Can Employers Now Give After-Tax 401(k) Match? SECURE 2.0: Yes

While defined-benefit pensions are a thing of bygone times for many, other plans have their place for most of us.

If you’re like me, your retirement depends on how well you take advantage…

A Brief History of (the Most Widely Used) Retirement Plans

In 1974, the Employee Retirement Income Security Act (ERISA) created tax-deferred individual retirement accounts (IRAs) that let us set aside tax-deferred money for retirement. 

Then, in 1978, Congress enacted Internal Revenue Code Section 401(k) as part of the Revenue Act, letting employers set up defined-contribution retirement plans. These shifted market-return risk from employers to employees, but also let employees benefit more if their investments performed well.

The Taxpayer Relief Act of 1997 that went into effect in 1998 added a twist to IRAs, by creating the so-called Roth IRA. This “kid-brother” version of the IRA doesn’t give you a tax deduction in the year you contribute to the plan, but makes all withdrawals (in retirement) from the plan tax-free.

In 2006, the 401(k) plan also welcomed a kid brother, the Roth 401(k). Just like the Roth IRA, this new type of 401(k) plan takes contributions in after-tax dollars, but withdrawals in retirement are completely tax-free.

Then, in December 2022, President Biden signed into law a $1.7 trillion piece of legislation that included the “Setting Every Community Up for Retirement Enhancement” (SECURE) 2.0 act. This new act made a lot of (mostly welcome) changes to retirement plans.

Two changes impacted the Roth 401(k)…

The SECURE 2.0 Act Is a Game-Changer for Roth 401(k) Plans

As of 2023, Required Minimum Distributions (RMDs) no longer apply to Roth 401(k) plans, so you can let those plans keep growing without taking any money out of your Roth 401(k) for as long as you like (if you don’t need the money to cover your expenses in retirement).

Michael Hunsberger, ChFC®, Owner, Next Mission Financial Planning, LLC explains, “SECURE 2.0 no longer requires you to take RMDs from Roth 401(k)/403(b) accounts as was already the case with Roth IRAs.”

Even better, employers can now direct matching contributions to employees’ Roth 401(k) plans if employees choose.

Previously, these contributions could only go to tax-deferred 401(k) accounts, which meant that once you withdrew that money, it would be taxed at the same rates as wage income. Now, every dollar contributed by your employer as a matching contribution to your Roth 401(k) is taxed as regular income in the year it enters your plan, but will be tax-free forever after that.

Jorey Bernstein, Executive Director, Wealth Manager, and Founder, Bernstein Investment Consultants points out the advantages, “Qualified withdrawals from Roth accounts are tax-free, providing more control over retirement income without tax liabilities. Roth accounts may also provide estate planning benefits due to their tax-free nature and lack of RMDs. Also, contributing to both traditional and Roth accounts enhances your retirement funds’ diversification across pre-tax and after-tax accounts, making it easier to accommodate a wider range of financial needs and tax situations during retirement.”

Note that the same changes apply to 403(b) and 457(b) plans.

Who Benefits Most from the New Roth 401(k) Matching?

Since you pay tax now on Roth 401(k) employer matching contributions (actually when you file your next tax return), lowering your current take-home pay, you may wonder if it’s such a great deal.

As is usually the case with all personal finance questions, the answer is “It depends.”

If your current income is relatively low, the tax deduction you’d get from a tax-deferred 401(k) matching contribution may not be worth as much for you compared to avoiding tax on withdrawals from a Roth plan in retirement, when your income may push you into higher tax brackets.

As Hunsberger says, “The new Roth match is a great option for people who are in lower tax brackets now vs. when they’ll withdraw funds in retirement. If you’re in a higher tax bracket now, I’d recommend continuing to defer taxes.”

Bernstein points out, however, “If you’re a long way from retirement, the tax-free growth potential of Roth accounts may be more advantageous than the immediate tax deduction offered by traditional ones.”

What if Roth contributions don’t make sense in your situation? 

The new rule allows but doesn’t require you to take employer-matching contributions into your Roth account. So if it doesn’t make sense given your current tax bracket and a potentially lower tax bracket in retirement, you may not have to.

Another benefit of taking your employer matching contribution into your Roth 401(k) is that it increases how much money you’ll have available in retirement, especially if you don’t usually increase your taxable investments each year by however much your 401(k) contributions reduced your tax owed for the current year.

As Jonathan Grannick, CFP®, Owner & Financial Planner, Wonder Wealth, LLC says, “If I recommend clients max out their Roth retirement plan, that means we’re convinced a Roth contribution makes the most sense for them. For those clients, electing an employer match in Roth dollars would be a natural choice to back up real conviction in that strategy. 

“I recommend Roth for many reasons. First, you lock in today’s historically low tax rates. Second, for clients with decades until retirement, that’s a long time to benefit from tax-free growth. Finally, there’s a big one - behavior. A $20,000 Roth 401(k) contribution is $20,000 saved. That same $20,000 put into a traditional 401(k) is likely $14,000–15,000 after tax when you withdraw it in retirement (not to mention the tax impact on decades of growth). Since people rarely ‘reinvest’ their 401(k) contribution tax savings upfront, you save more when you put the same amount in a Roth 401(k).”

If you do take a Roth matching contribution, you need to plan accordingly. 

Consider adjusting your withholding (by submitting a revised W4 form to your employer) to avoid getting hit with an unexpectedly high tax bill next April (potentially including penalties).

Important Note: You must be fully vested to direct employer matching contributions to your Roth plan.

A Related SECURE 2.0 Change to Retirement Accounts

SECURE 2.0 also allows employers to create Roth SIMPLE and SEP plans, where previously all such plans could only take pre-tax contributions.

The Bottom Line

SECURE 2.0 made a whole raft of changes to the retirement-plan landscape, mostly welcome ones.

One of these welcome changes was the ability of fully vested employees to ask their employers to make 401(k) (or 403(b) or 457(b) matching contributions into their Roth plan.

This isn’t necessarily advantageous to everyone, but the flexibility lets those who would benefit make that choice.

However, if you take advantage, don’t forget to ensure your tax withholding is high enough to prevent significant underpayment of taxes during the tax year, which could lead to penalties and a big tax bill when you file your tax return.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.

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Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.