Many 401k plans offer a Roth provision in addition to the traditional 401k option. Roth 401k contributions are made on an after-tax basis so there is no immediate savings as there is with traditional 401k contributions. However, if the Roth 401k account has been established for 5 years or more and distributions are taken after age 59 1/2 accumulated investment earnings are received on a tax-free basis. With a traditional 401k, taxes are paid on the accounts investment earnings when they are ultimately withdrawn from the plan.
This can be a huge benefit for younger plan participants who have many years or even decades to accumulate money on a tax-free basis. Over the course of time investment earnings may represent a large part of a participant’s account balance. Contributions can be split between Roth and traditional 401k accounts but combined they may not exceed the 401k contribution limits.
Investment earnings on Roth contributions where the age or 5-year requirement is not reached are taxed as ordinary income and may be subject to an additional 10% excise tax for distributions made prior to age 59 1/2.
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