Roth 401(k) | Pros and Cons of a Roth 401(k) | Fidelity (2024)

In the last few years, it's likely your employer added a Roth 401(k) option to your benefits package. But it's just as likely that you have ignored it so far.

Among the retirement plans that Fidelity provides administrative services for, nearly 80% now offer a Roth 401(k) option. But only 14.8% of those eligible currently contribute to a Roth 401(k). Those who have chosen the Roth 401(k) option span all ages and incomes, but it's most utilized among participants aged 25 to 29.¹

"There's no right or wrong answer," says Aaron Korthas, senior vice president for workplace investing at Fidelity. "The best option depends on an individual's unique situation."

The low uptake numbers might be chalked up largely to a lack of education and conditioning toward tax-deferred retirement savings.

"Many people just don't understand the option so they haven't chosen it," says Ellen O'Connell, a financial consultant with Fidelity. "Some don't know if their company offers it, some just assume they aren't eligible, and some are just used to getting that lowered income tax now."

What's a Roth 401(k)?

A Roth 401(k) is a kind of hybrid between a Roth IRA and a 401(k), with some rules from each kind of plan. Similar to a Roth IRA, an employee makes post-tax contributions, and any earnings grow potentially tax-free.² But the contributions are made through regular payroll deductions and have the same limits as a tax-deferred 401(k), which are considerably higher than the limits for a Roth IRA. In 2024, you can contribute up to $23,000 pre-tax to your 401(k), with a catch-up contribution of $7,500 pre-tax if you're over 50 (versus $7,000 and $1,000, respectively, for a Roth IRA). If you begin withdrawals, either due to leaving your company or if your plan allows in-service withdrawals, the portion of the withdrawals from contributions will be tax and penalty-free; however, any portion of the withdrawals from earnings may be subject to taxes and penalties if withdrawn before age 59½ unless rolled into another Roth 401(k) or Roth IRA.

To figure out if a Roth 401(k) may make sense for you, consider these pros and cons:

Roth 401(k) pros
Potentially tax-free growth

It can be complicated to quantify the value of potentially tax-free growth versus a current tax deferral if you don't know what your income will be in the future or what your tax rate will be.

"If you expect your marginal tax rate to be at least as high in retirement as it is currently—which would apply to many younger participants who anticipate growing incomes over time—the Roth option could work in your favor over the long term," says Andrew Bachman, director of financial solutions at Fidelity. "This also sometimes applies to those who plan to move in retirement from a low-tax state to a high-tax state, say Texas to California."

It could also work out that the dollar amount difference in the taxes you'd pay by the time you get to retirement is very small, meaning the income tax you would pay per year on Roth 401(k) contributions could be roughly equal to what you'd pay eventually on qualified distributions after 59½. A distribution from a Roth 401(k) account will be “qualified” if it meets the following conditions:

1. The distribution is made after the participant's death, disability, or attainment of age 59 ½, and
2. The distribution is made after the five-year period beginning on January 1 of the first year that the participant made a Roth contribution into the plan.

Your age and your level of income will influence the bottom line.

Help with RMD concerns

Starting in 2024, RMDs are no longer required for Roth 401(k)s. While you still need to take RMDs from your tax-deferred 401(k) at age 73, this is no longer the case for Roth 401(k)s. The exception to this would be if you turned RMD age in 2023 and waited until 2024 to take your first RMD from your Roth 401(k). In that case, you would need to withdraw your first RMD from your Roth 401(k), but you would not need to do so thereafter.

High contribution limits with no income restrictions

As with 401(k)s, high earners are not restricted from contributing to Roth 401(k)s. This differs from Roth IRAs, which are limited to those with modified adjusted gross incomes (MAGIs) under $161,000 if single and $240,000 if married and filing jointly.

You can also make higher contributions to a Roth 401(k). In 2024, you can put up to $23,000 into a Roth 401(k), with an additional $7,500 catch-up contribution if you're age 50 or older. This is compared to a Roth IRA, which limits contributions to $7,000 if you're under age 50, with a $1,000 catch-up contribution available to those 50 and above.

With a Roth 401(k), you can mix and match deferrals and make some pre-tax contributions and some post-tax contributions. You can also adjust throughout the year according to your needs and your plan specifications.

Roth 401(k) cons
No tax deferral now

The list of cons may be short for Roth 401(k)s, but missing tax deferral is a big one. When faced with a choice of paying more tax now or later, most people choose to pay later, hence the low participation rates for Roth 401(k)s.

Encouraging people to save for retirement is important, and tax deferral has always been a key driver of savings. The financial justification for this has been that historically, people typically had lower tax rates in retirement than during their working years, and the math generally worked in their favor to have a lower adjusted gross income now and take taxable distributions in retirement.

There are a host of other reasons why a taxpayer might benefit from a lower adjusted gross income today, such as the calculation of child tax credits, financial aid for college, or federal aid.

Then there is the impact on take-home pay. There are many reasons why a person might simply want more cash in their paychecks today.

This hypothetical example is solely based on the assumed income tax withholding rate shown. No other payroll deductions are taken into account. Actual taxes and take-home pay will depend on your individual tax situation. Pre-tax contributions and any related earnings will be taxed at the time of withdrawal. Any earnings on after-tax Roth contributions are income tax-free if certain conditions are met.

Since contributions to a Roth 401(k) are with post-tax dollars, the impact gets magnified as salaries grow. But the relative impact to an individual can be very personal, as even a few dollars more in your paycheck can be consequential to your budget, especially when you're just starting out. Choosing more pay today might have other impacts on what you're able to save for and do now, while the rest of your life unfolds.

No matter which option you choose, your future tax rate may be different if your income changes or tax rates change. One big caveat is that the uncertain future can swing the math either way. You could take the tax deferral now thinking that you'll benefit in the future, but it could turn out the other way. "Some people expect to be in a lower tax bracket when they retire, but sometimes they have higher taxable income than they anticipated," says O'Connell.

The bottom line on Roth 401(k)s

Figuring out what's right for you might come down to more than just deciding if you can afford to pay the taxes now, and if so, if you want to. Remember, there's no right or wrong answer. You can consider all your options and see what works best for your situation. Also note that you can change your elections if you want to experiment or don't like how things are going, but the timing of the change will depend on the rules of your employer's retirement plan. If you have concerns, you may want to consult with a financial professional or tax advisor to see how your financial situation might be affected.