Making a case for Roth 401(k) accounts in your retirement

You might think you’re set for retirement because you’ve ridden this bull market to new highs and now sport a seven-figure 401(k) balance.

The number on your screen might look impressive, but if your savings is in a traditional 401(k) account, the cold, hard reality is: Federal and state income taxes are going to claim a substantial share — often a painful amount — before you can enjoy it in retirement.

Whether your nest egg is six figures or seven, the tax man is waiting to collect. Years of disciplined saving might feel rewarding, yet the final take‑home might leave you wanting.

But there is a way to avoid this disappointment. Roth 401(k) accounts, available since 2006, offer relief by letting you save through payroll deduction, invest broadly and withdraw all contributions and accumulated earnings entirely tax‑free.

The Roth solution comes with a cost. You can place only after‑tax dollars into a Roth account, which means to benefit from a Roth’s tax‑free compounding, you cannot deduct your contributions from taxable income. For those under 40 who are able to practice some delayed gratification, the advantage of avoiding taxes on all future accumulated earnings typically substantially outweighs the immediate tax savings of deducting contributions.

For those older than 40, the Roth decision demands sharper analysis. At this point, you have fewer years for compounding to work its magic. Yet you’re also in your peak earning years, when every tax deduction is most valuable. The irony is that for most, decades of employer contributions have already stuffed your 401(k) account with pre-tax dollars, leaving you with a sizable — and growing — tax bill waiting in retirement. Shifting some savings into a Roth now creates crucial tax diversification and gives you real control of how much income you expose to taxation later.

For those nearing, or already in, retirement, the Roth 401(k) account offers some real advantages. If you’re looking to maximize the amount you’re stashing away in your final working years, Roth contributions are worth more because there is no tax when withdrawn in retirement. Even better, you don’t have to withdraw Roth 401(k) assets because of RMDs (Required Minimum Distributions) that start at age 73. You’re also able to pass Roth assets to heirs entirely free from income tax. And unlike distributions from a traditional pre-tax 401(k) account, Roth distributions don’t count when calculating income to determine the taxability of your Social Security benefits.

A backdoor Roth is a strategy that involves contributing money to an after‑tax account in your employer’s 401(k), if available, and lets you save a substantial amount more than the current $23,500 limit. Current tax law allows you to convert these dollars into Roth. Since the contributions are already after‑tax, converting them to Roth does not create a tax bill, and the funds can then compound tax‑free forever. Check with your employer to confirm whether your plan allows after-tax contributions. This strategy is particularly effective for high earners seeking to maximize retirement savings.

Recent legislation affecting 401(k) plans now allows employers to give workers the option to receive their company matching and profit‑sharing contributions directly into their Roth accounts. At present, few employers have implemented this feature, waiting for the 401(k) record-keeping industry to support it. Historically, company contributions have always gone into pre‑tax accounts and were not reported as taxable income. If you choose to direct future company contributions into your Roth account, however, those amounts will count as part of your taxable income for that year. For the reasons outlined in this article, this approach could make sense for many long‑term retirement savers.

No matter the size of your retirement nest egg, the message is the same: What you see in your account isn’t fully yours if it resides in a traditional 401(k). That’s why Roth accounts are attracting so much attention. Tax‑free accumulation of wealth, freedom from RMDs, the ability to pass assets on tax‑free and even access to contributions during your working years all put more control in your hands.

Once in retirement, it’s not how much you’ve saved that matters, it’s how much you can actually spend. For many savers, that’s where a Roth can truly change the game.