The Roth Contribution Option...Another Way to Prepare for a Secure Retirement
Financial experts often advise that those who are doing long-term financial planning should consider the income tax bracket they may be in during retirement. That’s why many employer-sponsored retirement plans now offer another way to help individuals save for a more secure retirement—a Roth contribution option. If your retirement plan offers this option, you may choose to make both Roth and traditional, before-tax contributions to your account.
How Do Roth Contributions Work?
When you choose to make Roth contributions, taxes are taken from your paycheck and then your Roth contributions are made to your retirement plan account. Roth contributions and any investment returns, like traditional contributions made to your retirement plan, grow tax deferred until retirement. But unlike before-tax contributions, Roth money can be withdrawn federal income tax free as long as you meet certain requirements. See “Tax-free Withdrawals of Your Roth Contributions” below for details.
Important Information About Roth Contributions
- You can make before-tax and Roth contributions (combined) of up to $16,500 (although certain restrictions may apply). If you’re age 50 or older by December 31, you can contribute an additional $5,500—for a total of $22,000 in before-tax and Roth contributions.
- Your Roth contributions are invested in your retirement plan account, as are any before-tax contributions you make. But your Roth money is tracked separately from your before-tax money, and will appear as a separate item on the participant website and on your retirement plan statements.
- A Roth contribution provides similar tax benefits as a Roth IRA—but Roth contribution limits under a retirement plan are generally higher than the Roth IRA limits.
- There are no income restrictions with the Roth contribution option. As long as you’re participating in your retirement plan, you’re eligible to make a Roth contribution if your plan offers this feature.
- If your employer currently matches your before-tax contributions, it’s possible that your Roth contributions will be matched using a similar formula—although any money your employer contributes to match your Roth contributions (and any investment earnings resulting from the employer match dollars) would be taxable when you withdraw it.
- Even if you choose the Roth contribution option, you may still be eligible to contribute to a Roth IRA—as long as you can satisfy the Roth IRA contribution rules.
- You may be able to convert your before-tax account balance to a Roth account if your employer's plan permits in-plan rollovers. Income tax is due in the year of the rollover and the entire before-tax amount is taxed at ordinary income tax rates. If you hold appreciated employer securities in a before-tax account, you may not benefit from an in-plan Roth rollover of those securities. You should discuss your situation with your tax advisor.
Roth or Before-tax Contributions?
Roth contributions are subject to federal income tax before the money is contributed to your account—unlike before-tax contributions, which are made to your account without federal income taxes being deducted. So you defer federal taxes on your before-tax contributions (and any investment earnings) to a later date—when you withdraw the funds.
The upside with Roth contributions is that your Roth withdrawals in retirement—including any earnings on your Roth contributions—are completely federal income tax free if you meet certain requirements.
When deciding whether you should make Roth contributions, before-tax contributions, or a combination of the two, here are some important considerations:
- If you feel your tax rate in retirement will be higher than it is today, Roth contributions may make sense for you.
- If you expect your tax rate to be lower in retirement than during your working years, you may benefit more from making before-tax contributions and paying taxes when you withdraw your money.
- You may choose to “diversify” your contributions by putting both before-tax and Roth (after-tax) money in your retirement account.
- If you will not be retiring in the near future, Roth contributions may make a good deal of sense, since your account has more time to potentially grow in value. This may make the tax advantages of Roth contributions even more important to you—although Roth dollars can benefit retirement savers of all ages.
Take a Contribution “Test-Drive”
To model your own contribution scenarios, visit our Roth Contributions Calculator. The calculator will compare the two different types of contributions—and help you determine which contribution type(s) may make the most sense for you. You may also wish to consult your accountant, tax advisor, or financial professional before making your contribution decisions. If you prefer, a Prudential Retirement Counselor can assist you. Simply call
1-877-PRU-2100 toll free, Monday through Friday, from 8 a.m. to 6 p.m., ET.
Tax-free Withdrawals of Your Roth Contributions
To qualify for federally tax-free withdrawals of your Roth contributions (and any related investment earnings), there are certain tax law requirements:
- Generally, you wait at least five years after January 1st of the year you make your first Roth contribution before taking a withdrawal; and
- Your withdrawals must begin after:
- You have reached age 59½ or older; or
- You have died; or
- You have become disabled.
If you take a Roth distribution and you have not met these qualifications, your accumulated Roth earnings will be taxed, and may be subject to an early distribution penalty—10% of the taxable amount you withdraw. In addition, you must meet your plan’s general requirements for withdrawals before you can take a distribution of any Roth dollars.
How Your Withdrawals Will Be Processed
When you withdraw money from your retirement plan account, if you have both before-tax and after-tax (Roth) money invested, each withdrawal will be made from the before- and after-tax portions of your account on a pro rata basis. So, for example, at the time a withdrawal is made, if 60% of your account balance is made up of pre-tax money and 40% is Roth money, 60% of your distribution will come from the pre-tax portion of your account and the remaining 40% will be taken from your after-tax funds.
After the end of each tax year, your retirement provider will send you a tax statement indicating the dollar amount of your distributions that are considered to be taxable for that year.
Required Minimum Distributions
Required minimum distribution rules apply to Roth contributions you make to your retirement plan account. That means you generally must begin taking withdrawals (of both before-tax and Roth money) from your account by the April 1st following the year in which you reach age 70½ or retire, whichever is later—although your plan may require an earlier distribution. This is different than a Roth IRA, which has no lifetime minimum distribution requirements.
You Can Take It With You
If you leave your employer for any reason, you can take your Roth contributions with you. You may roll over your Roth money to another employer’s qualified retirement plan—but only if the new plan permits Roth rollovers. Your other option is to roll your Roth account over to a Roth IRA.
Remember, only you can choose the type of retirement plan contributions that are best for you. But whatever you decide, be sure to save as much as you can for as long as you can—to give yourself more financial security in retirement.
This is general information, and actual provisions will be determined by your retirement plan provisions.