Should I Invest in a Traditional or Roth 401(k)
I got an interesting email at work yesterday. As of November 1st of this year, my company is going to begin offering a Roth 401(k) along side its traditional 401(k) plan. Yes, that says Roth 401(k), not IRA! I’ve spent much of my time since then researching the topic to see if I should steer some or all of my 401(k) contribution to the Roth option. Here’s what I found, and what you should know…
Benefits of the Roth 401(k)
Much like the Roth IRA, the Roth 401(k) is funded upfront with after-tax dollars. Once you hit age 59.5 you are able to start withdrawing from the account tax-free.
The edge the Roth 401(k) has over its IRA cousin is that the 401(k) contribution limits still apply to the 401(k) version. Meaning that you can contribute a full $17,000 per year to the Roth 401(k) while you are limited to just $5000 in the Roth IRA.
So the Roth 401(k) is great just like the Roth IRA except that we’re able to contribute A LOT more money to it each year. The only disadvantage it has to the Roth IRA is that you’re still limited to just the investment choices your company offers in your 401(k) plan. Other than that, they’re very similar.
Should I Invest In The Traditional Or Roth 401(k)?
As you might expect…it depends. If you think you’ll be in a higher tax bracket come retirement than you are today, a Roth 401(k) will be a good option. So if you’re in your 20’s or early 30’s you should strongly consider the Roth option if your company offers it.
A Roth 401(k) could also make a lot of sense for higher income earners who don’t meet the income limits for a Roth IRA but still want to build up a tax-free reserve for retirement.
Personally I’m going to pass on my company’s Roth 401(k) option. I contribute to the traditional 401(k) up to the match and then contribute to my Roth IRA each month. Because my company has pretty limited investment choices in our 401(k) plan I prefer to invest anything above the company match in an IRA where I have more control over what I can invest in. If/when I reach the point where I’m maxing out my Roth IRA each year, I’ll turn to the Roth 401(k) option to keep building a tax-free pool of money to withdraw from when I retire. Keep in mind, this is only my personal choice, your situation may vary!
What else to consider
Before investing in a Roth 401(k) its important to read the fine print. Make sure your company will match funds contributed to the Roth 401(k) as well as the Traditional version. This won’t be a problem for most, but I have heard of companies that will only match in the Traditional.
You’ll also want to consider taxes. If you decide to contribute to a Roth instead of a your Traditional 401(k) you can expect your tax bill to go up in April because you’ll be contributing after tax dollars instead of pre-tax as you had been.
If you have a Roth 401(k) available to you definitely take the time to consider your options. Remember, there’s no rule saying you have to choose one or the other! You can always split your current contribution between the two types or better yet, increase your contribution and put the extra towards the Roth 401(k) option. You can’t go too wrong with whatever you choose. The important thing is that you’re focusing on saving and actively looking for better ways to invest your money. That alone puts you way ahead of the 8-ball.