Picture this…You just accepted a new job and are working through the onboarding process: setting up direct deposit, enrolling in benefits and determining contributions for your 401(k) plan. You’re familiar with a traditional 401(k), but you learn that your company gives you the option to make contributions to a Roth 401(k).
Is a Roth 401(k) a good fit for you? You may not have ever considered it before. Let’s take a look.
What should you think about before enrolling in a Roth 401(k)?
It all comes down to taxes, and when the IRS takes its cut. As you know, for a traditional 401(k), you make pre-tax contributions and then you’ll pay taxes later when you begin qualified withdrawals. For the Roth option, you will pay income tax now, then make post-tax contributions, which you will be able to withdraw tax-free in retirement.
This is a great option if you expect to be in a higher tax bracket when you’ll be making withdrawals. The account grows tax-free and distributions are tax-free in the future, as long as the account has been established for 5+ years.
The other benefit to a Roth 401(k) is that when you separate from service at your job, you can roll over your Roth 401(k) into a Roth IRA. By doing so, you are not required to take the IRA mandated Required Minimum Distributions (RMD) that you would otherwise have to take from a traditional IRA.
If you think your income might be lower in retirement, and your tax bracket will follow suit, you may want to focus on maximizing your traditional 401(k). Maximize your 401(k) contributions now—as those will grow tax-deferred until you distribute at retirement.
If you believe your tax rates are going to be proportionally higher in your retirement years, it may be in your best interest to consider a Roth 401(k). Pay the taxes now, and withdraw worry-free later.
That being said, for highly compensated tech professionals in the upper tax brackets, we would advise you to coordinate with your CPA on this strategy. Since you are so highly compensated today, you could end up paying more in taxes now than you will in the future.
Still need help determining your 401(k) strategy, and if the Roth option is right for you? Let’s chat!
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