Your employer's plan offers an alternative to pre-tax contributions for your retirement account: Roth after-tax contributions. Roth contributions give you a way to get tax-free income in retirement.

How do Roth contributions work?

If you've reached age 59½ and it's been at least five years since you made your first Roth contribution, your Roth contributions and any earnings they produce can be withdrawn tax-free.*

*Subject to plan rules. All references to taxes are federal taxes only. State tax laws vary.

That could be a significant advantage over pre-tax contributions. Withdrawals of pre-tax contributions are currently taxed at 10% to 39.6%, depending on your federal income tax bracket.

What's the catch?

Sound too good to be true? It's not. That's because you make Roth contributions with after-tax dollars. So you'll pay more in taxes today if you make Roth contributions. But that could be a price worth paying if it means more money in retirement.

Here's an example: Sophia and Fred each contribute $3,600 a year to a retirement plan, and they both earn 6% annually on their investments. But Sophia makes pre-tax contributions while Fred makes Roth contributions. (That means Fred's contributions are taxed as regular income before being added to his account.)

After 30 years, each has $284,609 for retirement. However, Sophia will owe taxes on her withdrawals, while Fred's will be tax-free.**


This hypothetical illustration does not represent any particular investment. All investing is subject to risk, including possible loss of principal.

**The amount of taxes Sophia owes will depend on the tax rate at the time of the distribution and the amount withdrawn. Fred pays $16,200 in taxes on contributions over 30 years, assuming a 15% tax bracket. All tax references apply to federal taxes only. Individual state tax laws vary.

Pay taxes today? Or later?

So should you pay taxes today by making Roth contributions to your plan? Or should you stick with pre-tax contributions, where you postpone paying taxes today but owe them in retirement? As always, it depends.

  • If you think your marginal tax rate will be lower in retirement, you may want to stick with pre-tax contributions. That way you'll postpone paying taxes until you may be in a lower tax bracket.
  • If you think your marginal tax rate will be the same or higher in retirement, you may want to make Roth contributions. That way you'll pay taxes at the current rate.

Of course, you don't have a crystal ball to tell you what your marginal tax rate will be in retirement. It depends on so many things—your income, family status, retirement benefits, even government tax policy.

Consider tax diversification

What can you do in the face of this uncertainty? Consider doing what you already do when dealing with investment uncertainty: diversify. Consider holding both pre-tax and after-tax savings in your retirement account. That's known as tax diversification.

But before you make any decision about Roth contributions, consider consulting a professional tax advisor about your situation.

Are Roth contributions right for you?

There are certain situations in which it can be an especially good idea to make Roth after-tax contributions to your plan and others in which it makes less sense.

Is Roth right for me?

Who might benefit Why
You're financially well-fixed for retirement, with substantial savings and good benefits.

Chances are you'll be in the same or a higher tax bracket in retirement. Roth savings would be exempt from taxation.

You contribute the maximum to your plan.*

Switching to Roth contributions increases your tax-advantaged saving. For example, if you contribute $18,000 on a pre-tax basis, you'll owe taxes on this amount, and any earnings, in retirement. Contribute $18,000 on a Roth basis instead, and all of it will be tax-free in retirement.

Your income prevents you from contributing to a Roth IRA.**

You can obtain the advantages of a Roth IRA within your retirement plan, which has no income restrictions comparable to those of the Roth IRA.

You don't earn a lot today—but just wait.

Your career is just getting started. You expect your income—and tax rate—to rise in the years to come.

You pay taxes at a low rate today (10% or 15%). Making Roth contributions would cost you less today and could result in tax savings in retirement.

Who might not benefit from Roth contributions?

Who might not benefit Why

You're behind on saving and expect Social Security to be the mainstay of your retirement.

Chances are your income will fall in retirement. Consequently, you'll be in a lower tax bracket.
Your pay spikes, thanks to big commissions or bonuses.

Your marginal tax rate may be higher now than in retirement. So you may be better off deferring taxes now with pre-tax contributions and paying at a lower rate later.

You have children, a family income generally between $20,000 and $50,000, and receive the earned income tax credit or the additional child tax credit.

Switching to Roth contributions would raise your taxable income and could cost you these valuable tax credits. These credits are more valuable than the Roth option would be to you.

*The maximum employer retirement plan contribution is $18,000 annually in 2016, or $24,000 if you're age 50 or older and your plan allows catch-up contributions. Any future increase will be indexed for inflation.

**To contribute to a Roth IRA in 2016, your modified adjusted gross income must be less than $194,000 for married taxpayers filing jointly or $132,000 for single filers.

The cost of Roth contributions

You can designate all, some, or none of your contributions as Roth after-tax contributions.

If you already make pre-tax contributions to your plan, it's important to remember that your take-home pay will decrease if you switch any portion of your contributions to Roth. That's because more of your income will be subject to taxes today.

Here's an example: John is in the 15% tax bracket and saves $3,000 a year in his plan through pre-tax contributions. If he were to switch to Roth contributions, he would pay $450 more in taxes annually ($3,000 x 0.15 = $450). John is paid every other week, so each paycheck would be reduced by $17.31 ($450 ÷ 26 = $17.31).*

*All references to taxes are federal taxes only. State tax laws vary.

