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

What Is a Roth 401(k)?
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You've probably heard of a 401(k) or an IRA or even a Roth IRA. But what about a Roth 401(k)?

A Roth 401(k) is similar to a traditional 401(k) in many aspects, with one main difference – it deducts your contributions post-tax. That way, you will likely not have to pay taxes on your distributions and income when you retire. It's ideal for those who expect to be in a higher income bracket come retirement.

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

The Roth 401(k) investments are after-tax investments. This means that your contributions will be deducted from your paycheck after 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), but the biggest pro is that once you are retired, you can withdraw your funds tax-free. Though 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. You may want to talk to your CPA or financial planner and decide how a Roth 401(k) could benefit you.

Your financial planner can also help you to develop an overall investment 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.

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

When considering either a traditional 401(k) or a Roth 401(k), you should do your research to figure out the best option for you.

First, estimate the tax bracket you will be in during retirement when you will begin making withdrawals, as this will affect the amount of tax you may have to pay. If you look at it only from a tax standpoint, a Roth 401(k) makes more sense.

However, if you estimate that you will be in a lower tax bracket when you retire, then contributing to a traditional 401(k) makes more sense. However, not all employers offer Roth 401(k)s, so better to invest in a traditional 401(k), rather than not invest at all. 

How Much Should I Be Contributing to Retirement? 

Experts suggest putting aside 15% of your take-home pay for retirement, but you may need to work up to this amount. That's OK. The important thing is to get started.

You may also want to open a Roth IRA and contribute to both that and your 401(k) to max out your retirement savings. If 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 build your retirement savings more quickly.

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 at the time of rollover. If you do not have the money available, it is best to roll it into a traditional IRA instead. 

Updated by Rachel Morgan Cautero.