What is the difference between Traditional and Roth 401(k) contributions?
The key difference between Traditional and Roth 401(k) contributions is how they are taxed:
- Traditional 401(k): Contributions are made with pre-tax dollars, reducing employees’ taxable income in the year of contribution. Taxes are paid upon withdrawal in retirement.
- Roth 401(k): Contributions are made with after-tax dollars, meaning employees pay taxes upfront. Earnings and withdrawals are tax-free in retirement if the account has been open for at least five years and the employee is 59½ or older.
If an employee withdraws Roth 401(k) earnings before meeting these requirements, the earnings may be subject to income tax and a 10% early withdrawal penalty, unless an exception applies.
Are non-Roth after-tax contributions an option?
Non-Roth after-tax contributions are another way employees can save for retirement, but they work differently than Roth 401(k) contributions:
- Like Roth 401(k) contributions, they are made with after-tax dollars.
- Unlike Roth 401(k) contributions, their earnings are taxable upon withdrawal unless rolled over into a Roth account.
Betterment does not currently support non-Roth after-tax contributions, but some other retirement plans may offer this option.
Will participants have access to both Roth and Traditional 401(k) options?
Yes. All participants will have access to both a Roth and Traditional 401(k) as part of their plan at Betterment. This gives employees flexibility in how they choose to save for retirement based on their tax situation and financial goals.
What are the benefits of offering both Traditional and Roth 401(k) options?
Providing both options gives employees flexibility in retirement planning:
- Traditional 401(k) Pros: Lowers taxable income now, which may be beneficial for employees in higher tax brackets.
- Traditional 401(k) Cons: Withdrawals in retirement are taxed as ordinary income.
- Roth 401(k) Pros: Contributions grow tax-free, and withdrawals are tax-free if conditions are met.
- Roth 401(k) Cons: Contributions do not reduce taxable income in the year they are made.
Offering both options allows employees to choose based on their expected future tax situation.
How do employer contributions work for Traditional and Roth 401(k) accounts?
Employer contributions are always pre-tax, regardless of whether an employee contributes to a Traditional or Roth 401(k). This means:
- Employer matching or profit-sharing contributions go into a Traditional 401(k) account, even if the employee contributes to a Roth 401(k).
- Employees who contribute to a Roth 401(k) will have two account balances—one for their after-tax Roth contributions and one for pre-tax employer contributions, which will be taxed upon withdrawal.
How do payroll and tax reporting differ for Roth and Traditional 401(k) contributions?
Payroll systems must track and report Roth and Traditional 401(k) contributions separately:
- Traditional 401(k) contributions reduce an employee’s taxable income and do not appear in W-2 wages.
- Roth 401(k) contributions are made with after-tax income and are reported as taxable wages on the employee’s W-2.
Employers should work with their payroll provider to ensure proper tracking of pre-tax (Traditional 401(k)) contributions, after-tax Roth 401(k) contributions, and pre-tax employer contributions for compliance and accurate tax reporting.
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