Roth 401(k) Employer Matches Could Result in Unexpected Tax Bill: All you need to know

Roth 401(k) Employer Matches: You should make adequate contributions to your Roth 401(k) if your employer matches it, as this will increase your retirement savings and provide you free money.

With the passage of SECURE Act 2.0 in December 2022, companies are now able to match employee contributions to 401(k) plans straight into a Roth account. Before the new law, employers contributing to retirement plans were required to set up a second standard 401(k).

However, there is a snag in the new regulations.

It’s important to keep in mind that your Roth 401(k) contributions are taxed, which means that you, the employee, can take out the money tax-free when you retire.

It’s not the same for your employer, though. Like with a standard 401(k) match from your employer, their pretax contributions to your Roth 401(k) through matching are made.

Therefore, you are responsible for paying taxes on the Roth contributions made by your firm in the year that they are made.

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The chief tax information officer at tax preparation Jackson Hewitt, Mark Steber, stated that forgetting to pay employer contributions is the most mistake.

According to him, for instance, if your company makes a $500 contribution to your Roth 401(k), you will have $500 in income that needs to be taxed.

How much will you be taxed?

Your employer’s yearly contribution will be subject to any federal taxes owed to you.

According to USAToday, Mark Jaeger, vice president of tax operations at tax software provider TaxAct, you’ll “receive a 1099-R with a Code G in Box 7.”

Do you file taxes with a Roth 401(k)?

Your contributions are post-tax, so you do not need to declare them on your tax return; instead, they should show up on your W-2.

However, the 1099-R you should receive will indicate whether your company has made any direct Roth 401(k) contributions, which you would need to disclose. There will be tax on that sum.

How am I going to pay taxes?

According to tax professionals, you have a few choices for paying the taxes:

Include the donations in your income on your tax return and make payment at the time of tax filing.

If you wish to avoid a higher tax bill when you file your taxes, you can increase your federal withholdings from your W-2 by submitting a new W-4 to your employer.

To pay the extra taxes, make approximated tax payments every quarter.

You might want to follow suit if you reside in a state where income taxes are levied, according to Jaeger.

What are the Roth 401(k) contribution caps for 2024?

If you are under 50, the maximum amount you can contribute to a Roth 401(k) in 2024 is $23,000.

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If you are fifty years of age or older, you may contribute an additional $7,500 year in “catch-up” payments, making your annual total $30,500.

There is a cap on the total amount that both employers and employees can contribute; employer match contributions are not deducted from those personal contribution caps. Either 100% of your pay or $69,000 (not including catch-up payments) will be required in 2024, whichever is less.

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Before SECURE Act 2.0, how were Roth 401(k) matches managed?

Before SECURE Act 2.0, employees would fund a Roth 401(k), while employer contributions were placed into a separate standard 401(k).

For instance, you may deposit $2,000 into a Roth 401(k) using after-tax cash, and your employer will match that contribution up to $1,000 in pretax funds into a conventional 401(k).

“I would pay ordinary taxes (no special capital gains rate) on that $1,000, plus or minus any gains or losses earned through that account if I wanted to convert that traditional 401(k) over to a Roth 401(k),” stated Jaeger.

In light of the SECURE Act 2.0, contributions would be made as follows: you would make a $2,000 post-tax contribution to a Roth 401(k), and your employer would match that amount with $1,000. You receive a 1099-R from your employer, and you have to pay taxes on the $1,000.

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How many businesses match 401(k)s with Roth accounts?

According to brokerage behemoth Fidelity, more than 90% of retirement plans provide a Roth 401(k) option; however, very few offer the match in its most recent iteration.

The Plan Sponsor Council of America, a trade association for businesses, reports that 15% of participants have added the optional SECURE 2.0 provision that lets them choose to treat employer contributions as Roth accounts, and 25% are actively contemplating doing so. About 40% have not and will not put this clause into practice, while the remaining 4% are unclear.

According to the Plan Sponsor Council of America, “many plan sponsors don’t want the added administrative complexity, especially if they already allow in-plan Roth conversions, even though many like this provision in theory and the recent guidance has made it more attractive to offer.”