“New Under-The-Radar Retirement Account”
For years, the term “Roth” was held just for Individual Retirement Accounts (IRA’s). However, the 401K and Roth IRA have birthed a beautiful child called the “Roth 401K” that a lot of companies are starting to offer to their employees but is rarely used. 70% of large American companies offer the Roth 401K option but only 11% of employees elect to use the option. For those workers in their 20’s and 30’s the Roth 401K account can be especially attractive because not only do your contributions into the account grow tax free, but when you withdraw the money after age 59 ½ it is withdrawn tax free! The real question is whether someone can accept the delayed gratification of forgoing a tax benefit today, for tax free withdrawals in the future. Here are a few reasons why we encourage employees to explore a Roth 401K option if their employer offers it.
My Tax Bracket Today is Lower than it Will be in the Future
One reason that a Roth 401K can make sense for someone compared to a regular 401K is if they believe their tax bracket in retirement will be higher than their current marginal tax bracket. In other words, if I’m in a 12% marginal tax bracket today then I will only get a tax benefit of 12 cents for every $1 of 401K contributions. If I believe my tax bracket will be higher than 12% in the future, then the benefit of tax-free withdrawals later, outweighs the benefits of lower taxes today. For someone who just started earning an income and believes their future earnings potential (even into retirement) will be higher than today, then this is a good strategy to pursue.
The Roth 401K is available regardless of your income
Another reason why a Roth 401K makes sense for employees to pursue is that there is no income limit like there is with a Roth IRA. In 2019, for a married couple filing jointly, your ability to contribute to a Roth IRA starts to diminish at $193,000 of combined income. That amount is $122,00 if you are single. While this is certainly a high-income threshold, this can be a great advantage of the Roth 401K for high earning individuals and families.
Roth 401K to Roth IRA transfers allow for greater flexibility in retirement
Another benefit of a Roth 401K is that it can be rolled over into a Roth IRA when you leave your current employer. This direct rollover is a tax-free event and then allows the individual to have complete control over where the Roth IRA funds are invested. Additionally, when this person reaches retirement, the Roth IRA has no requirements for minimum distributions like a 401K or traditional IRA would. Therefore, it provides a flexible, tax-free, alternative for people well into their retirement years.
August 2nd, 2019