Thursday, September 15, 2011

Employer Matching in Roth 401(k), Roth 403(b) and Roth 457(b) Plans

Most people understand the employer matching concept as it applies to traditional 401(k), 403(b) and 457(b) plans. In these plans, employees make pre-tax contributions and employers make pre-tax matching contributions into the employees’ accounts. Usually, there is vesting period for the employee before he gains access to the employer matching funds. However, employees are always 100% vested in their own contributions.

When it comes to Roth 401(k), Roth 403(b) and Roth 457(b) plans, the mechanics are different. The IRS states that the “Roth” prefix does not create a new plan. Instead, Roth defines the type of contribution being made to the plan. Designated Roth contributions are included in your gross income, unlike non-Roth contributions. However, your employer’s matching contribution goes into a pre-tax account, just like the non-Roth versions of the plan. Here is an example.

Let’s say you make $100,000 per year and you elect to contribute 5% of your salary to your employer provided 401(k) plan. And, your employer matches 100% of your contribution to the plan. So, you contribute $5000 to your account, and your employer matches your contribution, contributing $5000. The total deposit into your account is $10,000. Your employer will report that your salary is $95,000 for the year (W-2 Box 1). When you withdraw the money from your 401(k), you’ll have to pay tax on the entire withdrawal. If that $10,000 grew to $12,000, you would have to pay tax on $12,000.

Using the same facts as before, but you now contribute to a Roth 401(k). Your $5000 contribution goes into your post-tax account, but your employer’s matching contribution goes into a pre-tax account. The total deposit into your account is still $10,000. However, your employer will report that you made $100,000 (W-2 Box 1), instead of $95,000. Also, let’s assume that the $10,000 contribution also grows to $12,000. When you withdraw the $12,000, you will only need to pay tax on $6000, instead of $12,000.

In summary, even though you contribute to a Roth plan, the employer matching contributions are treated as if the plan is non-Roth.

For more information, read the IRS FAQ.

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