A 401 (k) is key to many retirement notes, but about half of plan sponsors now offer a second option: a Roth 401 (k).
A Roth 401 (k) is a type of 401 (k) that allows you to make after-tax contributions and then receive tax-free withdrawals when you retire. Conventional 401 (k) s, on the other hand, allow input tax contributions and the withdrawals at retirement are taxable.
Can I contribute to both a 401 (k) and a Roth 401 (k)?
Most employers who offer both a Roth 401 (k) and a traditional 401 (k) let you switch back and forth between them or even split your contributions. Employers can even top up Roth 401 (k) contributions. In fact, if your employer offers matching dollars and you contribute to a Roth 401 (k), you also have a traditional 401 (k) as the appropriate amount must go to a pre-tax account.
Use both accounts – especially if you are not entitled to a. to have Roth IRA because of income limits – can enable tax diversification in retirement. Each year you can choose whether you want to withdraw money from a tax-free or tax-deferred pot or a combination of both. This will help you better manage your taxable income.
What are the advantages of a Roth 401 (k)?
The Roth 401 (k) combines the best of a 401 (k) and the popular Roth IRA. It has:
There is no income limit for a Roth 401 (k).
The Roth IRA’s post-tax contributions, so qualified withdrawals are tax-free.
These attributes can be hard to turn your back on, but is a Roth 401 (k) right for you? Here are the factors to consider.
It can cost you more on the front end to use a Roth 401 (k). Contributions to a Roth 401 (k) can be harder on your budget today because an after-tax contribution takes a bigger bite off your paycheck than a pre-tax contribution to a traditional 401 (k).
The Roth account can be more valuable in retirement. That’s because if you subtract a dollar from this account, you can put that entire dollar in your pocket. If you pull a dollar off a traditional 401 (k), you can only keep the balance after paying taxes on the distribution.
“If you pull a dollar out of a Roth 401 (k), you can put that entire dollar in your pocket.”
If you deposit the maximum into one of the accounts every year, you will receive the same pot of money in retirement. The traditional 401 (k) balance would then be reduced by your tax rate in retirement, while the Roth 401 (k) balance would remain intact.
Your tax rates now vs. later
If you can commit to investing the tax savings from a traditional 401 (k) contribution, this debate is mostly about comparison Your tax bracket now versus in the future.
If your tax rate is low now and you expect it to be higher in retirement
You might want to contribute with after-tax dollars – which you can do with a Roth 401 (k).
Then you won’t pay tax at that higher rate when making qualifying distributions in retirement.
This lower rate now, higher rate later scenario can affect many workers, especially those early in their careers. Your income and standard of living are likely to increase over time, so you may want to withdraw more money in retirement than you are making now.
There is also the possibility of general statutory tax increases; The current tax rates are low in a historical context.
If your tax rate is now higher than you would expect in retirement
It can make sense to contribute to a traditional 401 (k) input tax.
You will then pay tax at the lower expected rate when you make distributions in retirement.
If you are about to retire, you may have a better idea of how your tax rate can change over these years. Many retirees live frugally, which results in a lower tax burden.
Roth 401 (k) Withdrawal Rules
The distribution rules for a Roth 401 (k) are not as flexible as those for a Roth IRA.
In contrast to the IRA version, you cannot withdraw contributions from a Roth 401 (k) at any time. The Roth 401 (k) has a five year rule for dividends; You must hold the account for five years before distributions are considered eligible and tax-free. This rule applies even after you reach 59½, the age at which pension distributions are normally allowed. This is something to keep in mind if you are starting out late and looking to access that money soon. In this case, a Roth IRA may be a better choice. (Here are the Top Roth IRA provider.)
Then there is the opposite scenario: you would rather not have access to this money at all. Like traditional 401 (k) s and traditional IRAs, Roth 401 (k) s require you to start taking payouts at 72. These are known as the minimum required distributions. But the Roth 401 (k) has an easy way out: you can roll its balance directly into a Roth IRA with no tax burden. The Roth IRA does not require any minimum payouts, so you could keep that money and pass the account on to your heirs.
If you need help managing your 401 (k) (traditional or Roth), some online providers such as blossom, will manage your account with your existing broker for you. And online planning services like Facet and Personal Capital and many others on our list of best financial advisor, provide affordable access to human advisors to help you invest in your 401 (k).
Ready to start? Everything you need to know about owning and operating a Roth 401 (k) can be found here.
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