The 401(k) is probably the most popular retirement plan in America. Most of you probably have one where you work.
But what’s this Roth 401(k) you’ve been hearing about?
How does it work?
Is it as good a deal for you?
The Roth 401(k) seems to be cause more confusion than squirrel in a four-way intersection. So let’s get started!
What’s The Difference? Taxes
With the traditional 401(k) your money is withheld pre-tax from your paycheck. So you don’t pay any tax on that money that is contributed. On the flip side, the Roth 401(k) allows you to put in contributions post-tax. You will be taxed on the money before putting into the Roth 401(k). It works exactly the same way as a Roth IRA.
As far as investments go, there is no difference. You will be able to select anything you have in your 401(k) menu. Of course, you’ll want to diversify and select investments based on time horizon and risk tolerance.
Which Is Right For You? It Depends
Well that depends. There is no easy answer. If you think you’ll be in a higher tax bracket as you get closer to retirement, than the Roth 401(k) may be the best choice. If you need a break on current taxes, then the traditional 401(k) is the best choice for that.
Here’s another interesting thought. If you have a high income now and are hitting the phase out limits on a traditional Roth, which are $127,000 for you single folks, and $188,000 for married couples. The Roth 401(k) may be a blessing. You see, there are no income limitations with the Roth 401(k)! You can place your entire yearly contribution of $17,500 or $23,000 for those over 50, in the Roth 401(k). If you’re not sure which to select, then consult with a qualified financial advisor.
You Really Don’t Have To Choose! Seriously
Yep. You can have your cake and eat it too. You can divide your annual contribution up any way you like between the two, so long as you don’t go over the annual limit. You can elect to change to the Roth 401(k) for your contributions. There are certain times of the year you can do it, so check with your plan. However, all matching contributions from your employer have to go to the Traditional 401(k). Bummer.
Naturally, no article, calculator or website can help you figure this out. Consult with your financial advisor and a good accountant. If you liked my article, you can subscribe here for free! I’ll have my virtual paperboy toss one in your email inbox every Friday.