Roth 401(k) Explained: Tax Benefits and Contribution Limits

A Roth 401(k) is an employer-sponsored retirement plan that allows employees to contribute after-tax dollars. Withdrawals are completely tax-free, as long as you meet the age and account duration requirements. This differs from a traditional 401(k), where contributions are made with pre-tax dollars and taxes are paid when you start making withdrawals. Roth 401(k)s are very popular because they offer long-term tax advantages, giving savers more predictable income in retirement.

Understanding the Mechanics of Roth 401(k) Plans

Investors can save for retirement in various ways, with employer-sponsored plans like 401(k)s being common. Participation is voluntary, and those who enroll agree to automatic payroll deductions for a special retirement account. Some employers even match contributions to a certain limit.

There are several varieties of 401(k)s. The Roth 401(k) option became available at the beginning of 2006, while the traditional 401(k) has been around since 1978. Both were authorized by Congress as tax-advantaged retirement plans to encourage employees to save for their retirement.

Their tax advantages are different:

• A traditional 401(k) reduces the employee’s gross income for the year, giving them an instant tax break in addition to a retirement savings vehicle. The employee will owe regular income tax on every withdrawal made during retirement.
• The Roth 401(k) requires that the income tax be paid immediately, so the employee’s real net income is reduced by the amount earmarked for savings. But no further taxes will be owed on withdrawals of either the contributions or the profits earned over the years.

2025 Contribution Limits for Roth 401(k) Plans

Roth 401(k) contribution limits depend on the individual's age and adjust annually for inflation, as set by the IRS.

In 2025, individuals can contribute up to $23,500, with an extra $7,500 for those 50 and older. In 2024, the limit was $23,000. Unlike other plans, there is no income cap for participation.

Note that you cannot contribute more than your taxable income for the year.

Withdrawal Guidelines for Roth 401(k) Accounts

Withdrawals of any contributions and earnings are not taxed as long as the withdrawal is a qualified distribution, which means certain criteria must be met. This means that:

• The Roth 401(k) account must have been held for at least five years.
• The withdrawal must have occurred because of a disability, on or after the death of an account owner, or when an account holder reaches at least age 59½.

Starting in 2024, the IRS no longer requires RMDs from designated Roth accounts.

“[F]or 2024 and later years, RMDs are no longer required from designated Roth accounts. You must still take RMDs from designated Roth accounts for 2023, including those with a required beginning date of April 1, 2024.”

Keep in mind that individuals can withdraw more than the RMD. But there is a penalty if you miss an RMD or if your withdrawal is less than outlined during a calendar year. Previously 50% of the value of the missed withdrawal, this penalty is now 25% of the missed withdrawal’s value. You can reduce the amount of the penalty to 10% if you fix the mistake before the date that the penalty is imposed, which is known as the correction window.

Pros and Cons of Roth 401(k) Plans

Roth 401(k)s benefit employees now in a low tax bracket who expect a higher one in retirement. Contributions made to a Roth 401(k) are taxed at the lower tax rate. Distributions are tax free in retirement, making them the greatest single advantage. Regardless of account growth, money remains tax-exempt after the account holder retires.

The downside is a little more immediate financial pain. Because contributions to a traditional 401(k) are not taxed immediately (but effectively reduce the amount of your gross income), the impact on your take-home pay is reduced and your tax break for the year is maximized. But there’s no such deal with a Roth 401(k). This means that you are out of pocket for (and taxed on) the deposits you make in the year you make them.

Roth 401(k)s vs. Other Retirement Accounts

A Roth 401(k) is an employer-sponsored plan that helps people prepare for retirement. But it’s not the only option available to investors.

401(k) Plans

Like a Roth 401(k), the traditional 401(k) is employer-sponsored, meaning you can't set it up alone. Money is deducted from your paycheck and invested in mutual funds of your choice.

The IRS sets limits on how much you can contribute to the plan each year. This figure is adjusted annually for inflation.

• Employees below age 50 cannot contribute more than $23,500 in 2025. In 2024, it was $23,000.
• Those 50 and older can make a catch-up contribution of $7,500 in 2024 and 2025.
• Those age 60, 61, 62 and 63 can make a catch-up contribution of $11,250 in 2025.

Employers can also contribute to their employees’ plans, as long as the total contribution does not exceed the employee’s annual salary. The limit for employer and employee contributions together is capped at $70,000 in 2025, or $77,500 including the catch-up contribution. For 2024, those limits were $69,000 and $76,500, respectively.

This plan is a defined contribution plan, which means your contributions determine the account balance and how well your account performs. Contributions are made using pretax dollars, reducing the income tax you pay. Withdrawals made during retirement are subject to income tax.

Individual Retirement Accounts (IRAs)

If you don’t have the option to invest in an employer-sponsored plan, you may want to consider an individual retirement account (IRA). This kind of account can be set up by anyone through a financial institution or investment firm, which means anyone who has earned income is entitled to one.

You can invest in a variety of investments under an IRA, including stocks, bonds, exchange-traded funds (ETFs), mutual funds, and real estate investment trusts (REITs). Just like the 401(k), there are several types of IRA options available:

• Traditional IRA: Contributions made to a traditional IRA are tax deductible, thereby decreasing your taxable income. Withdrawals made during retirement are taxed at your normal income tax rate. For 2025, you can only contribute up to $7,000 if you’re under 50. In 2024, it was up to $7,000. You can make an additional $1,000 catch-up contribution if you are 50 or older in both 2024 and 2025.
  
• Roth IRA: Contributions made to a Roth IRA are made using after-tax dollars. This means you can’t use them to reduce your taxable income. The limits are the same as traditional IRAs. Any withdrawals you make during retirement are tax free. Roth IRAs don’t require you to take minimum distributions—or any at all. You can leave the money in your account if you choose to do so. You will be hit with a 10% early withdrawal penalty if you take money out before age 59½.

You can also choose a Simplified Employee Pension (SEP) IRA or a Savings Incentive Match Plan for Employees (SIMPLE) IRA if you’re self-employed or work for a small business.

403(b) Plans

These plans are just like the 401(k) but are sponsored by employers for individuals who work in schools and other tax-exempt organizations. This includes teachers, professors, clergy people, government employees, and librarians.

403(b)s come with regular payroll deductions, and potentially additional contributions by the employer.

These plans have the same contribution limits as 401(k) plans. You can contribute a maximum of $23,500 in 2025, and $23,000 in 2024. People 50 and older can make an additional contribution of $7,500 in 2024 and in 2025. If you are age 60, 61, 62, or 63, you can contribute an additional $11,250 instead of $7,500.

The Bottom Line

Roth 401(k) plans let employees invest for retirement using after-tax dollars, which means withdrawals in retirement are tax-free. A Roth 401(k) may be a good option if you expect to receive more income during retirement. And remember, Roth 401(k)s have no RMDs starting in 2024. This plan is particularly suitable for younger or lower-income earners seeking tax-free growth, offering long-term benefits despite the upfront tax cost.