Roth 401(k)

A designated Roth contribution under Section 402A is an elective deferral that the employee irrevocably designates as an after-tax contribution at the time of deferral — the designation cannot be changed after the contribution is made. The employer includes the designated Roth contribution in the employee's gross income for the year of contribution — unlike traditional pre-tax 401(k) deferrals, which reduce taxable income in the year of deferral. The contributed amount is reported on the employee's W-2 as taxable wages, and income tax is paid on the contribution in the current year.

The plan must maintain a separate accounting of designated Roth contributions, the earnings thereon, and any losses attributable to the designated Roth account — separate from the employee's pre-tax traditional 401(k) account and from any employer matching or nonelective contribution account. This separate accounting requirement exists so that the plan can track which distributions come from after-tax designated Roth funds — entitled to tax-free qualified distribution treatment — and which come from pre-tax funds — subject to ordinary income tax upon distribution.

Contributions — Limits and Mechanics

The contribution limit for designated Roth contributions is the same annual elective deferral limit that applies to all 401(k) plan elective deferrals under IRC Section 402(g) — twenty-three thousand dollars for 2024, with an additional seven thousand five hundred dollar catch-up contribution available to participants who are age fifty or older during the plan year. This combined limit applies to the participant's total elective deferrals across both the traditional pre-tax and designated Roth portions of their 401(k) — the participant may allocate any proportion of the total deferral limit between traditional pre-tax and designated Roth contributions, but the combined total cannot exceed the annual limit.

This combined limit structure means that a participant who maximises their designated Roth contributions at twenty-three thousand dollars has used their entire elective deferral limit and cannot make additional pre-tax traditional contributions in the same year. Conversely, a participant who defers twenty-three thousand dollars in traditional pre-tax contributions has no remaining capacity for designated Roth contributions that year.

The designated Roth account is not subject to the income-based phase-outs that limit Roth IRA contributions. For 2024, the ability to contribute to a Roth IRA phases out for single filers with modified adjusted gross income between one hundred and forty-six thousand and one hundred and sixty-one thousand dollars, and for married filing jointly filers between two hundred and thirty thousand and two hundred and forty thousand dollars. No such income limit applies to Roth 401(k) contributions — a participant earning five hundred thousand dollars or one million dollars annually may direct the full elective deferral limit into the designated Roth account, making the Roth 401(k) particularly valuable for high-income employees who are ineligible to contribute to a Roth IRA directly.

Employer Matching Contributions — The SECURE 2.0 Change

Traditional employer matching contributions — amounts the employer contributes based on the employee's deferral rate — were historically required to be made on a pre-tax basis to the traditional 401(k) account regardless of whether the employee's own deferrals were directed to the designated Roth account. This meant that even employees who directed all of their deferrals to the Roth account still accumulated a pre-tax traditional account balance from employer matching contributions.

The SECURE 2.0 Act of 2022 — enacted as Division T of Public Law 117-328 — created a new option allowing employers to permit employees to designate employer matching and nonelective contributions as Roth contributions, receiving them in the designated Roth account rather than the traditional pre-tax account. Under this SECURE 2.0 provision, employer Roth contributions are includible in the employee's gross income in the year made and are reported as taxable wages on the W-2. The provision requires that employer Roth contributions be fully vested at the time of designation — employers cannot offer Roth treatment for unvested matching contributions. While this provision was effective immediately upon enactment in December 2022, many plan administrators and recordkeeping systems had not yet implemented the required infrastructure as of 2024, limiting practical availability.

Qualified Distributions — The Five-Year Rule and Age Requirements

For a distribution from a designated Roth account to be a qualified distribution — received entirely free of federal income tax including all accumulated earnings — two conditions must both be satisfied simultaneously.

The five-year participation requirement must be met. The five-year period begins on the first day of the taxable year for which the participant first made designated Roth contributions to any 401(k) plan — not necessarily the current plan. Under Treasury Regulation 26 CFR Section 1.402A-1, if a participant rolls over designated Roth assets from one employer's plan to another employer's plan, the five-year period for the recipient plan is measured from the earlier of the first year of Roth contributions to either plan — preserving the participant's prior Roth seniority. If the participant rolls the designated Roth account into a Roth IRA, the Roth IRA's own five-year period governs — which may be more or less favourable depending on when the Roth IRA was first established.

The distributing event requirement must also be met. The participant must be at least age fifty-nine and a half at the time of distribution, or the distribution must be made on account of the participant's death and paid to a beneficiary or the estate, or the distribution must be on account of the participant becoming totally and permanently disabled.

Distributions that do not satisfy both conditions simultaneously — either because five years have not elapsed or because none of the qualifying distributing events has occurred — are non-qualified distributions. Non-qualified distributions from a designated Roth account are partially taxable — the pro-rata earnings portion is included in gross income and may be subject to the ten percent early withdrawal penalty under IRC Section 72(t) if the participant is under age fifty-nine and a half, while the return of after-tax contributions is always received tax-free since those amounts were already taxed in the year of contribution.

