When people think of employer-based retirement accounts like 401(k) plans, people often think that that implies pre-tax contributions. It’s only your own self-directed retirement accounts (IRAs) that have the post-tax (Roth) option.
I used to be one of those people.
But these days, employers can offer what is known as a Roth 401(k) plan in addition to the regular 401(k) plan.
Because the plan combines some of the aspects of a 401(k) and some aspects of a Roth IRA, I call it the retirement mutant hybrid.
But like comic book characters, the mutants aren’t always the bad guys. And in this case, I believe this one can be pretty good.
I can give you the official definition of a Roth 401(k), but I won’t. First of all, even the IRS doesn’t go out of its way to tell you what a Roth 401(k) is. But secondly, it generally is as straightforward as it sounds.
- With a regular 401(k) (or 403(b), etc.) contributions come out of the paycheck before tax. So a $125 contribution might result in only a $75 reduction in a paycheck, depending on the tax rate. You will need to pay income tax when withdrawing that money later.
- With a Roth 401(k), contributions come out of the paycheck after tax. So a $125 contribution will result in a $125 reduction in a paycheck. No taxes need to be paid on that money ever again.
I’ve already talked about why I like Roth IRAs over Traditional IRAs. Put simply:
- While I’m no clairvoyant, I suspect that tax rates will be higher in the future, so I’m paying taxes now.
- There are no required minimum distributions. I can take the money out whenever I choose.
There are some downsides to Roth IRAs. One of which is the income limitations. If you make too much money ($117,000 as a single person, as an example) you can’t contribute to a Roth IRA. But many people won’t hit these limits, which is why Roth is such a good option for many people.
A sightly bigger issue is the contribution limits to a Roth IRA. As of right now it’s $5,500 if you’re under 50, $6,500 otherwise. And while that may seem like a lot of money, it’s not a lot for many people. If you adhere to the rule of thumb of saving 15% of your gross income for retirement, you’ll max that right out when you hit $37,000 in salary.
Enter the mutant
A Roth 401(k) doesn’t have any income limitations. You can contribute to a Roth IRA no matter how much money you make.
More excitingly, a Roth 401(k) has the same contribution limits as a regular 401(k). At the time of writing, that’s $18,000 a year if you’re under 50, and $24,000 otherwise. That’s a huge difference over $5,500!
A Roth 401(k) has a required minimum distribution just like a regular 401(k), but we don’t care about that, because you can easily rollover a Roth 401(k) into a Roth IRA. Problem solved!
So as far as I’m concerned, a Roth 401(k) has all the benefits of a Roth IRA and regular 401(k) rolled into one. It’s pretty awesome.
What about that match?
If you have an employee match, the match will always go into a pre-tax account. That should make sense, as otherwise you’d be getting more money out of the employer just for choosing the Roth option. ($100 before taxes ends up being less money than $100 after taxes.)
Your 3% (or whatever) contribution might be able to go into the Roth, but you will want to make sure. Remember, don’t leave a 100% return on the table!
Ask your employer
You may have the option to contribute to a Roth 401(k) and not know it! That happened to me a few years ago. I assumed that the pre-tax option was the only option until one day when I asked. I found out that not only was there a Roth 401(k) an option, but I could elect to contribute to both if I wanted!
And that isn’t a bad idea either. Besides, isn’t it true that the mutants always join forces to defeat evil?
But enough about comic books. What do you think about the Roth 401(k)?
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