Deciding if a Roth 401(k) is Right for Me

by Jason Hamilton, CFP^®

Most of us have known for years that we can contribute to our employer 401(k) through automatic payroll deductions. It’s become a common practice and many employers have established retirement plans to help attract and retain employees. When the company matches employee contributions, it becomes a powerful tool for you as a savings plan for retirement.

Some of you may be questioning whether a Traditional 401(k) is the appropriate tool compared to the Roth 401(k) option your employer may now offer. Don’t get confused; these are not two different plans that you can max out. This is an option within your employer plan where you allocate contributions. You can split your contributions between both account types up to the annual maximum amount of $23,000, or $30,500 if you are 50 or older.

The biggest difference between these two types of 401(k)s is the timing on payment of income taxes. Traditional 401(k) contributions are pre-tax, therefore you will recognize the tax benefit today and defer taxes until retirement when you receive the money. This helps lower your taxable income today and if you think you’re in a higher tax bracket now than you will be in retirement, it may be the right choice.

Roth 401(k) contributions are funded with after tax money. Your contribution will be made after you’ve paid taxes. The money will grow tax free and not be subject to tax upon withdrawal at retirement. This can be an extremely powerful tool and beneficial to those who believe they may be in a higher tax bracket during retirement.

Most people don’t know for sure if they will be in a higher or lower tax bracket during retirement. For those nearing retirement now, you may have a better picture of what tax bracket you’ll be in during retirement, but if you haven’t been utilizing a Roth 401(k), the power of tax-free compounding over time will be diminished. For those who are younger, it’s difficult to gauge retirement taxes for the future, but a solid financial plan can help you better understand your options and what potential future taxes may look like.

If you’re still not sure what to do, we recommend an account type diversification. It is just as important as portfolio diversification. If you can have several investment buckets to choose from in retirement, this will greatly add to the flexibility of where you can pull funds from while managing taxes. Having a traditional IRA/401(k), a Roth IRA/401(k) and taxable investment account provides great flexibility. If you haven’t started funding a Roth account, maybe you start by splitting your 401(k) contributions between a Traditional and Roth 401(k). Remember, for now, employer matches always fund into your Traditional 401(k). If you have questions, please reach out to us as we would be glad to have a conversation with you about what is right for you. 

We provide the information in this newsletter for general guidance only. It does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, investment, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, expressed or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.