Most employees are familiar with the concept of socking away a portion of their paychecks toward their 401(K). However, few realize that they also have the option to contribute to a Roth 401(K) plan. In fact, since this new plan became available in the market in 2006, only 11% of eligible employees elected this option. Are you also missing out on a great retirement planning opportunity?
How does a Roth 401(k) work?
If you’re well-versed with the mechanics of a Roth IRA, this type of employer-provided retirement account should be fairly intuitive. This account allows the employee to designate Roth contributions of up to $17,500 or $22,500 if older than 50 (reference IRC Section 402(g)). Similar to a Roth IRA, the contributions are made with after-tax dollars, but appreciate tax-free over time. A key benefit of the Roth 401(K) is that there is no income limit as is the case with a Roth IRA. You can earn $1 million and still be eligible.
How is this different from a traditional 401(k)?
The contribution limits are both the same, but Roth contributions are taxed now while contributions for a traditional 401(K) are deferred until you withdraw the funds. Thus, it’s generally best for young employees to contribute to a Roth 401(K) when their tax rate is lower than it will be when they eventually withdraw from the account. A traditional 401(K) on the other hand can be more advantageous for individuals that are in a higher tax bracket now than they will be later in life. However, this logic is not always the case as detailed below.
Roth 401(K)’s aren’t just for younger workers
There are a number of reasons why even baby boomers may want to consider a Roth 401(K). First, this type of plan provides greater flexibility as you can avoid required minimum withdrawals after age 70 1/2. You would just need to roll over your Roth 401(k) to a Roth IRA. In addition, if you need the monies for an emergency, you will not have to worry about potential large tax liabilities as is the case with a traditional 401(K) plan. Furthermore, it’s important to acknowledge that having tax-free monies when you retire can be very useful as it will not impact the taxability of your Social Security benefits or your Medicare eligibility.
How do I know if my employer offers this option?
There’s likely a 50/50 chance that your employer provides you with this option as it is estimated that almost 50% of all employers offer this plan as per a recent study by AON Hewitt. However, even if they do not currently provide this option, it is very easy for them to make this change. We would recommend that you inquire with the benefits department at your employer about this possibility.
More Questions? Try our professional tax research service.
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Tags: tax questions, roth 401K questions, 401k tax questions, Ryan Himmel
