The Benefits of Offering a Roth Option in Your Small Business 401(k) Plan

Author: Siân Killingsworth / 18 Apr 2023 / 401(k) Plan Information

As a small business owner, you have a lot of decisions to make when it comes to managing your company’s benefits package. While traditional 401(k) plans with pre-tax contributions are popular, adding a Roth 401(k) option can be beneficial for you and your employees.

What is a 401(k) with Roth?

Simply put, it is an employer-sponsored 401(k) retirement plan with a Roth option. However, unlike a traditional 401(k), contributions to a Roth are made with after-tax dollars. This means that employees do not get a tax deduction for their contributions, but they also don’t have to pay taxes on their withdrawals after age 59½.

 

 

 

Advantages of a Roth 401(k) for Employers

Attract and Retain Employees. Offering a Roth 401(k) option can be an attractive benefit for employees. Since Roth 401(k) contributions are made with after-tax dollars, employees can withdraw their contributions tax-free in retirement. This can be especially appealing to employees who expect to be in a higher tax bracket in retirement than they are currently.

Advantages of a Roth 401(k) for Employees

• Tax-Free Distributions. One of the biggest benefits of a Roth 401(k) is the ability to withdraw contributions tax-free in retirement. Since contributions are made with after-tax dollars, there is no tax owed on that money when it is withdrawn upon a qualified distributable event.
• Flexibility in Retirement. Another advantage of a Roth 401(k) is its retirement flexibility. Since contributions have already been taxed, employees can withdraw their contributions at any time after age 59 ½.
• No Required Minimum Distributions. Traditional 401(k) plans require employees to start taking required minimum distributions (RMDs) at age 72. This means that employees must withdraw a certain percentage of their retirement savings each year, whether they need the money or not. With a Roth 401(k), minimum distributions are not required. This allows employees to keep their savings invested for as long as they want, potentially allowing it to grow even more over time.
• High Contribution Limits. Roth 401(k) plans have the same contribution limits as traditional 401(k) plans, which means that employees can contribute significantly more than with an IRA or other type of plan. As of 2023, the individual contribution limit for a traditional or Roth 401(k) is $22,500, plus an additional $7,500 if you’re age 50 or older.

Drawbacks of a Roth 401(k)

While there are many advantages to a Roth 401(k), there are also a drawback to consider:

• Taxes on Contributions. With a Roth IRA, you have to pay taxes on contributions. This means there is no possible reduction of taxable income, and it may be more difficult to reach the contribution limit. Plus, you still have to pay taxes on any interest.

The pros and cons of a Roth option are going to affect some people more than others, which is why it’s important to offer a choice. You can learn more about Roth 401(k) plans here.

 

IRS source: https://www.irs.gov/pub/irs-access/p4530_accessible.pdf