Designated Roth Contributions in a Section 401(k) Plan

A designated Roth contribution is an after-tax contribution an employee makes to their 401(k) plan, allowing for potentially tax-free withdrawals in retirement, including investment earnings. The ability to make Roth contributions is an optional feature that employers must formally add to their plan. Unlike traditional pre-tax contributions, Roth contributions provide no upfront tax deduction.

This structure can be appealing for those who anticipate being in a higher tax bracket during retirement than in their current working years.

Contribution Rules and Mechanics

Designated Roth contributions are made on a post-tax basis, meaning they are included in an employee’s gross income for the year. This is the main distinction from traditional 401(k) contributions, which are made with pre-tax dollars and reduce a participant’s current taxable income. An employee makes this choice by irrevocably designating their elective deferrals as Roth contributions.

The annual contribution limit set by the Internal Revenue Service (IRS) applies to the combined total of both traditional and Roth 401(k) contributions. For 2025, this limit is $23,500. An employee cannot contribute the maximum to both a traditional and a Roth 401(k) in the same year, as the limit is shared between them.

In addition to the standard limit, participants age 50 and over can make catch-up contributions. For 2025, the catch-up limit is $7,500. Under a new provision, individuals aged 60 through 63 can make a higher catch-up contribution of $11,250.

A mechanical detail involves employer matching funds. Even if an employee makes contributions to a Roth 401(k), any matching contributions from the employer are always made on a pre-tax basis. These employer funds are deposited into a separate traditional 401(k) account for the employee. An employee who contributes to a Roth 401(k) and receives a company match will have both a Roth account and a traditional account.

Beginning in 2026, the SECURE 2.0 Act will mandate that catch-up contributions made by employees who earned more than $145,000 in the prior year must be designated as Roth contributions. This threshold is indexed for inflation. The rule does not affect regular contributions up to the standard limit, which can still be made on a pre-tax or Roth basis.

Taxation of Distributions

The tax treatment of money withdrawn from a Roth 401(k) depends on whether the withdrawal is a “qualified” or “non-qualified” distribution. A qualified distribution is entirely tax-free, meaning neither the original contributions nor the accumulated investment earnings are subject to federal income tax.

For a distribution to be qualified, it must satisfy two requirements. The first is the five-year holding period, which begins on January 1st of the first year the participant made their first designated Roth contribution to the plan. The second condition is that the distribution must occur after the participant reaches age 59½, becomes permanently disabled, or upon their death.

If a withdrawal does not meet the criteria for a qualified distribution, it is considered non-qualified. A non-qualified distribution is taxed on a pro-rata basis, meaning each withdrawal is composed of both the employee’s tax-free contributions and taxable investment earnings. The portion of the withdrawal representing contributions is returned tax-free, but the portion representing earnings is subject to ordinary income tax.

Furthermore, the earnings portion of a non-qualified distribution may also be subject to a 10% early withdrawal penalty if the participant is under age 59½ and does not meet an exception. To determine the taxable amount, one must calculate the ratio of earnings to the total account balance and apply that percentage to the amount being withdrawn.

Rollovers and Conversions

Funds in a Roth 401(k) can be moved to other retirement accounts through a rollover, preserving their tax-advantaged status. A participant can perform a direct rollover, transferring funds from their Roth 401(k) to another Roth 401(k) or a Roth IRA. An indirect rollover, where the participant receives a check and has 60 days to deposit it into another eligible Roth account, is also possible.

Some 401(k) plans offer an in-plan Roth rollover, which allows a participant to convert existing pre-tax funds within their plan into the designated Roth account. This is an irrevocable election. When pre-tax funds are converted, the entire amount is included in the participant’s gross income for that tax year and is subject to ordinary income tax.

The motivation for an in-plan conversion is to move tax-deferred assets into a tax-free growth environment, which is advantageous for those who expect to be in a higher tax bracket in the future. No taxes are withheld at the time of the conversion; the participant is responsible for paying the resulting tax liability when they file their annual income tax return.

Special Plan Considerations

Separate Accounting

Plan administrators are required by law to maintain separate accounting for all designated Roth contributions and their earnings. The plan must track Roth funds independently from any traditional pre-tax and employer matching funds. This recordkeeping is necessary to correctly determine the taxability of distributions, especially for non-qualified withdrawals.

Required Minimum Distributions (RMDs)

Historically, Roth 401(k) accounts were subject to Required Minimum Distribution (RMD) rules. However, the SECURE 2.0 Act of 2022 eliminated pre-death RMDs for Roth 401(k) accounts for plan years beginning after December 31, 2023. This change aligns the rules for Roth 401(k)s with those of Roth IRAs, allowing funds to grow tax-free throughout the owner’s lifetime without forced withdrawals.

Loans and Hardship Withdrawals

If a 401(k) plan permits loans, participants can borrow from their designated Roth account balance. The loan amount from the Roth account is combined with other plan loans to determine if it falls within the legal borrowing limits, generally the lesser of $50,000 or 50% of the vested account balance. If the plan allows for hardship withdrawals, they are taken on a pro-rata basis from both pre-tax and Roth balances if the participant has both.