What Is a Designated Roth Account and How Does It Work?
Understand how a Designated Roth Account works, including its tax treatment, contribution rules, and key differences from traditional retirement options.
Saving for retirement involves selecting accounts with specific tax advantages and rules. A Designated Roth Account (DRA), available within employer-sponsored plans like 401(k)s and 403(b)s, offers distinct benefits compared to traditional options. Understanding how these accounts function helps individuals make informed financial decisions.
Contribution Guidelines
Employees in an employer-sponsored plan with a DRA can allocate part of their salary to this after-tax savings option. Contribution limits mirror those of traditional 401(k) and 403(b) plans. In 2024, the maximum elective deferral is $23,000, with an additional $7,500 catch-up contribution for individuals 50 and older. These limits apply across both traditional and Roth components, meaning total contributions cannot exceed the cap.
Unlike Roth IRAs, DRAs have no income restrictions, allowing high earners to contribute regardless of their modified adjusted gross income (MAGI). This makes them an option for those exceeding Roth IRA income limits, which in 2024 begin at $146,000 for single filers and $230,000 for married couples filing jointly. However, not all employers offer a Roth component, so employees should confirm availability before planning contributions.
Tax Treatment
Contributions to a DRA are made with after-tax dollars and do not reduce taxable income in the contribution year. In contrast, traditional 401(k) and 403(b) contributions lower taxable income upfront. While DRAs lack immediate tax benefits, they offer tax-free growth and withdrawals if certain conditions are met.
Investment gains grow tax-deferred, similar to traditional accounts. Qualified distributions—including contributions and earnings—are tax-free if the account holder meets the five-year rule and takes withdrawals after 59½, due to disability, or upon death. Otherwise, earnings are subject to income tax and possibly a 10% early withdrawal penalty.
Employers must track DRA contributions separately from pre-tax deferrals due to their differing tax treatment. Accurate recordkeeping is essential to avoid unexpected tax liabilities on distributions and rollovers.
Distribution Requirements
Withdrawals from a DRA follow specific rules to determine tax treatment. Contributions can be accessed anytime without taxes or penalties. Earnings, however, must meet the five-year rule and qualifying event criteria to remain tax-free. Otherwise, they are taxed as income and may incur a 10% penalty.
Employer-sponsored plans may impose additional restrictions, such as requiring employees to reach retirement age or leave the company before accessing funds. Some allow in-service withdrawals under limited circumstances, while hardship distributions may be permitted for immediate financial needs but often exclude earnings.
Unlike Roth IRAs, DRAs are subject to required minimum distributions (RMDs) starting at age 73 under the SECURE 2.0 Act of 2022. Rolling a DRA balance into a Roth IRA before the RMD deadline eliminates this requirement.
Rollover Regulations
The tax treatment of a DRA rollover depends on the destination account. A direct rollover to a Roth IRA maintains the tax-free status of qualified distributions and removes RMD obligations. However, the five-year clock for Roth IRA withdrawals starts from the date of the first contribution to the Roth IRA unless the account holder already has an existing Roth IRA that meets this requirement.
Funds can also be rolled into another employer’s Roth 401(k) or 403(b) plan if the new plan accepts such rollovers. In this case, the original five-year holding period carries over, preventing a reset that could delay tax-free access to earnings. If the new employer’s plan does not offer a Roth option, rolling the balance into a Roth IRA remains an alternative, though understanding the timing of qualified distributions is necessary to avoid unexpected taxes.
Distinctions From Traditional Options
Choosing between a DRA and a traditional retirement account depends on tax strategy, withdrawal rules, and long-term financial goals. While both exist within employer-sponsored plans, their tax treatment and benefits differ.
Traditional 401(k) and 403(b) contributions reduce taxable income in the year they are made, deferring taxes until retirement withdrawals begin. This benefits individuals who expect a lower tax rate in retirement. DRAs, on the other hand, require after-tax contributions, but qualified withdrawals—including earnings—are tax-free. This structure benefits those anticipating higher tax rates in the future or aiming to minimize taxable income in retirement.
Estate planning is another key difference. Traditional accounts are taxed upon distribution, which can create a tax burden for beneficiaries, especially under the SECURE Act of 2019, which generally requires inherited accounts to be withdrawn within 10 years. DRAs, when rolled into a Roth IRA, allow heirs to take tax-free distributions if the five-year rule is met, making them a useful tool for tax-efficient wealth transfer.