Help employees understand the pros & cons of Roth options

November 22, 2023

employees at a table

The differences between a traditional 401(k) and a Roth 401(k) are considered common knowledge among financial professionals and plan sponsors. But for the average employee who participates in a defined contribution plan, it’s not always cut and dried.

Educating employees about the differences between them is more important than ever in light of recent SECURE 2.0 provisions. The legislation expands Roth savings options within defined contribution plans, allowing employees more flexibility when planning their retirement strategy. The inclusion of a Roth savings vehicle may also help supercharge the powers of your retirement benefit offerings.

SECURE 2.0 updates for Roth contributions

A major change brought about by SECURE 2.0 is the option for employers to offer matching pre-tax contributions on a Roth basis in their 401(k), 403(b), and governmental 457(b) plans.1 Additionally, employees over age 50 who earn more than $145,000 annually will solely be limited to making catch-up contributions on a Roth basis beginning in 2026.1

These changes will require nearly all defined contribution plans to offer a Roth feature to all participants. Now is a great time for plan sponsors and financial professionals to engage employees in conversations about their retirement plan options so they feel more confident about where to direct their funds.

What employees need know about a Roth 401(k)

With the expansion of choices resulting from SECURE 2.0, employees can make traditional pre-tax contributions, after-tax Roth contributions or a combination of both. By combining the two, they have the flexibility to decide which account they want to contribute to and draw from based on their taxable situation. 

Employees who choose a Roth 401(k) as their investment vehicle can expect the following:

  • Income taxes on contributions are paid up front2
  • Taxes on current earnings are not collected as a Roth account grows2
  • Roth account earnings may be distributed tax-free if the account was held for a minimum of five years and the employee is at least 59½2 

And younger employees may benefit from paying taxes now rather than several years later when their income is more likely to be taxed at a higher rate. Likewise, the tax-free earnings of a Roth may be beneficial to those who anticipate being in a higher tax bracket after they retire.

By contrast, traditional 401(k) plans are funded with contributions that haven’t yet been taxed. Instead, taxes are paid on contributions once they’re withdrawn at retirement, and any earnings are also taxable.2 For those who anticipate being in a lower tax bracket once they retire, the tax break on the front end might be more beneficial.

Next steps for plan sponsors

If your payroll has higher earners, you’ll likely need to add a Roth option. Even if you’re not required to offer one, it can be a good idea to help participants potentially save more for retirement and take advantage of tax benefits.

Once your Roth plan is implemented, educate employees by offering informational meetings and/or webinars. Also consider providing educational resources via your employee newsletter, email, or intranet. And check back soon for more insights related to SECURE 2.0.

1, SECURE 2.0 Act of 2022, Dec. 19, 2022
2, Roth 401(k), Roth IRA, and Pre-tax 401(k) Retirement Accounts, Sept. 21, 2023