Misconceptions About the Roth 401k

The Roth 401k option differs from a traditional 401k in a number of ways, but the key difference is how you are taxed. A traditional 401k allows you to pay pre-tax dollars into the account, and then pay taxes when you withdraw. A Roth option is the reverse: you pay taxes first, and then your contribution grows tax free. There are a number of misconceptions about this type of account.

  • It is the same as the Roth IRA - The Roth 401k option is similar to a Roth IRA, but the contribution limit is much higher on a 401k. There is also no income limit on the 401k, while there is on the IRA option.
  • You can withdraw without penalty - There are penalties for early withdrawal from both the traditional and Roth 401k option. The main difference is you will not be taxed on the funds you withdraw from the Roth option since you have already paid taxes on this.
  • There is no employer match - Your employer may match either 401k option but is not entitled to provide this benefit to you. Your employer may also permit you to borrow against your 401k, but this is also not required by law.


Can you have a 401k and an IRA at the same time?

You may contribute to both a 401k and an IRA if you have the financial wherewithal to do so. Many individuals will not have enough extra cash to place money into multiple retirement savings accounts. Others may also choose to place only a certain amount in a 401k and use extra savings for other forms of investment. It is up to you how you choose to invest and save for retirement; the bottom line is that you can open two retirement accounts and deposit up to the annual maximum in both accounts. You may even be eligible to open more than two accounts depending on the account structures you are looking to administer. 

What is the maximum pre-tax 401k contribution limit?

The maximum pre-tax 401k contribution limit is set on an annual basis. It is the lower of 100 percent of the employee's salary or $16,500, as of 2010. The reason for this limit is simple: highly compensated employees may receive a greater benefit than low-income individuals if they were able to continue to contribute to the tax-deferred account after reaching the annual maximum. This could become a strategy for tax reduction rather than a strategy for retirement savings. By imposing the maximum, the IRS aims to ensure all tax payers have the opportunity to benefit equally from the option.