Influential, Yet Often Overlooked Roth 401(k) Plan Design Features

Roth 401(k) benefits came into existence in 2001.¹ Since then, this option has become an attractive, low-cost, and easy to implement plan design feature, available in over 90% of available retirement plans.²

As opposed to a traditional 401(k), which is pre-tax, a Roth 401(k) offers an after-tax contribution option with tax-free withdrawals provided they are qualified distributions made after a 5-taxable-year period of participation and are either made on or after the date participants attain age 59½, made after death, or attributable to a participant being disabled.  For plan sponsors, a Roth option, opens another design feature that allows participants to take advantage of an additional, often overlooked, tax strategy - the In-plan Roth Conversion.  Let’s take a deeper dive into Roth 401(k) plans and their benefits.

Benefits of a Roth 401(k)

There are certain financial motivations as to why employees may want to consider contributing into a Roth 401(k). Here are a few:

• Retirement account with tax-free growth potential
• Employee pays taxes now while in an assumed lower tax bracket than during retirement
• The possibility that Federal, State and Local income tax rates will continue to rise
• Ability for future “tax diversification” (access to assets taxed at different rates can provide both taxable income and tax rate flexibility)
• Qualified distributions are tax-free

These reasons can be particularly appealing for high-income earners, high-net worth individuals, and younger employees who seek the flexibility offered through Roth diversification.

During times of market volatility or a recession, like our current economic environment, participants may consider taking their lower account values as a conversion opportunity, since they would owe less taxes on the smaller account basis. For specific participants, the long-term tax advantages, growth potential of assets, and investable time horizon could be a valuable retirement, tax and estate planning strategy.

Confusion of the Roths

Unlike the similarly named Roth IRA, the Roth 401(k) is different. A Roth IRA is an individual retirement account; whereas a Roth 401(k) is part of and offered through an employer sponsored retirement plan.

This minor confusion might be an invisible obstacle for some employees, especially high-income earners who have been told they cannot contribute to a “Roth.”

High-income earners may be pleasantly surprised to hear they can contribute because a Roth 401(k) does not have income limits like a Roth IRA does. This means they now have access to a savings vehicle that can grow tax-free.

Additionally, since Roth 401(k) accounts follow traditional 401(k) contribution guidelines, the amount that can be saved per year is subject to 401(k) maximums. For example, in 2025, employees can contribute up to $23,500 in a Roth 401(k) and if the employee is 50 years old or older, they may make a catch-up contribution of up to $7,500, and 60-63 years old can make catch-up contributions up to $11,250.³

2025 Roth 401(k) and Roth IRA Retirement Accounts Comparison³

In-plan Roth Conversion Strategy

Simply stated, participants can convert before-tax 401(k) plan assets to a Roth 401(k). It’s done through an In-plan Roth Conversion (also known as an In-plan Roth Rollover). The same financial motivations that make the Roth 401(k) attractive are the same considerations for an In-plan Roth Conversion.

For employees looking for additional approaches to retirement and tax planning, converting pre-tax 401(k) assets into a Roth 401(k) could be an attractive strategy and serve a wide variety of participants. As an example, for high-net worth individuals looking to pass on their assets tax-free, this strategy could help soften the impact of rising taxes and provide tax diversification options. Then for younger workers in a low tax bracket, an In-plan Roth Conversion allows for years of tax-free investment growth potential.

In-plan Roth Conversion Need to Knows

Let us cover a few basics and common questions about In-plan Roth Conversions.⁵

• The Roth plan feature is required to allow for In-plan Roth Conversions
• Participants can convert their entire account balance or just a portion
• At the time of conversion, participants are required to pay income taxes on the converted amount
• Participants must wait five years after each conversion and reach the age of 59½ to have penalty-free access to the funds
• Once the pre-tax contributions are converted, they cannot be converted back
• Roth 401(k) accounts require Required Minimum Distributions (RMDs) after you reach a certain age (No requirements starting in 2024 with changes resulting from SECURE 2.0 Act provisions)
• The surviving spouse, a child who has not reached the age of majority, a disabled or chronically ill person or a person not more than ten years younger than the employee or IRA account owner may withdraw the account over the course of their lifetime
• For other beneficiaries, the entire balance of the participant's account needs to be distributed within ten years

Before executing an In-plan Roth Conversion, participants should consider contacting their tax and legal advisor and retirement plan service provider.

May Be Worth a Second Look

There are many aspects of a Roth 401(k) benefit that make the option worth a second look for many participants.

As your employees come to you and ask questions about their retirement planning needs, understanding the differences could help you to financially empower your workforce.

If you have questions, feel free to reach out to your Morgan Stanley Financial Advisor to discuss your options. You should also consult with your legal and tax advisor.