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My employer matches dollar for dollar up to 6% in our 401k.

For simplicity's sake, I'll speak in round fictional numbers: So suppose my traditional 401k contribution has been $600/month, and the employer has matched that with $600/month. I now decide I want 5% to go the traditional 401k "side" and 1% to get the Roth 401k treatment. So my next month's check shows $500+$500 going to the regular 401k, and $82+$82 going to the Roth 401k.

Just like my normal withholding, the $18+$18 withheld from that 1% which is now going to the Roth 401k is estimated, not actual. The exact rate to tax at won't be known til year's end.

How does this get corrected? How are shares I buy during the year which are based on these estimated balances modified once the final rate of taxation is determined next year? This seems messy and complicated with lots of opportunity for problems.

  • On a side note - In general, I'd look at my marginal rate on my return, and choose pretax vs posttax to avoid the next bracket or drop to the one below. The most common situation is to avoid tax on 25% income, and try to stay at 15. – JoeTaxpayer Jul 16 '13 at 14:42
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When you adjust your investments the following will happen:

Initial condition:

  • $600 pre-tax divided into whatever options your 401K allows (company stock, small company, bonds, international, fixed...)
  • $600 Company match (some companies allow you to specify a different investment split for your company match). This is considered pre-tax. You will pay taxes when you withdraw it.
  • Your contribution of $600 pre-tax reduced your apparent income by $600 a month which if you are in the 25% tax bracket could have saved you $150 a month in federal taxes*

Modified condition:

  • $500 pre-tax divided into whatever options your 401K allows (company stock, small company, bonds, international, fixed...)
  • $100 post-tax divided into whatever options your 401K allows (company stock, small company, bonds, international, fixed...)
  • $600 Company match (some companies allow you to specify a different investment split for your company match). This is still all considered pre-tax. You will pay taxes when you withdraw it.
  • Your contribution of $500 pre-tax reduced your apparent income by $500 a month which if you are in the 25% tax bracket could have saved you $125 a month in federal taxes*

This means that after this change you will note that the amount of federal tax you pay each month via withholding will go up. You are now contributing less pre-tax, so your taxable income has increased.

If you make no other changes, then in April you will either have increased your refund by 6 months x the additional $25 a month, or decreased the amount you owe by the same amount.

There is no change in the total 401K balance at the end of the year, other than accounting for how much is held pre-tax vs. Roth post-tax.

Keep in mind that employer contributions must be pre-tax. The company could never guess what your tax situation is. They withhold money for taxes based on the form you fill out, but they have no idea of your family's tax situation. If you fail to have enough withheld, you pay the penalty — not the company.

*The tax savings are complex because it depends on marital status, your other pre-tax amounts for medical, and how much income your spouse makes, plus your other income and deductions.

4

Its easier than that: employer matching contributions are always pre-tax. While your contribution is split between the pre-tax and the Roth post-tax parts, matching contributions are always pre-tax.

Quote from the regulations I linked to:

For example, matching contributions are not permitted to be allocated to a designated Roth account.

So the tax you pay is only on the Roth portion of your contribution.

One of the reasons for that is the complexity you're talking about, but not only. Matching is not always vested, and it would be hard to determine what portion to tax and at what rate if matching would be allowed to go to Roth.

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Your 401k IRA will now have three different sub-accounts, the one holding your Traditional (pre-tax) 401k contributions, the one holding your Roth 401k contributions, and the one holding the employer match contributions (which, as has been pointed out to you, cannot be considered to be Roth 401k contributions). That is, it is not true that

So my next month's check shows $500+$500 going to the regular 401k, and $82+$82 going to the Roth 401k.

Your next month's paystub will show $500 going into the regular 401k, $100 going into the Roth 401k, and if employer matching contributions are listed on the paystub, it will still show $600 going into the employer match.

If you have chosen to invest your 401k in mutual funds (or stocks), shares are purchased when the 401k administrator receives the money and are also segregated in the three subaccounts. If you are paid monthly, then you will know on a month-by-month basis how many shares you hold in the three separate subaccounts, and there is no end-of-year modification of how many shares were purchased with Roth 401k contributions versus how many were purchased with pretax contributions or with employer matching funds as you seem to think.

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    Re: "three different sub-accounts". I'll add that the plan custodian tracks even more detail than that, since Roth basis (original contributions) -- though not earnings -- can be withdrawn tax-free before age 59.5. – Chris W. Rea Jul 16 '13 at 14:45
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    @ChrisW.Rea Yes, of course, and plan custodians track these details even in the employee contributions and employer contributions, and especially in the latter since employer contributions often do not vest immediately for new employees. – Dilip Sarwate Jul 16 '13 at 16:34

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