Changes to federal law governing retirement savings plans allow employers to make matching contributions to employees’ 401(k) accounts using after-tax dollars as with a Roth 401(k). Employees get to choose whether contributions will be made after-tax or pretax.
However, the decision to offer the option or to match employee contributions at all is up to the employer. If the employer offers the option and the employer chooses to receive matching contributions after-tax, taxes on the Roth employer contributions are due in the current year. We’ll go over the details.
Talk to a financial advisor about your retirement savings plan.
Roth 401(k) Basics
A Roth 401(k) is a qualified retirement plan that lets employees choose to defer salary. And instead of receiving the money when it’s earned, you can place it in a tax-advantaged retirement account. Employers can also choose to match employee contributions, which can significantly increase the size and growth of a retirement account.
Unlike regular 401(k) plans, in which employees contribute pre-tax, Roth 401(k) contributions are made after the employee pays income taxes on the contributed amount.
The benefit of this arrangement is that withdrawals of the contributions plus any investment earnings can be withdrawn tax-free after the employee reaches age 59.5 and the account is at least five years old. Withdrawals from regular 401(k) accounts are taxed as regular income when the employee takes money out of the plan.
Roth 401(k) Matching
Until recently, employer matching contributions to all 401(k) plans had to be made pre-tax. A new federal law called the Secure 2.0 Act, changes this requirement.
The Secure 2.0 Act allows employers to offer employees the ability to choose whether or not to receive employer-matching contributions as pre-tax or after-tax. Someone who works for an employer that offers the Roth matching contribution can, at their option, choose to receive matches as pre-tax or after-tax.
Unlike some of the provisions of the Secure 2.0 Act, the Roth employer matching option is effective immediately.
Employers can add the option to their 401(k) plans by making changes to the plan documents. Employees will then have the option to decide whether to take employer matches as Roth after-tax or regular 401(k) pre-tax contributions.
Roth Employer Matching Example
Employer matching can significantly increase the growth rate of an employee’s retirement savings account.
For instance, if a 35-year-old employee making $60,000 per year elects to defer 3% of their salary, this would result in the employee contributing $1,800 per year to retirement. After, 30 years, assuming an 8% growth rate and not accounting for any pay increases, this would result in a retirement savings account worth approximately $204,916.
With an employer matching contribution equal to 3%, this would put another $1,800 per year into the account. After 30 years, assuming an 8% annual investment return and not accounting for pay raises, this would roughly double the amount in the retirement account to approximately $408,826.
Making the Most of a Roth 401(k)
In order to get the best use of the new 401(k) account rules, employees can start by asking the administrator of their employer’s retirement plan whether it includes a pre-tax employer matching option. If the option exists, the employee can make the most out of it by deferring at least as much salary as the employer will match.
Roth retirement accounts are most effective when contributions and earnings are allowed to grow for a long period of time. Therefore, starting to save for retirement at a younger age is an important way to make the most of a 401(k) plan that allows Roth-style after-tax employer matching contributions.
Another way to maximize the benefits of a tax-advantaged retirement savings account is to increase contributions regularly. When salary deferrals are designated as a percentage of the employee’s salary, this will automatically increase contributions when the employee receives a pay hike. To save even more, employees can arrange to have 100% of any pay increases contributed to the retirement account.
Bottom Line
Changes to the laws affecting 401(k) plans now allows employers to offer employees the option to take employer-matching contributions to the plans on a pre-tax or after-tax basis, similar to a Roth 401(k). Employees will owe taxes on Roth matching contributions in the year they were made. Employer matching contributions are required to be 100% vested immediately.
Tips for Creating Your Retirement Plan
- A financial advisor can help you take care of your finances when you’re retired. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Are you self-employed? You won’t have access to a 401(k) but don’t let that be an excuse to put off retirement savings. You can still save by opening a SEP-IRA. A SEP-IRA is relatively easy to set up and has flexible rules on annual contributions.
- It can be a challenge to save for retirement if you don’t earn a lot of money. However, there are a few incentives to help individuals and couples with low or moderate income. One to take advantage of is the Saver’s Tax Credit. It allows eligible filers to receive a tax credit of up to 50% of their retirement savings.
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