives you more flexibility with your investments and access to your money. If you need help rolling over a Roth 401K, please request a complimentary meeting here.
Roth 401K Costs
Costs to setup and operate a 401K, whether Roth or Traditional, depends on the size of the plan, number of participants, and if you are combining it with any other type of retirement and deferred compensation plans. Generally speaking, there are setup costs, annual administration expenses, and advisory or underlying investment fees.
Solo 401Ks can be only a few hundred dollars to setup and administer annually. Small size business 401K plans are not much more expensive, usually costing less than $1,000 to setup and around $1,000 to administer annually depending on the number of plan participants. You will need to talk with your financial advisor about 401k costs for medium or large businesses and/or complex retirement plans.
One big cost benefit for a 401K is a reduced financial advisor and platform fees. The larger the plan assets the less percentage a financial advisor and investment platform usually charges. As a business owner, this may be one advantage of rolling over your outside 401K or IRA into your new retirement plan.
Roth 401K Summary
Roth 401K’s provide a valuable qualified investment vehicle for business owners. It allows you to save up to $57,000 ($63,500 if over 50) for the 2021 tax year with a good portion of that money growing tax deferred and coming out tax-free as a qualified distribution.
They are relatively simple to setup and maintain with Third Party Administrators (TPAs) handling a majority of the forms and reporting. Employees are usually grateful that they have a retirement plan at work, and an employer contribution is a great incentive to keep employees engaged. Most importantly, 401Ks help give you a powerful way to save towards your financial independence.
Links to Articles:
https://www.irs.gov/retirement-plans/401k-plans
https://www.irs.gov/retirement-plans/roth-comparison-chart
https://www.investopedia.com/terms/q/qualifieddistribution.asp
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