Why A Roth 401k Plan Makes Sense For You
Most everyone knows about a 401k plan. It is a typical benefit employers provide to help their employees save for retirement. While there are many benefits to investing in a 401k plan, there are some drawbacks. As such, a new version of the 401k plan has been growing in popularity. The Roth 401k plan.
What is this type of retirement plan and what are the benefits? And should you even consider this investment vehicle for your retirement savings?
In this post, I’ll walk you through everything there is to know about a Roth 401k plan and help you make a well thought out decision as to whether or not you should start investing in one.
What Is A Roth 401k Plan?
A Roth 401k plan is just like a Roth IRA. You invest after tax money into this retirement account and it grows tax free. The only major difference between a Roth 401k plan and a Roth IRA is that anyone can invest in a Roth IRA.
But to invest in a Roth 401k plan, your employer has to offer this plan to you. You cannot just open one with Vanguard or some other broker.
Benefits Of Investing In A Roth 401k
There are many benefits to investing in a Roth 401k plan. For example:
- Tax free growth. Since you invest after tax money into the plan, the money grows tax free. This means when you withdraw the money, you do not owe any taxes on it.
- No required minimum distributions. With a traditional 401k or IRA, you are required to begin taking withdraws from the account once you reach age 70 ½. But this is not the case with a Roth 401k. There are no required minimum distributions.
- No income tax for your heirs. When you pass away and leave your Roth 401k plan to your heirs they will be required to begin taking minimum distributions. However, they will not owe any income tax on their distributions.
While this could be a benefit or not, depending on how you view it, it is important to know that employer matches are invested in a traditional 401k plan.
This means if you invest your money into a Roth 401k plan, any employer match is placed into a traditional 401k plan. Therefore, you will have two 401k plans. While this sounds confusing, you will only receive one statement and it will break out the balance of each account.
Employer matches are made this way as they have to be made in a pre-tax manner.
Can You Invest In a Roth 401k?
While investing in a Roth 401k might sound like something you want to do, unfortunately not all employers have embraced it as of yet.
Therefore, you will need to reach out to your benefits department and inquire as to whether or not you have the option to invest in a Roth 401k.
Why You Should Invest Your Money In A Roth 401k
Now that you know what a Roth 401k plan is and the benefits, should you invest in one? This all depends on your personal financial situation.
For some people who earn a large income and live in a high tax state, they could be better off continuing to invest in a traditional 401k plan. This is because the money that is contributed to the plan does not count towards income taxes, and this could save them a serious amount of money.
For those whose incomes are low, investing in a Roth 401k could be a great way to invest tax free for the future.
Finally, some people may want to review their current retirement holdings. If you have a lot of money in a traditional 401k plan and money in a traditional IRA, know that when you turn 70 ½ years old, you are going to have to start taking required distributions, regardless if you need the money or not.
This could cause you to end up in a higher tax bracket than you were expecting. By investing some money now into a Roth 401k and even a Roth IRA, you can save money for retirement and not have to worry about the tax impact.
Final Thoughts
The Roth 401k plan is a smart option for many people to save for retirement. By paying taxes now, you can enjoy tax free growth for many years down the line.
Be sure to look at your personal situation to see how and of investing in this retirement plan affords you any benefits.
Note: This article was originally published at Modest Money by Jon Dulin. Jon writes for Money Smart Guides, a personal finance blog that helps readers get out of debt and start investing for their future. He has been investing since he was 16 and has learned a lot through the years. He uses these investment lessons to help him be a more successful investor today.
Category: Personal Finance
