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Robert Bloink and William H. Byrnes

Retirement Planning > Spending in Retirement > Required Minimum Distributions

This Overlooked Secure Act Change Makes Roth 401(k)s More Attractive

By Robert Bloink By William H. Byrnes

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What You Need to Know

  • The Secure Act made many important changes that benefit retirement investors, adding flexibility with after-tax savings strategies.
  • Legislation has removed the lifetime required minimum distributions for Roth 401(k)s, treating them like Roth IRAs.
  • Clients looking to minimize their post-retirement RMDs may wish to consider a Roth 401(k) conversion strategy.

The Secure Act made many important changes that benefit retirement investors. One often-overlooked change enhances the appeal of Roth 401(k)s — which are themselves a retirement planning vehicle that are often overlooked in favor of Roth IRAs. 

Historically, the primary advantage of a Roth IRA as opposed to a Roth 401(k) was the ability to allow Roth IRA funds to continue growing tax-free even after the client became subject to the required minimum distribution rules. Now that the Secure Act has removed the lifetime RMD requirements for Roth 401(k)s starting in 2024, clients may want to take a closer look to determine whether a Roth 401(k) fits within their planning needs.

Roth 401(k)s: Basics and Background

Roth 401(k)s are very similar to Roth IRAs. They’re funded with after-tax dollars, and distributions are tax-free to the client during retirement.

There are, however, some key differences. Roth 401(k)s have higher annual contribution limits. They’re subject to the same limits that apply to traditional 401(k)s: $22,500 per employee in 2023 ($30,000 for those 50 and older) and $66,000 for combined employer-employee contributions. Direct Roth IRA contributions are limited to $6,500 in 2023 ($7,500 for those 50 and older).

Roth IRAs also come with an income limit. Taxpayers who exceed annual thresholds cannot contribute directly, although they are permitted to use a conversion strategy to convert traditional IRA dollars to a Roth. Roth 401(k)s do not have an income limit, so even high-earning taxpayers can contribute directly.

A 10% penalty will apply to Roth 401(k) withdrawals before age 59.5 unless an exception applies. After five years pass, investors can access Roth IRA contributions without penalty even before age 59.5.

Roth 401(k) contributions can be taken directly from the employee’s paycheck, just like traditional 401(k) contributions. One key advantage is the ability of the employer to make matching contributions based on the employee’s contribution to the Roth 401(k).

Secure Act Changes

The Secure Act eliminated one important difference between Roth IRAs and Roth 401(k)s. Before the legislation, taxpayers who invested in Roth 401(k)s were subject to the required minimum distribution rules. Once they reached their beginning date (currently, age 73), they were required to take distributions even if they didn’t need the money.

Beginning in 2024, the Secure Act has eliminated the RMD rules as they applied to Roth 401(k)s (first-time RMDs that were due for 2023 must still be taken by April 1). Like Roth IRA investors, Roth 401(k) investors can allow their Roth funds to continue growing tax-free for as long as they like.

Considerations for Roth 401(k) Conversions

The Secure Act changes give investors new flexibility when assessing their after-tax savings strategies. Clients looking to minimize their post-retirement RMDs may wish to consider a Roth 401(k) conversion strategy, where traditional 401(k) funds are converted to a Roth 401(k) within the plan. Clients who wish to leave a tax-free legacy may also be interested in increasing the value of their Roth 401(k)s sooner rather than later.

As with Roth IRA conversions, however, plan participants should remember that they will owe taxes on the amounts converted in the year of conversion. The conversion strategy will be most valuable for clients who have non-retirement funds available to cover the tax bill.

Like Roth IRAs, Roth 401(k)s are inherited tax-free. Because most non-eligible designated beneficiaries will be required to empty an inherited 401(k) within 10 years of the original account owner’s death, that can create significant tax liability for the beneficiaries. While Roth 401(k)s do have to be emptied within the same time period, the beneficiary doesn’t pay taxes on the funds because the account was originally funded with after-tax dollars.

Conclusion

Roth 401(k)s have now become a much more attractive planning vehicle for clients looking to diversify their retirement accounts. Removal of the RMD rules for 2024 and beyond should encourage retirement investors to take a closer look at this often-overlooked planning option to see whether a Roth 401(k) fits within their retirement investing strategy.

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Robert Bloink

William H. Byrnes

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