Required Minimum Distributions — The SECURE 2.0 Elimination

Prior to the SECURE 2.0 Act of 2022, designated Roth accounts in employer-sponsored plans were subject to required minimum distribution rules beginning at the applicable RMD starting age — unlike Roth IRAs, which have never been subject to lifetime RMDs. This disparity between Roth 401(k) and Roth IRA RMD treatment was widely criticised as administratively inconvenient and economically illogical, given that distributions from both account types are tax-free when qualified.

The SECURE 2.0 Act eliminated lifetime RMDs from designated Roth accounts in employer-sponsored plans effective for tax years beginning after December 31, 2023 — meaning that beginning in 2024, participants are no longer required to take minimum distributions from their Roth 401(k) accounts during their lifetime. This change aligns the Roth 401(k) with the Roth IRA for lifetime distribution purposes and removes the primary practical disadvantage of the Roth 401(k) relative to the Roth IRA — the former requirement to either take unwanted taxable distributions or roll the balance to a Roth IRA to avoid RMDs.

The Roth 401(k) Versus the Traditional 401(k) — The Tax Timing Decision

The choice between making traditional pre-tax and designated Roth contributions to a 401(k) plan is fundamentally a decision about the timing of income tax payment relative to the expected tax rates at contribution time versus distribution time.

Traditional pre-tax contributions reduce taxable income now — the deferral amount is excluded from gross income in the year of contribution, reducing current federal and state income taxes at the participant's current marginal rate. Tax is paid later, when distributions are received in retirement, at the then-applicable marginal rate. This structure benefits participants who expect to be in a lower marginal tax bracket in retirement than during their working years — they defer income tax from a high-rate year to a lower-rate year.

Designated Roth contributions provide no current deduction — the contribution amount is taxed now at the current marginal rate. But qualified distributions in retirement are entirely tax-free — no federal income tax on principal or earnings regardless of how much the account has grown. This structure benefits participants who expect to be in the same or higher marginal tax bracket in retirement than during their working years — they pay tax now at the lower current rate and avoid tax later at the higher future rate.

The decision also has an RMD planning dimension. Because Roth 401(k) accounts are now exempt from lifetime RMDs under SECURE 2.0, high-income participants who do not need distributions for living expenses can allow the Roth account to continue growing tax-free indefinitely — passing the accumulated tax-free balance to heirs who may stretch distributions over the applicable period under the post-SECURE Act beneficiary rules. This estate planning advantage, combined with the elimination of taxable RMD income that could otherwise push the participant into higher marginal brackets or trigger Medicare premium surcharges, makes the Roth 401(k) particularly compelling for high-income participants with strong financial capacity to fund current living expenses from other sources.

Rollovers From the Roth 401(k)

Upon leaving employment or retiring, participants may roll their designated Roth account balance to a Roth IRA without current tax consequence — the rollover is not a taxable event because the funds move from one Roth environment to another. Under Treasury Regulation 26 CFR Section 1.402A-1, the five-year period for determining whether distributions from the receiving Roth IRA are qualified is measured from the earlier of the first year of Roth 401(k) contributions or the first year the Roth IRA was established — if the participant already has an existing Roth IRA with a five-year history, that history transfers to the rollover analysis and the prior Roth seniority is preserved.

Participants may also roll designated Roth account balances to a new employer's 401(k) plan that accepts Roth rollovers, maintaining the employer plan environment rather than moving to an IRA — useful for participants who want to preserve the creditor protection advantages of ERISA plan assets, which are generally superior to the creditor protection afforded to IRA assets under state law.

Examination Relevance and Key Takeaways

The Roth 401(k) is tested on the Series 65 examination in the context of retirement planning, tax treatment of employer plan contributions and distributions, the five-year rule, the SECURE 2.0 Act changes, and the comparison between Roth and traditional pre-tax treatment.

The key points to retain are these.

A Roth 401(k) — designated Roth account — is established under IRC Section 402A and allows employees to make after-tax elective deferrals to a separate account within a 401(k) plan, with all future qualified distributions received entirely free of federal income tax. The contribution limit equals the standard annual elective deferral limit — twenty-three thousand dollars for 2024 with seven thousand five hundred dollar catch-up for age fifty and older — shared between traditional pre-tax and designated Roth contributions with no separate Roth 401(k) limit and no income-based phase-out restricting eligibility regardless of income level.

Qualified distributions require two simultaneous conditions: five taxable years of participation measured from the first year of designated Roth contributions to any plan, and a qualifying distributing event — age fifty-nine and a half, death, or total disability. Non-qualified distributions return after-tax contributions tax-free but include earnings in gross income with potential ten percent early withdrawal penalty under IRC Section 72(t). The SECURE 2.0 Act eliminated lifetime RMDs from designated Roth accounts effective for tax years beginning after December 31, 2023 — aligning the Roth 401(k) with the Roth IRA for lifetime distribution purposes. Employer matching contributions may now be directed to the designated Roth account under SECURE 2.0 if the plan permits and the contributions are fully vested, though implementation remains limited. Designated Roth account balances may be rolled to a Roth IRA or to a new employer's designated Roth account without current tax — the five-year period for the receiving account is measured from the earlier of the originating or receiving account's first Roth contribution year.