What is Roth 401(k) Matching, And How Does It Work?
Many employers offer retirement plans to help employees prepare for the future. One of these options is a Roth 401(k) plan, which allows employees to contribute after-tax dollars toward their retirement savings. According to recent 2021 data, 95% of employers offered some form of contribution to employees, either matching or non-matching. Of these employers, around 85% provided a 401(k) match, while approximately 10% offered non-matching 401(k) contributions to their employees. An employer match can help employees maximize their retirement savings. Whether you are just starting your career or are nearing retirement age, understanding Roth 401(k) matching can help you make more informed decisions about your financial future.A financial advisor can help you understand the intricacies of the Roth 401(k) match. This article also explores a Roth 401(k) account, how it works, the employer match and its potential benefits, and how you can maximize the benefits of such a plan.
What is a Roth 401(k)?
A Roth 401(k) is often seen as a combination of a traditional 401(k) and a Roth Individual Retirement Account (IRA). The primary difference between a traditional and Roth 401(k) is how they are taxed. With a traditional 401(k), contributions are made pre-tax, which means they are deducted from your income before you pay any tax on it. This reduces your taxable income in the year you contribute. However, you will have to pay income tax on the funds when you withdraw them in retirement.
With a Roth 401(k), contributions are made after tax, which means you do not get a tax deduction for your contributions. However, when you withdraw the money in retirement, the withdrawals are tax-free, including any earnings on your contributions. A Roth 401(k) can primarily be suitable if you expect to be in a higher tax bracket in retirement.
Like a traditional 401(k), a Roth 401(k) can also offer an employer match.
How does 401(k) matching work, and do employers match Roth 401(k)s?
A Roth 401(k) match is one of the best features of a 401(k) plan. The match is offered by the employer over and above the employee contribution and is essentially extra money that is paid to you. It helps you reach your retirement goals sooner and speeds up the process of accumulating wealth, offering you more peace of mind.
A 401(k) matching can be offered to employees in different ways, such as matching a percentage of the employee contributions up to a specific limit of their gross salary or matching up to a limit irrespective of the employee’s contribution. Employers can choose from these options based on their preferences and needs. There is no hard and fast rule about how an employer offers the Roth 401(k) match. In fact, some companies may choose not to offer any match at all.
Here are two common types of 401(k) matching examples:
1. Partial Roth 401(k) matching
The employer may agree to contribute a percentage to your Roth 401(k) account in a partial match. This percentage is fixed based on your salary as well as your contribution. In most companies, employers offer a match of up to 6% of the employee’s income and up to 50% of their Roth 401(k) contribution.
For example, if you earn an annual income of $50,000, your employer may offer up to 50% of the 6% of your salary. In this case,
6% of your salary is $3,000
50% of $3,000 is $1,500.
2. Full Roth 401(k) matching
The second type of match is the dollar-for-dollar, 100%, or full match. In this case, the employer may contribute up to your total contribution limit. However, this is decided as a percentage of your income. For instance, if you contribute up to 6% of your income, the employer will also contribute up to 6% of your income. But there is usually a limit to this. For instance, if the limit of the 100% match is 6%, the employer will only match your contribution up to 6%. If you contribute 3%, they will contribute 3%. But if you contribute 7%, they will not contribute more than 6%.
It is important to note that the total contribution for a Roth 401(k) cannot exceed the prescribed contribution limits set up by the Internal Revenue Service (IRS). As of 2023, you can contribute up to $22,500 if you are under the age of 50 and up to $30,000 with a catch-up contribution of $7,500 if you are 50 or older. The total limit for employee and employer contributions in 2023 is up to $66,000 or 100% of compensation, whichever is less, for those under the age of 50. People aged 50 or more can contribute up to $73,500 or 100% of compensation, whichever is less, with both employee and employer contributions.
Is 401(k) employer match taxable?
Another thing to know about the Roth 401(k) employer match is that the employer’s contribution is not added to the Roth 401(k) account. Instead, it is placed in a different pre-tax traditional 401(k), and it is not taxable. Only the employee’s contributions are placed in the Roth 401(k). This is primarily done because the employer match is taxable in retirement when you may make a withdrawal. This may complicate the process of taxation and contributions, which is why many companies may choose not to offer a Roth 401(k). However, several employers are offering the Roth version due to its tax benefits for investors, and you can easily find a job with a Roth 401(k).
It is essential for you to understand the tax consequences of the type of 401(k) you choose based on your retirement needs and tax concerns.
