Introduction to each plan
401(k) plans are employer-sponsored retirement plans primarily funded through payroll deductions from the employee’s salary. A typical plan includes several investment choices, and the employee can select which vehicles to invest in, as well as the percentage allocation that will be in each. Contributions are tax-deductible to the employee, accumulate earnings on a tax deferred basis, often include a limited employer contribution match, and become taxable upon withdrawal.
Roth 401(k) plans blend the benefits of a Roth IRA with the more generous contribution limits of a regular 401(k) plan. Though there is no deduction for contributions made to the plan by the employee, earnings accumulate on a tax-free basis, but distributions can be withdrawn tax-free. A Roth 401(k) may feature an employer match, but the funds from the match must be placed into the regular portion of the 401(k).
Let’s take a closer look at the specific features of each plan.
401(k) — Up to $19,000 ($25,000 if you are 50 or older) per year
Roth 401(k) — Up to $19,000 ($25,000 if you are 50 or older) per year in combination with a regular 401(k)
401(k) — None, though the rules are more complicated in the case of highly compensated employees (HCEs)
Roth 401(k) — Same
Income tax considerations
401(k) — Contributions are tax-deductible in the year taken, but earnings in the plan accumulate on a tax-deferred basis. Funds become taxable as ordinary income upon withdrawal.
Roth 401(k) — Contributions are not tax-deductible when made, but earnings accumulate on a tax-free basis. There is no income tax liability on withdrawals from the plan if they are taken after reaching age 59 ½, and as long as the plan has been in existence for at least five years.
401(k) — Withdrawals taken prior to turning 59 ½ are taxable as ordinary income, and subject to an IRS additional tax on early withdrawals equal to 10% of the amount of the distribution.
Roth 401(k) — Contributions made to the plan are not taxable upon withdrawal, since they were not tax-deductible when made. Withdrawal of investment earnings within the plan will be subject to income tax upon withdrawal, as well as the 10% early withdrawal tax penalty.
401(k) — 50% of the value of the plan, up to $50,000
Roth 401(k) — Not available
Required minimum distributions (RMDs)
401(k) — Required when you reach 70 ½
Roth 401(k) — Required when you reach 70 ½, unless you are still employed
401(k) — Can be rolled over into the 401(k) plan of the next employer, an IRA, or a Roth IRA
Roth 401(k) — Can only be rolled over into another Roth 401(k) or a Roth IRA
Whatever plan you select, it’s important you get into a retirement plan and start building up your retirement portfolio as soon as possible.