Does your employer offer a Roth 401(k) plan? Wondering how that differs from a traditional 401(k) plan? It's pretty much all about the taxes. The Simple Explanation
With a traditional 401(k) your contributions are tax-free; but you have to pay income tax on 100% of the distributions when you start withdrawing money in retirement. So with a traditional 401(k) plan you lower your tax liability, and possibly your tax bracket, while you are still working but you increase your tax liability, and possibly your tax bracket, in retirement. With a Roth 401(k) plan you pay taxes on your contributions while you are working but your distributions (including the investment growth) are tax free in retirement. This increases your taxable income while you are working but could decrease your tax liability in retirement.
So Which Option is Best For You?
To answer that question you have to ask yourself "When do I want to pay taxes? Now or later?" Here are some thoughts that may help you decide.
A tax deduction while you are working seems pretty good, especially if you are trying to raise a family and need every dollar you can get.
However, with a traditional 401(k) plan, withdrawals in retirement will be taxed which could put you in a higher tax bracket. That could cause a potential increase in taxes on Social Security benefits and increase the cost of Medicare B plans.
It's Not Entirely About the Taxes
While taxes are the main discussion point there are a few other things to consider.
A Roth 401(k) is not a Roth IRA - while similar, there are differences:
A Roth IRA has income and contribution limits. The contribution limit for a Roth IRA is $6,000 in 2019 ($7,000 if you are over age 50). Also, if your adjusted gross income (AGI) is over a certain amount that number could be reduced, possibly to $0 (i.e. a single person who's AGI is $137,000 or more cannot contribute to a Roth IRA).
A Roth 401(k) does have contribution limits (the same as a traditional 401(k)) but there are not income limits. Contribution limits in 2019 are $19,000 a year (plus an additional $6,000 if over age 50).
With a Roth IRA you can withdraw money anytime. With a Roth 401(k) you have to wait 5 years before you can start making withdrawals (even if you are over 59 ½ ).
With a Roth IRA you do not have to take required minimum distributions (RMD) at age 70 ½; with a Roth 401(k) you do (however you can roll your Roth 401(k) into a Roth IRA to avoid that).
The Best of Both Worlds
If your employer offers a Roth 401(k) plan then it is likely that they also offer a traditional plan as well. If that is the case it is possible that you can contribute to both plans at the same time and adjust how much goes into each plan as your financial picture changes while you get older. You may need to check with your employer for more details. Have questions about your 401(k) or other retirement plan? Let’s talk about it. Contact me today at 866.QUEST.01 (866.783.7801).
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