The Roth 401(k): What Is It And Should I Invest In It?

Wednesday, June 3, 2020 | Leave a comment

By Darrell Bryant

Does your employer offer both traditional 401(k) and Roth 401(k) options? Are you confused about which one may be right for you? It’s hard to know if you’re better off paying taxes on our retirement dollars now or later. But when it comes to choosing how to save for retirement, there’s a lot more to consider than just taxes. Let’s look at the Roth 401(k), how it works, and whether or not it’s right for you.

Roth 401(k) Basics

If you take a traditional 401(k) and combine elements of it with a Roth IRA, you get the Roth 401(k). (1) It’s an employer-sponsored retirement savings plan—like your traditional 401(k). However, unlike your traditional 401(k), you fund it with after-tax dollars instead of pre-tax dollars. 

Like a 401(k), an employer-sponsored Roth 401(k) plan enables you to defer up to $19,500 of your salary per year (or $26,000 if you are age 50 or older due to the catch-up provision). Your funds grow tax-free for retirement and you won’t pay taxes when you start taking distributions as long as the withdrawal is a qualified distribution. 

The Fine Print 

Remember that you pay taxes up front with a Roth 401(k), which means you will contribute money from your paycheck after it is taxed. However, once it’s in the account, your money grows tax-sheltered and your qualified withdrawals are tax-free.

There are several rules when it comes to taking qualified distributions from your Roth 401(k). When you decide to retire, you can start taking distributions without penalties as early as age 59½ or if you’ve experienced a disability. If the account owner passes away, funds can be withdrawn by the beneficiaries. You must also have had your account for at least five years to withdraw from the account or you’ll be required to pay taxes on the gains.

Like most other retirement accounts, you are required to start taking distributions no later than the age 72 unless you are still employed and not a 5% owner of the business.

The Benefits Of A Roth 401(k)

One of the biggest benefits of a Roth 401(k) is that you can contribute to a retirement account that provides tax-free income regardless of your adjusted gross income. As there aren’t income limitations on Roth 401(k) contributions, high-income earners can invest in a Roth 401(k) to earn tax-free income rather than contribute to and convert a traditional IRA into a Roth IRA. This can make a Roth 401(k) a good option for an individual who doesn’t qualify for a Roth IRA but would like to generate a tax-free retirement income.

Additionally, with a Roth 401(k), you can also contribute to a traditional 401(k). Each year, you can contribute $19,500 (or $26,000 if you are over 50) to your 401(k), a Roth 401(k), or a combination of the two. 

Should I Invest In A Roth 401(k)?

Unfortunately, there isn’t a one-size-fits-all answer, as everyone’s needs and circumstances vary. However, here are a few reasons why someone may choose to invest in a Roth 401(k). 

If you’re early in your career, you may benefit from investing in a Roth 401(k) because you’ll enjoy a number of years of tax-free growth. Additionally, if you anticipate being in a higher tax bracket when you retire, a Roth 401(k) can make sense. You’ll be paying taxes up front based on your income now, rather than when you’re older, at a time when tax rates may potentially be higher. And if you don’t qualify for a Roth IRA but want to diversify your retirement income sources, a Roth 401(k) could be the solution. 

However, there are times when a traditional 401(k) might be a better choice than a Roth 401(k). If you anticipate your tax rate being lower when you retire than it is now, a traditional 401(k) could make more sense, as you’ll avoid having to pay taxes on your contributions now when your tax rate is higher.

Review this chart from the IRS, (2) which provides an overall comparison of your options:

How We Can Help

Should you invest in a Roth 401(k), traditional, or both? Are you eligible for a Roth IRA? Should you roll over a past 401(k)? There are a lot of questions to address when you’re planning for retirement. At D. Bryant Retirement Strategies, we’re committed to taking the complexity out of saving for retirement. We help manage your retirement accounts and simplify your financial life so you can focus on the things that matter most to you. To learn more, call us at (402) 932-2141 or email contact@dbretirement.com.

About Darrell

Darrell Bryant, CFS®, CAS® is Omaha’s Retirement Strategist. As the founder of D. Bryant Retirement Strategies, he focuses on helping individuals and couples nearing retirement do so successfully. Along with more than 30 years of experience, he received the Certified Fund Specialist (CFS®) designation and a Certified Annuity Specialist (CAS®) designation from the Institute of Business & Finance. Passionate about helping as many people as possible in his community, he hosts Retirement Strategies Radio, heard Saturday mornings at 8:00 a.m. on 1110 KFAB. He has also written articles on financial planning that have been featured on Fortune.com, FoxBusiness.com, Money.com, and in the Midland Business Journal. To learn more, visit his blog, his website, or connect with him on LinkedIn.

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(1) https://www.investopedia.com/terms/r/roth401k.asp

(2) https://www.irs.gov/retirement-plans/roth-comparison-chart

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