How to maximize the Roth 401(k) benefits of the employer match
Retirement savings can be daunting, but a workplace Roth 401(k) account can be an excellent tool to help build your nest egg. If you are fortunate enough to have access to a 401(k) through your employer, and your company offers a match, it is important for you to plan your contributions efficiently to further maximize your benefits. Here are some tips that can help:
1. Contribute up to the maximum limit to get a higher Roth 401(k) match
Firstly, taking full advantage of your employer’s 401(k) match is essential. Many companies offer a matching contribution to encourage employees to save for retirement. Typically, employers will match a percentage of your contribution up to a certain amount, as explained above. If you do not contribute enough to take advantage of the match, you will let go of the opportunity to earn free money that could significantly amplify your retirement savings. Therefore, assessing your retirement needs and contributing as much as possible is advised to get a higher employer match.
2. Start contributing to your Roth 401(k) from a young age to benefit from a long investment term
It is crucial to start contributing to your 401(k) immediately after starting your career. The earlier you begin, the more time your investments have to grow. Even if you can only contribute a small amount, the power of compounding makes a significant difference over time. Therefore, do not delay your contributions and aim to start using your 401k from your very first job.
3. Increase your Roth 401(k) contributions every year to speed up your retirement savings journey
It is vital to increase your contribution percentage regularly. Gradual increases each year can considerably impact your retirement savings over time without impacting your lifestyle. You can select a percentage increase based on your salary increments and other sources of income. A minimum of a 1% yearly increase can also be suitable as long as you do this consistently. It is also essential to contribute additional sources of income, like bonuses, towards your Roth 401(k).
4. Understand the vesting rules of your company to avoid confusion
Vesting refers to the period you must remain with the company before you take ownership of the total value of your employer’s contributions to your account. If you leave the company before the vesting period is up, you could lose some or all of the value of the matching contributions. For instance, consider a scenario where your company has a three-year vesting period, and your employer offers a 6% full Roth 401(k) employer match. In this case, even though your employer would match your contribution each year, you will not get this money until the vesting period ends. If you quit your job in two years, you will lose all your employer matches. Understanding the employer match concerning the vesting period can help you better plan your future contributions, career progression, and other aspects.
5. Ask for a Roth 401(k) employer matching the interview
Make sure to ask the company you interview whether or not they offer an employer match. Since not all companies offer a match, it is better to clear this in the first round of interviews. An employer match can be a considerable financial advantage. If you are in a position to negotiate, make sure you do so. You may negotiate the percentage of the match or between a partial and complete match.
Also, inquire about the company’s rules on employer contributions when the employee does not contribute to a 401(k). Some companies may offer a Roth 401(k) match even if the employee does not contribute. This usually happens if the company has seen high profits for the year. While it is advised for employees to always contribute, it can help to know whether or not your employer is willing to contribute, even if you do not.
6. Choose suitable investment options based on your financial goals
A Roth 401(k) can offer multiple types of investments, such as company stocks, target date funds, mutual funds, and others. Choosing the right investments that align with your risk appetite and financial goals is essential. The employer match is only a contribution. What matters is where it is invested to ensure it offers high returns that beat inflation. You can also consider hiring a financial advisor for this purpose. Financial advisors can help you select appropriate investment options, understand their risk and return ratio, select a suitable asset allocation, and more.
7. Roll over your Roth 401(k) when you switch jobs
Lastly, if you switch jobs, make sure you roll over your 401(k) into your new employer’s retirement plan or IRA. If the new employer offers a Roth 401(k) account, you can seamlessly roll over to it. If they provide a traditional 401(k), you may consider rolling over the funds to a Roth IRA. However, the IRA will not offer the same contributions. As of 2023, you can contribute $6,500 if you are under the age of 50 and $7,500 if you are 50 or older. This is considerably lower than the 401(k). A traditional 401(k) may be the ideal option if you wish to contribute more. However, you will have to pay taxes in retirement. Make sure to weigh all the pros and cons of your decision. Again, consulting a financial advisor may be advised if you are uncertain of your decision and need a professional’s perspective.
A workplace Roth 401(k) account can be a powerful tool to help build your retirement savings. Understanding how it works and how you can benefit from it is crucial. To maximize your benefits, it is essential to take full advantage of your employer’s match. Start by making regular contributions and consider goal-based investment options, negotiate a high match, increase your contribution percentage regularly, understand the vesting period, and roll over your 401(k) if you switch jobs. By following these tips, you can take control of your retirement savings and work towards a financially secure future. It can also help to hire a financial advisor to simplify the rules of the Roth 401(k) account and understand the plan’s tax consequences, contribution limits, and more.
WiserAdvisor’s free advisor match service can be used to find a suitable financial advisor near you who can assist you with your Roth 401k plan. All you have to do is answer a few simple questions based on your financial needs, and the match tool will help connect you with 1-3 advisors that are best suited to meet your financial requirements.