If you recognize the value of putting your money in a ROTH instead of a tax-deferred 401k plan, I have good news for you. Your employer can match your contributions straight into your ROTH 401k.
What’s the Difference?
401k plans are retirement plans with your employer. Sometimes they are 403b plans or 457b plans, but they all work the same. You set aside some of your salary for retirement. You do not pay income tax on that money now, but when you take it out. This lowers your overall income, and your taxes, right now.
Employers often ‘match’ or contribute money to your 401k. This money is also tax-deferred. You pay the tax when you take the money out.
However, there is another plan. Some employers have a ROTH 401k option. ROTH plans are reversed. You pay the taxes now, and you pay zero tax when you take it out. You also pay zero tax on the interest and growth. ROTH accounts give you long-term tax breaks instead of immediate ones.
How Does Matching Work?
What happens when employers match on a ROTH? How are the taxes paid on that money before it goes into the ROTH? It is supposed to be after-tax dollars, right? Wrong. Employer contributions are not part of payroll and not taxed when put in your account.
This is why up until recently, it wasn’t allowed. If an employer matched ROTH funds, it had to go in a tax-deferred account, giving you 2 or more retirement accounts with your employer. The ROTH funds you contributed were tax-paid, but any employer matches were tax-deferred and you had to pay the tax when you took out the money after retirement.
New Rule: ROTH Matches Allowed
Secure 2.0 section 604 now allows employers to match your ROTH contributions directly into your ROTH 401k. So, who pays the income tax on the contributions? You do. When your employer contributes to your ROTH retirement, the money is not taxed as payroll. It is not subject to social security, Medicare, or unemployment taxes. It IS subject to income tax. Since you are bypassing payroll, your employer cannot withhold the taxes. You will get a 1099R at the end of the year for the taxable employer contributions. In other words, you need to make payments during the year or you will owe at tax time.
If you want to have a tax-free retirement and avoid having multiple plans at work, ask your employer if they now offer a ROTH option with your retirement plan.