New Legislation Now Allows For Roth Matching

The advantages of the after-tax Roth IRA and Roth 401(k) are well-established, but since Roth accounts first came into being in 1997, they’ve been off-limits to most investors saving in workplace retirement plans. Now, thanks to the recently signed Secure 2.0 Act, that limit is gone.

Before you get too excited, there’s one limitation – only the matching money contributed by the employer can go into a Roth account. The contributions made by the investor still go into a traditional pre-tax 401(k).

For more help with planning your own retirement, consider working with a financial advisor.

Roth Advantages

The biggest benefit of a Roth 401(k) account is that the contributions are made with after-tax dollars, unlike a traditional 401(k), which creates a tax deduction for the investor. When it comes time to withdraw money in retirement, Roth contributions come out tax-free, while money taken out of regular 401(k) plans faces a tax bite.

The primary advantage of the Roth account is that, over time, the compounded tax-free earnings in the account will produce more income in retirement than a taxable 401(k) account – even if the investor plowed the refunded tax money back into the traditional plan. The difference is that the Roth account holder pays taxes only on the contributions, not on the investment gains, while the traditional 401(k) investor is taxed on the contributions and gains. The younger the investor is, the better the Roth performs.

Take the example of a 30-year-old worker making $80,000 a year who contributes 5% of their salary to a 410(k), and receives a 30% employer match of $1,200 each year until he hits full retirement age at 67, for a total employer investment of $44,000.

Traditional 401(k) after-tax value: $193,685
Roth 401(k) after-tax value: $205,873

The result is that the Roth 401(k) total beats the traditional plan by more than 6%, generating an additional $12,188 when the money is withdrawn in retirement. The total return for the Roth account is 468% vs 440% for the traditional account.

(This example assumes a 7% annual rate of return, joint filing status, a 24% tax rate before retirement and a 22% tax rate after retirement.)

New Roth Matching Rules

There are just three caveats to the new option for Roth matching. The first is that it’s only an option; your employer needs to add the Roth election to the workplace plan. The second is that unlike a Roth IRA, where the IRS doesn’t mandate a required minimum distribution (RMD), the Roth 401(k) includes an RMD that goes into effect at age 73 this year (age 75 in 2033), although it won’t cost anything in taxes. The third point is that the Roth matching option counts only if the employer plan offers a matching contribution.

One advantage the Roth 401(k) has over the Roth IRA is that the contribution limit is much higher. While investors can contribute just $6,500 to a Roth IRA during 2023, plus $1,000 in catch-up contributions for anyone older than 50, the Roth 401(k) limit is $22,500, with up to $7,500 in catch-up contributions. And the matching contributions don’t count toward the investor’s annual limit.

The Bottom Line

The new SECURE 2.0 Act makes it easier to save with a Roth plan by allowing companies to offer tax-free plans to their workers. While there are several caveats worth considering, this still gives more options to potential retirement savers, which should allow some to plan for their later years more easily.

Retirement Planning Tips

A financial advisor can help you make sure everything is in line for your retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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