Why Choose Roth 401(k)?
While a traditional 401(k) is a pretax retirement savings account, the Roth 401(k) is an after-tax account. With a Roth account, taxes are withdrawn from your pay, and then your Roth contribution is withdrawn.
This means that you pay taxes on your 401(k) before investing.
When you retire and begin taking your money out of your account, you pay no taxes, even on the capital gains, or growth of your account.
There are a few distinct benefits to a Roth account.
First, if you think that you will be in a higher tax bracket when you retire, then this is a good strategy to lock in a lower tax rate now, and avoid paying higher taxes in the future.
If you think you’ll pay more taxes because tax rates will be raised in the future, or you’ll have different income sources like other investments, or you will receive a raise, then a Roth 401(k) could be a good consideration for you.
Second, if you are already in a low enough tax bracket that the traditional pre-tax contribution isn’t enough to lower your taxes, then the Roth is a good consideration.
This is especially true if you have a very long retirement horizon. If you will be working for another 20-40 years, capital gains on your investment will more than likely grow enough to make up for the tax you pay before investing.
Third, you can have both Roth and traditional accounts.
In fact, this may be helpful in diversifying your retirement savings.
There are two requirements with Roth accounts in order to avoid paying tax
- You must be past the age of 59 ½.
- You must have the account for at least 5 years
If you fail to meet those two requirements, the IRS will not allow you to avoid paying income tax, and you may face a 10% penalty.
The IRS limits for 401(k) plans include Roth and traditional, meaning that the total combined amount that you contribute must not surpass the IRS limit for that year.