Does your company offer a ROTH 401(k)? If so, have you considered contributing to it rather than a Traditional 401(k)? Personally I contribute all of my funds to a Roth account in my government Thrift Savings Plan which is the government equivalent to a 401(k). However, all of the matching funds I receive have to be placed in a Traditional account as taxes have not been paid on those funds yet. So it goes to reason I will have two streams of income when I do in fact decide to retire 1. Being a taxable source and 2. Being a tax free source. Considering that it is vital to have some of both types of income in retirement depending on what you are needing to achieve.
A little history on the Roth 401(k) as they were first started in 2006 and basically allow for you to save up to $17,500 in 2014 in after-tax money and $23,000 if you are over age 50. And unlike a ROTH IRA there are no income limitations on a ROTH 401(k) so anyone who works somewhere that they are offered can participate in a ROTH account. ROTH IRA’s are phased out at certain income levels for individuals and couples whereas this is not held to the same standard. All withdrawals from a ROTH 401(k) are tax free provided the account has been active for five years and the participant is at least age 59 ½. And more employers are offering ROTH 401(k)’s now estimated to be at 50% as compared to just 11% in 2007.
Need some reasons as to why a ROTH 401(k) is a better option? Here are a few of them that come to mind. Consider this, you put a dollar in a traditional 401(k) and get the tax advantages now of reducing your taxes by a dollar. That dollar then grow for the rest of your working career until you decide to tax it out long with its earnings. Now you saved say 25% on your taxes for that dollar but you will now pay taxes on the dollar along with all of its accumulated earnings possibly resulting in placing you in a higher tax bracket than you would have been otherwise in retirement. That is because withdrawals from 401(k) accounts are treated as ordinary income by the IRS. If you need to withdrawal a large sum for some reason this could really put you in a higher tax bracket than you would have otherwise been in. Now consider a ROTH 401(k) account with the same dollar. You pay the taxes now, and if you are just starting your career your tax bracket is most likely relatively low, and that dollar will grow just as the Traditional 401(k) account did earning you more money. Now you meet the guidelines of a ROTH account and decided to withdrawal your dollar and its earnings. Now these funds are 100% tax free and do not affect your income taxes as the money has already been taxed, the earnings are considered taxed as well, and the entire amount is tax free for income tax purposes. Now if you pull out a large amount from a ROTH 401(k) it will not place you in a higher tax bracket. And to be honest I do not see taxes or the tax brackets being reduced all that much over the next 30 years as more people retire and there are fewer workers earning money the government will have to keep taxes relatively stable as to ensure the funding source for government operations continues.
While all 401(k)’s require minimum withdrawals at age 70 ½ there is a way around this for ROTH 401(k) accounts. As a ROTH 401(k) participant you are allowed to withdrawal the funds and roll them over into a ROTH IRA that in turn does not have any minimum withdrawal requirements. And by doing this you can create a legacy account for your heirs with the use of beneficiary designations on the ROTH IRA allowing the beneficiary to make minimum withdrawals over their lifetime while allowing the account to still earn money. If you have any questions on this process feel free to contact me or seek a local financial advisor to assist you.
A ROTH 401(k) also allows for you to diversify your taxes by providing tax free income in your retirement years. While it is true that many will be in a lower tax bracket in retirement having a tax free source of income will aid in many respects. One it will have no effect on your Social Security benefits like a Traditional 401(k) might. As I mentioned earlier large withdrawals from a ROTH 401(k) will not be treated as a large influx of income for income tax purposes. And finally if you decide to retire before you reach age 65 and Medicare starts making withdrawals from a ROTH 401(k) will not increase your income for health insurance under the new health care law enabling you to possibly get government subsidies when you purchase your interim health insurance policies.
While ROTH 401(k) accounts are relatively new they have many positives and few negatives for people saving for their retirement. I would advise anyone to contribute to a ROTH account over a Traditional one as the benefits are better in my opinion. If you have any questions or need anything clarified please feel free to contact me or seek a financial advisor.