You could reduce your contribution rate to reduce your tax bill, of course. But it may be best to avoid that strategy, especially if it means that you might forfeit employer matching contributions.

The effect on your take-home pay

For an idea of how Roth contributions could change your take-home pay, look at the table below. Find the figure closest to your total household income and contribution percentage. The dollar figure at the intersection of the two factors is the reduction in pay that you might experience on a biweekly basis (26 pay periods per year).

The cost of switching to Roth in your employer's plan
Total household income Contribution
3% 6% 9% 12% 15%
$25,000 $3 $6 $9 $12 $14
$50,000 $9 $17 $26 $35 $43
$75,000 $13 $26 $39 $52 $65
$100,000 $29 $58 $87 $115 $144

Estimates are rounded to the nearest whole dollar and are based on the IRS’s Percentage Method Income Tax Withholding with two exemption allowances. Your withholding could also be affected by any other pre-tax deductions you have, such as those for health benefits.

An important note about costs

Switching to Roth contributions increases your taxable income. This could reduce your eligibility for various tax credits and deductions, such as those for children and day care expenses.

Before you switch to Roth contributions, it pays to check your tax return or ask your tax preparer to see which deductions or credits might be lowered or eliminated. Most of these credits and deductions (except for the earned income tax credit or the additional child tax credit) phase out gradually. That said, the impact could be large or small depending on your situation.

Questions and answers about Roth contributions

What are Roth contributions?

Roth contributions are a way to save for retirement through an employer's retirement plan (or an IRA) using after-tax dollars. They are available to you in your retirement plan if your plan has adopted them.

You get no current-year tax deduction for your Roth contributions. However, you can withdraw your contributions and any earnings tax-free if you meet certain conditions.*

*All references to taxes are federal taxes only. State tax laws vary.

What are the conditions for tax-free withdrawals?

In general, for a withdrawal of Roth contributions and any earnings to be tax- and penalty-free, the first Roth contributions to your account must have been made at least five years before the withdrawal. Additionally, the withdrawal must be made at or after age 59½ or be as a result of permanent disability or death. If you die, your beneficiary will be entitled to tax-free withdrawals if the account has been held at least five years from the time you first made a Roth contribution.

Withdrawals are also subject to the conditions specified by your employer's plan. For example, many plans don't allow withdrawals by participants who are still eligible to contribute to the plan.

When does the five-year period begin?

It begins on January 1 of the year you make your first Roth contribution, which can be made at any time during a calendar year. Even if you contribute in December, you'll receive a year's credit. Also, you don't have to make a contribution every year. Your first contribution “starts the clock.”

What if a withdrawal doesn't meet these conditions?

Withdrawals that do not meet these conditions are considered “nonqualified withdrawals.” Nonqualified withdrawals are treated as a prorated return of Roth contributions and earnings. The portion of the distribution that represents earnings will be subject to ordinary income tax and possibly a 10% federal penalty tax for premature distributions. However, the portion of the withdrawal that represents a return of Roth contributions would not be taxed.

Are Roth contributions subject to IRA contribution limits?

No. In 2016 you can make Roth contributions of up to $18,000, plus an additional $6,000 if you’re age 50 or older at any time during the year and your plan permits these catch-up contributions. (Plan rules apply; your plan may have a lower limit.)

Note that your annual limit applies to your total combined Roth and pre-tax contributions.

If I make Roth contributions, can I still contribute to a Roth IRA?

Yes, as long as you meet the income limits for a Roth IRA. To contribute to a Roth IRA for tax year 2016, your modified adjusted gross income must be less than $194,000 for married taxpayers filing jointly or $132,000 for single filers.

Be aware that switching to Roth contributions may push you above the qualifying limits for a Roth IRA.

Will my employer match my Roth contributions?

Your employer may match your Roth contributions. However, the match would be on a pre-tax basis, not a Roth after-tax basis. This means you would owe income taxes on the matching funds and their earnings at withdrawal. If you withdraw them prematurely (generally before age 59½), you might owe an additional 10% federal penalty tax on the match and its earnings.

Can I convert my pre-tax balance to Roth?

Potentially. You can convert all or a portion of your pre-tax savings to a Roth account within the plan, as long as your plan allows.

Alternatively, money in your employer-sponsored plan can be converted to a Roth IRA if you have access to your savings through a "distributable event." Generally, a distributable event means you have access to your retirement plan assets, either because you have left the service of your employer or because your plan allows certain types of in-service withdrawals. These can include withdrawals available to active employees age 59½ or older and withdrawals of after-tax, rollover, or profit-sharing money from the plan.

Be aware that pre-tax money converted to Roth money, either in a Roth IRA or within your plan, will be taxed at ordinary income tax rates. We recommend that you consult a tax advisor about whether converting pre-tax assets to Roth may be right for you.

Do I have to take required minimum distributions (RMDs) from my Roth savings?

Yes, you have to take RMDs after age 70½ unless you are still employed at the company in whose plan you have your retirement savings. But you can avoid them by rolling your Roth money to a Roth IRA after you have left your employer-sponsored plan.

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