Roth 401(k)

What Is a Roth 401(k)?
••• Jason York/E+/Getty Images

A Roth 401(k) is a new option that many companies are now offering their employees. The Roth 401(k) is similar to the 401(k) since it uses the same investment methods and tools. You will have the same types of accounts to choose from, and be able to choose if you want to invest aggressively or conservatively. You will have to choose from the options offered through your employer, but you will be able to choose whether or not you want more aggressive investments or safer investments. There are the same penalties for early withdrawal as you would find with a traditional IRA.


What Are the Tax Benefits of a Roth 401(k)?

The Roth 401(k) investments are after tax investments. This means that any contributions will come out of your paycheck after you have paid income taxes. You will not get a tax break or lower your taxable income when you choose to invest in a Roth 401(k). However, the Roth 401(k) withdrawals are tax free, whereas you will pay taxes on the traditional 401(k) withdrawals.

There can be definite tax advantages to a Roth 401(k). You may want to talk to your CPA or financial planner and decide how this could benefit you. You will still have the annual contribution limits that accompany a traditional 401(k). While you can have both a traditional and a Roth 401(k), the total annual contribution limit stays the same, it does not double if you have two accounts. Your financial planner can also help you to develop an overall investing strategy that will help you build wealth over time.

You can often begin investing even without a large initial investment amount, if you will make monthly contributions. Take the time now to create a solid financial plan for your future.

Should I Choose a Traditional or Roth 401(k)?

As you choose between a 401(k) and a Roth 401(k), you should consider many things. You may want to estimate the tax bracket you will be in when you are making the withdrawals, as this will affect the amount of tax you may have to pay. Additionally it is important to consider the amount of money you will be paying taxes on. If you pay taxes on your contributions, then you will be paying taxes on less money, then if you pay on what you earn from your 401(k). If you look at it only from a tax standpoint, a Roth 401(k) makes more sense.

You may also be in a situation in which contributing to a traditional 401(k) will keep you in a lower tax bracket. This might be something that can help you save a bit of money now. However, not all employers offer this option, and it is better to invest in a traditional 401(k), rather than not invest at all. 

Why Should I Invest in a 401(k)? 

A Roth 401(k) may be your best investing tool for your retirement, since it happens automatically. You can also have your employer's match go into this account. A 401(k) also makes it easier to choose the type of investments since your employer will give you a few options to choose from. The options will focus primarily on low risk and lower growth, or higher risk with higher growth options.  

How Much Should I Be Contributing to Retirement? 

You need to work up to investing fifteen percent of your income to your retirement each year, which means you may also want to open a Roth IRA and have contributions go into that account. When you do this, you should choose an IRA that allows you to invest in mutual funds as opposed to one that just offers CDs, like you may find through your bank. This will give you a higher rate of return and help you plan for retirement better.

What Happens If I Change Jobs? 

If you change jobs, you can roll your 401(k) into an IRA. When you do this, it is best to roll it into the same type of IRA. For example, if you have a Roth 401(k), you will want to roll it into a Roth IRA, or you will end up paying taxes on your contributions and withdrawals. You can roll a traditional 401(k) into a Roth 401(k), but you will be expected to pay taxes on the amount when you do the rollover. If you do not have the money available, it is best to roll it into a traditional IRA instead.