What current tax bracket is used for Roth 401(k)? What happens if it's incorrect?

Question

When contributing to a Roth 401(k), you get taxed on it immediately.

But we know that, in general, your company won't know your exact tax rate and brackets; it'll only have an approximation—that's why so many people get refunds (or make payments) when they file their taxes exactly.

So what happens when the company withholds too much or too little tax for a Roth 401(k)?
If they overestimate your income, when/how do you get a refund?
If they underestimate your income, when/how are you liable for paying it?

Answer 1

A contribution to a Roth 401(k) has no bearing on your income tax at all. The contribution is made with after-tax money. For income tax purposes, a contribution to a Roth does not affect the amount of income tax you pay.

Let's say that you and I both have a monthly salary of $5000, and we both have the same number of exemptions claimed. You contribute $1000 per month to a Roth 401(k), and I don't contribute anything to a retirement fund. Our employer will withhold the exact same amount of tax from both of our checks. Your Roth 401(k) contribution does not change your taxable income.

Now if I contribute $1000 per month to a traditional 401(k), that reduces my taxable income, and our employer will withhold less tax from my check as a result than he does on yours with your Roth 401(k) contribution. We both put $1000 into our retirement accounts, but my paycheck will be larger than yours.

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When an employer withholds tax, they are not technically estimating anything about how much tax you owe. There are formulas that they need to use that determine precisely how much is taken out of your check. It is a function of how big your paycheck is and the information you submitted on your W-4.

If you end up having too little withheld, your employer does not get involved, nor does your 401(k). You submit the required payment to the IRS at tax time.

If it turns out that you had too much withheld, this also does not involve your employer. The IRS sends you a refund at tax time.

A contribution to a traditional 401(k) will ultimately reduce your income tax liability for the year, and a contribution to a Roth 401(k) will not. The contribution limits for the 401(k) is a fixed amount: $19,500 for 2021, possibly more if you are over age 50. Your income/paycheck size/tax withholding have no bearing on how much you can contribute, with one important caveat: Payroll deduction is the only way to contribute to a 401(k), so you can only contribute up to 100% of your paycheck after all of the other things (including federal tax) have been withheld from your check.

When you get a refund from the IRS, it goes into your personal bank account. There is normally no way to make a prior year 401(k) contribution (unlike an IRA). The only way to make a 401(k) contribution is through payroll deduction, and it is only made for the current tax year.

Answer 2

When contributing to a Roth 401(k), you get taxed on it immediately.

Not exactly... You are not "taxed" on a Roth contribution. You're taxed on your income. The difference is that you don't get a deduction for Roth contributions, unlike a Traditional 401(k). So you'd have the same problem if your withholdings were wrong and you contributed to a traditional 401(k) instead of a Roth.

So what happens when the company withholds too much or too little tax for a Roth 401(k)?

You'll possibly get a refund (if they withhold too much) or have a tax bill (if they withhold too little). It all depends on what your total taxable income is and how many exemptions you claim on your W-4. The amount withheld is calculated based on your income for the period (minus deductions) and extrapolated out to a year. Often times it is wrong and you need to adjust your exemptions or face either a large refund or a large bill, neither of which are ideal.

If they overestimate your income, when/how do you get a refund?

When you file your taxes (plus time for processing).

If they underestimate your income, when/how are you liable for paying it?

When you file your taxes (plus time for processing).

Answer 3

The reason for under/over withholding doesn't matter. Whether the net funds went to your bank account or some went to a Roth or to a charity the company pushes employees to donate to.

The April Tax form is where it all gets reconciled. Where you calculate the exact 'taxable income' and 'tax due'. The difference between taxes paid that year and tax due is either owed or refunded.

(If I missed something here, please edit the question to clarify)

Answer 4

It seems like this question is really about the situation that pops up when one is starting a new job near the end of the year, and they want to maximize their 401(k) on the last few paychecks of the year. It also occurs when they want to maximize contributions when they are leaving a company that has a 401(k) and they are going to one without a 401(k) or one without a Roth so they want to contribute as much as possible before switching jobs.

This is from a comment on another answer:

You're missing some key details because of your assumptions of $100k salary + full employment throughout the entire year. Imagine the salary for your position is $100k, but you only join the company on Aug 1, and you didn't have any income earlier that year. And you only become eligible for the 401(k) after 3 months. So now you have only 2 months (Nov, Dec) to make contributions, which grosses $16k. If your employer takes any excess tax out of that (which they in general will, especially if they extrapolate to $100k income), it forcefully reduces your Roth contributions.

First of all many/most/all companies place a limit on the percent of gross that one can send to the 401(k), regardless of Roth or Traditional. They limit the percentage to something less than 100% because items such as insurance, and other benefits that the employee pays, also have to come out of the paycheck. I just did a search of the maximum percent of gross my current and former employers allow: 30% - 75% - 90%.

If your company has a lower limit, then it doesn't matter if you are going to get a tax refund. The company set limit will be the determining factor.

Because in the example there is time to act while waiting for the eligibility to kick in, you could modify your W-4 to drop the tax rate. This is done by increasing the number of deductions temporarily.

Something to keep in mind, the order of operations will never allow a negative paycheck. Therefor the company, even if they allow 90% to go to the 401(k), those things they are required to withhold (state and federal taxes), insurance, FSA and HSA contributions will always come first.

Answer 5

Roths are irrelevant to withholding/taxes.

They simply don't count at all for computing both tax and withholding.

Bob takes a Roth. Ann doesn't.

Ann makes $70,000/year and takes no Roth.
With 1 exemption, withholding is $9000. Tax is $8841.

Bob makes $70,000/year and takes a $5000 Roth.
With 1 exemption, withholding is $9000. Tax is $8841.

If you looked at both their tax forms, they'd be identical. There isn't even a place on the form to enter a Roth contribution.

And because of the way Roths work, there isn't any tax paperwork after age 59-1/2 when they start withdrawing. That does not create reportable income and no taxes need be paid.