There’s no question that contributing to a 401(k) or similar employer-provided plan is one of the most effective ways to ensure you’ll enjoy a comfortable retirement. But there’s a downside to traditional 401(k) plans, especially if you fall into the millionaire category: All of that money will be taxed when you take it out—possibly at a higher tax rate than you’re paying now.
One way around this dilemma is to direct some of your savings to a Roth 401(k). As is the case with a Roth IRA, contributions to a Roth 401(k) are after-tax, but withdrawals will be tax-free as long as you’re 59½ and have owned the Roth for at least five years. And unlike with a Roth IRA, there are no income limits on contributions to a Roth 401(k) plan.
By 2026, some workers may be required to contribute to a Roth 401(k), whether they like it or not. The legislation known as SECURE Act 2.0 will require workers age 50 and older who earned $145,000 or more in the previous year to funnel catch-up contributions to a Roth 401(k) plan. The change was set to take effect in January 2024, but the IRS recently postponed implementation of the rule until 2026.
The IRS move came after major employers and plan providers—particularly those who don’t yet offer a Roth 401(k)—said they needed more time to implement the provision. Plan providers “can’t just cut and paste a new plan when they’re not even sure of the rules,” says Ed Slott, founder of IRAhelp.com.
Even with the delay, employees who have access to a Roth 401(k) should consider contributing to it, especially those who have accumulated a large balance in a traditional 401(k). Although you’ll lose the up-front tax break you get with a traditional 401(k), that deduction is “really a loan that will have to be paid back in the future,” Slott says.
Many high earners resist contributing to a Roth 401(k) because they assume their tax rate will be lower in retirement, when they’ll eventually be required to take taxable required minimum distributions. But that’s not a safe bet, especially if you’re a serious saver, Slott says. The funds you invest in a tax-deferred account will continue to compound and grow until you’re required to take required minimum distributions (RMDs) (currently at age 73, increasing to age 75 in 2033). Depending on the size of your account, those RMDs may be larger than your pay was during your final year of work, he says.
And with a traditional 401(k), you’ll have to take taxable RMDs for the rest of your life; starting in 2024, though, you won’t have to take RMDs from your Roth 401(k). In addition, Slott says, many retirees lose other tax breaks, such as tax credits for dependent children and deductions for mortgage interest. The loss of those tax breaks, combined with substantial RMDs, could easily push you into a higher tax bracket in retirement, he says.
Large RMDs could also trigger taxes on your Social Security benefits and triggering a surcharge on your Medicare Part B and Part D premiums.
Sheltering some of your retirement savings in an after-tax account can help avoid that, and it will protect you from future tax increases, Slott notes.
