Pros And Cons Of The Roth 401(k)

The Roth 401(k) first became available in January 2006, is an option available for employers to provide as a part of “normal” 401(k) plans, either existing or new.  The Roth provision allows the employee to choose to direct all or part of his or her salary deferrals into the 401(k) plan to a separate account, called a Designated Roth Account, or DRAC.

The DRAC account is segregated from the regular 401(k) account, because of the way the funds are treated.  When you direct a portion of your salary into a DRAC, you pay tax on the deferred salary just the same as if you had received it in cash.  This deferred salary is subject to ordinary income tax, Medicare withholding, and Social Security withholding if applicable.

The unique thing about your DRAC funds is that, upon withdrawal for a qualified purpose (e.g., after you have reached age 59½, among other purposes) the growth that has occurred in the account is not subject to tax.  If this sounds familiar, it’s because this is the same type of tax treatment that is applied to a Roth IRA.  Conversely, the regular 401(k) growth and contributions are subject to ordinary income tax upon withdrawal – just the same as a regular (non-Roth) IRA.

Pros of a Roth 401(k)

Among the positive aspects of a Roth 401(k) versus a regular 401(k) are:

  • Future taxation is eliminated (for qualified purposes).  Growth and contributions are tax-free when withdrawn after age 59½.
  • Concerns over future tax rates are eliminated since you’ve already paid the tax on your contributions. If the future tax rates are greater you’d pay the higher rates on regular 401(k) distributions – no tax is due on qualified Roth 401(k) distributions.
  • Contributions could be withdrawn tax-free, with restrictions, prior to age 59½ – after you have left the employer.
  • Early distribution options for education, home down payment, or medical expenses are not available for a DRAC as they are from a regular 401(k).

Benefits of a Roth 401(k) versus a Roth IRA:

  • Higher contribution amounts for the Roth 401(k) – up to $23,000 in 2013, versus $6,500 for a Roth IRA (catch-up contributions have been included, the maximums are $17,500 and $5,500 if under age 50).
  • Employer matching contributions are available, although these must be directed to a “regular” 401(k) account, not the DRAC.
  • Income restrictions that are applied to Roth IRA contributions are more-or-less eliminated with the DRAC.
  • Contributions can be made to the account after reaching age 70½ if still employed and not a 5% or greater owner of the employer.
  • Loans may be available against the balance in the Roth 401(k) account while still employed, if allowed by the plan administrator.

Cons of a Roth 401(k)

Negative aspects of a Roth 401(k) compared to a regular 401(k):

  • You must pay tax on the salary deferred into the DRAC, whereas deferrals to a regular 401(k) are not subject to ordinary income tax.
  • If tax rates are lower for you in retirement, you have paid a higher rate on the contributions to the account, although the growth is still tax free for qualified withdrawals.

When comparing a Roth 401(k) to a Roth IRA, the following downsides are evident:

  • Upon reaching age 70½ your DRAC account will be subject to Required Minimum Distributions, just like a regular 401(k) or IRA.  This can be mitigated by rolling over the Roth 401(k) to a Roth IRA upon leaving the employer.
  • You can’t access the contributions to the DRAC before you leave employment, while you can always have access to the contributions to a Roth IRA account.


The decision of whether to participate in a Roth 401(k) if your employer provides one is primarily the same as the decision-point of contributing to a Roth IRA versus a regular IRA.  Actually, the decision between the two types of IRA is a bit more complicated due to restrictions on income levels and deductibility, which don’t apply here.  The primary questions that need to be asked are:

  1. Can you afford the tax on the maximum contribution to a Roth 401(k) account?
  2. Do you think the tax rates will be higher or lower when you reach retirement age?


If you can’t afford to pay the additional tax on the deferred salary (as compared to when you place the money in a regular 401(k)), then it would probably be better to choose the regular 401(k).

For example, if you’re in the 25% tax bracket deferring the maximum $23,000 into a regular 401(k) will reduce your taxes by $5,750 – and so if you chose the DRAC instead, you’d have to pay that much more in tax.  If this kind of additional tax will have a negative impact on being able to pay your day-to-day expenses, the Roth 401(k) is probably not a good option for you.

Keep in mind that the decision isn’t all-or-nothing: you could choose to direct a portion of your deferral to Roth 401(k) and the remainder to the regular 401(k), which would allow you to manage the amount of extra tax that you pay.

Future Tax Rates

If you believe that the future tax rates will be greater than they are for you now, it will be to your advantage to use the Roth 401(k) – so that you pay tax at the lower rate now and avoid the future higher rate.  On the other hand, if you believe that the rates will be lower for you in the future, deferring tax on regular (non-Roth) 401(k) contributions will be more to your advantage.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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