We're told we're supposed to save diligently for retirement during our working years, and socking away funds in a 401(k) is a great way to do so. If your employer offers a 401(k) plan, you can consider yourself lucky. And if that 401(k) comes with a Roth savings option, consider yourself even luckier.
Roth 401(k)s have grown increasingly popular over the past few years, so much so that 70% of all 401(k) plans offer a Roth feature, according to the Plan Sponsor Council of America. Here are a few reasons to consider taking advantage of a Roth 401(k) if it's available to you.
1. You get the same generous annual contribution limits as a traditional 401(k)
One major advantage that both traditional and Roth 401(k)s have over IRAs is their contribution limits. Beginning in 2019, workers under 50 can sock away up to $19,000 a year, while those 50 and over get a catch-up provision that allows them to set aside up to $25,000 on an annual basis. The annual limits for traditional and Roth IRAs, on the other hand, will be just $6,000 for younger workers and $7,000 for those 50 and over as of 2019.
2. You get tax-free growth on your investments
The money you contribute to a traditional 401(k) gets to grow on a tax-deferred basis. This means you don't pay taxes year after year as you see gains in your account, but you do pay taxes eventually. Roth 401(k)s, by contrast, offer tax-free growth, which means that once you have money in your account, you'll never have to pay taxes on it again, regardless of how much the investments in your account earn.
3. Your withdrawals in retirement will be tax free
Many savers are drawn to the traditional 401(k) because contributions go in on a pretax basis. Roth 401(k) contributions do not, which means there's no up-front tax break involved. But whereas traditional 401(k) withdrawals are taxed in retirement, Roth 401(k) withdrawals are not. This means that if you save $1 million in your Roth 401(k) for retirement, that entire $1 million will be yours to use; you won't have to factor taxes on that amount into your retirement budget.
4. You can fund a Roth 401(k) as a higher earner
Up until the Roth 401(k) was introduced, Roths only existed in the world of IRAs. The problem, however, is that higher earners are barred from making direct contributions to a Roth IRA, thereby taking that option largely off the table (though it is possible to convert a traditional IRA into a Roth as a higher earner). The beauty of the Roth 401(k) is that income limits don't apply -- you can fund a Roth 401(k) directly no matter what you earn, provided your employer offers that option.
Is a Roth 401(k) right for you?
If you're contemplating whether a Roth 401(k) makes more sense than a traditional one, a big question to ask yourself is this: Will my tax bracket be higher in retirement than it is today? If the answer is yes, then it generally pays to save in a Roth, pay taxes on your contributions at today's lower rate, and then enjoy tax-free withdrawals when you're potentially in a higher bracket.
Another thing to keep in mind is that we don't know what tax brackets will look like in the future. The tax code can change over time, and if rates go up substantially across the board, having a traditional 401(k) might end up costing you more money in taxes than you may have anticipated. By saving in a Roth 401(k), you're effectively locking in your current tax rate each time you make a contribution, thereby avoiding the risk of the unknown.
One final thing: If you like the idea of a Roth 401(k) but don't want to completely lose out on the immediate tax break you'll get from its traditional counterpart, consider divvying your savings equally among both. This way, you get some tax benefits today, but you'll also have money available to withdraw tax free in retirement.
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