Steve Coker, CFP
Making the Most of Your Roth 401(k)
When it comes to saving for retirement, your 401k plan is a great place to start. 401k plans offer higher contribution limits ($18,500 for 2018) and often include employer matching. Many also allow employees to make either traditional or Roth 401k contributions. So, which should you choose? Traditional or Roth? The answer is, of course, it depends. In this article, we will give you guidelines to help you get the most benefit out of the Roth option in your 401k. First, let’s discuss how your 401k works. A traditional 401k is structured so that you receive tax savings right now in the form of deductions for your contributions, but you must pay taxes later when you pull the money back out for retirement. In the meantime, your money grows tax-deferred (meaning you don’t have to pay taxes on earnings in your 401k until you pull the money out). In contrast, your Roth 401k is funded with after-tax money, meaning you pay taxes on the money you contribute, and you get no immediate benefit. However, the money grows tax-free, essentially forever, giving you significant long-term benefits. To help you decide when to contribute to what, we’ve created a simple game plan that will guide you through making the most of your 401k options. In your 20s In your earliest working years, we recommend that you begin saving for retirement in a Roth 401k. This is because in your earliest earning years you are likely making less than you will later in your career, thereby placing you in a lower tax bracket. Also, you have many years until retirement, and therefore, you will take full advantage of the tax-free growth in the Roth 401k. In your 30s As you earn more, you will slowly be pushed up into higher tax brackets, but your earnings may be offset by deductions for a mortgage or dependents if you choose to buy a house or have children. If possible, it is still a good idea to target Roth contributions first. In your 40s For most individuals, your 40s are when you begin to hit peak earning years. Despite this, it is usually still best to contribute to a Roth 401k. Admittedly the benefit of the Roth 401k is less since you are likely in high tax brackets and you are closer to needing the money. If you are in higher tax brackets you may want to consider splitting your contribution. Alternatively, consider discussing your situation with a financial planner. Making the right decision could save you thousands in taxes. In your 50s At this point you are beginning to approach retirement and likely should be contributing to a traditional 401k. Once you reach the age of 50 you also become eligible for what the IRS refers to as “catch-up contributions.” Catch-up contributions are intended to help individuals “catch-up” on their retirement savings by contributing extra beyond the regular limit. In your 60s Once you reach retirement, depending on your situation, you may want to look at converting some of your traditional 401k money into a Roth IRA. In doing so, you will have to pay the taxes, but after the conversion, the Roth money will grow tax-free. This option is not right for everyone so I would consult with your financial planner. Consider this option especially if you have a large 401k or IRA that you will not spend during your lifetime. Roth money is much better to leave to heirs and is not subject to Required Minimum Distributions at 70.5, making Roth’s a very helpful tool later in life.
The process of saving for retirement can seem daunting but having a good game plan can make all the difference. To learn more about the best way to set up your 401k plan and to get help on creating a winning game plan, request a meeting with one of our knowledgeable advisors today.
*A version of this article first appeared on March 20, 2015
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