The Roth 401K Enters Our Arena
Last week, my spouse’s work rolled out a new option for retirement investing – the Roth 401K. We’ve been given a lot of information about it, and my spouse and I are in a bit of disagreement on whether or not we should utilize it. Since this was a new (to me) investment vehicle, I wanted to explain what it is, how it works, the options we’re given through my spouse’s work in utilizing it, and then what we’re deciding on so far (although we have a little while to make a decision, and then we can change our mind every quarter if we’d like, so we’re not locking into anything permanent).
The Roth 401K is basically a retirement savings option quite similar to the traditional 401K. The big difference is that with a traditional 401K, taxes are deferred until you retire and start taking money out of the plan, but with a Roth 401K, you pay taxes now on your contributions, and not when you retire and start taking money out. You also do not pay taxes on any earnings from the Roth 401K contributions (you do in a traditional plan). This is because when you put the money into a Roth 401K, you pay taxes on it immediately. In a traditional plan, you pay taxes on your withdrawals, which include the earnings on the money.
For our particular offerings, we can choose to have a traditional plan, a Roth plan, or a combination of both. My spouse’s employer pays a 20% match on the first 6% of salary in contributions (so 20 cents per dollar up to the first 6% of their salary they are investing), and will pay that to match either plan. The one difference is that no matter which you contribute to, the employer match will go into a traditional 401K since you did not pay taxes on their match. We also cannot move money we previously invested in the traditional 401K into the Roth 401K, just new contributions can go there. the total allowable contributions to both plans combined is still the maximum allowable to a 401K, you can’t contribute the maximum to each plan to double your retirement savings each year.
For us, right now we are sticking with the traditional 401K we are already investing in. This is my spouse’s decision, and I am fine with his choice. We’ve discussed it at length, and although I would personally change over to the Roth 401K plan myself, he thinks that the tax benefits serve us better now than they will in the future when we retire. This is, however, an ongoing discussion and we may change it at some point. I’m not surprised, for I am the one with the Roth IRA and he has a traditional IRA. Since we have to pay a big tax bill this year as it is, I suspect that is factoring into his current decision. But in the future we may adjust or change completely over, we’ll see.
Do you have multiple 401K offerings through your workplace? What’s factored into your current investment decisions?
March 23rd, 2009 at 1:29 pm
Most experts will tell you to invest in both, but put more towards the 401(k) rather than the Roth. Most people are advised to have both a Roth IRA and utilize their companies 401(k). My company also offers both so I did not have to find a Roth IRA on my own.
March 23rd, 2009 at 1:59 pm
Erin – it is actually not a Roth IRA they offer, it is a Roth 401K. SO it has the same investing rules as the regular 401K as far as how much to contribute.
March 23rd, 2009 at 2:24 pm
My husband’s employer offered this last year and we switched to the Roth 401K. It may still be the right move, however there was one thing we didn’t factor into the decision that has just come back to hurt us. With a regular 401K, you reduce your wages by the amount you contributed when you calculate your taxes. With the Roth, you do not. So our income this year on our tax forms was $15K higher than last year. We have been paying taxes on it all along, so we don’t owe more, HOWEVER, it bumped us up enough that we now don’t qualify for other types of tax breaks that are offered for lower income brackets. We didn’t make more this year, we just didn’t get the lower AGI. I can’t complain too much, we make enough that this is even a problem, most people should be so lucky! But we didn’t think about this at the time. So we are now over the limits for several other things that rely on AGI. Just something to think about to see if it applies to your situation.
March 23rd, 2009 at 2:47 pm
I currently hedge by putting about 50/50 into each. If you have money in both it will give you more flexibility to work the system to your advantage when you retire (you might take out of the roth if you are close to bumping up to the next bracket, etc.). Ultimately, who knows if tax rates will go up or down in the future.
March 23rd, 2009 at 3:22 pm
We do the same thing as Mark. We’re in a pretty low tax bracket right now, so one would think that paying the taxes now makes more sense than later, but like Mark said, who knows what tax brackets will do in the future? Radical changes could be coming and screw up all your planning…
March 23rd, 2009 at 5:44 pm
I have the same Roth versus Traditional 401(k) options at work. I put a small percentage towards the Roth, and a larger percentage towards the Traditional. I’d like to do more in Roth, but right now I want a bit more of the tax break (even though I’m well under any tax bracket cut-offs).
March 23rd, 2009 at 6:45 pm
Couple of things:
@Mark – splitting it does seem to be an option where I work
@Claire/thisisbeth – it is tempting to switch now due to taxes being lower now than they may be later. I guess my holdup is that we are in debt now but hopefully won’t be when we retire
March 23rd, 2009 at 7:29 pm
It takes a whole lot of math and assumptions to figure out which is better, at least in a state with no income taxes and in a high federal bracket. I love this article:
http://www.livingalmostlarge.com/2008/08/07/to-roth-or-not-2/
March 23rd, 2009 at 9:45 pm
In the end, the decision between Roth & traditional — whether IRA or 401(k) — is about how much money you’ll be making in retirement vs your current. Most people’s retirement will take them down a tax bracket or two, so it makes more sense to pay lower taxes on a bigger amount than higher taxes on a smaller amount.
But since matching funds come into the picture, well that’s just a new fun wrinkle. I’m sure there’s a more precise way to figure it out, but I would probably just split it since you’re going to get the matching contributions in a traditional 401(k) anyway. And clearly you and your spouse have different opinions on tax benefits. This way you hedge your bets.
March 24th, 2009 at 7:36 am
When I last looked at this you could actually put marginally more into a Roth IRA ($15.5k after tax is more than $15.5k before tax). I’m a bit of a tax hedge person and contribute to British investment accounts that are pre-tax, and post-tax.
This is one of those choices where nothing is really wrong. Undoubtedly one will turn out to be better than the other but it’s impossible to know in advance which one that’s going to be.
March 24th, 2009 at 5:32 pm
My workplace only offers the traditional 401K that I’m aware of. What I do is put enough into the 401K to get the full company match and the rest into a Roth IRA. If I somehow max out the Roth, then I would bump up my 401K contribution more.
March 24th, 2009 at 6:37 pm
I guess what I do is actually the most popular thing to do (splitting between the two)! My husband and I get our company matches on the traditional 401k’s and max out our Roths.
March 29th, 2009 at 8:04 pm
Having recently finished our taxes, I have some of the tax consequences fresh in my mind.
Karen pointed out the benefits if you go with the traditional account and the amount that you contribute to the 401k reduces your Adjusted Gross Income to and amount where qualify you for other benefits. I believe (for me at least) this is in the ballpark of $40k AGI. Once you get under whatever that magic number is, you qualify for EIC and additional child tax credits, and probably other things.
If your income is above that level, then it is a question of which tax rate do you want to pay: the rate you are at now, or the rate you will be at after you start withdrawing money from that 401k. My basic thought is that you are probably at a higher tax rate now then you will be in retirement, so the Roth plan makes more sense since it is taxed during retirement (presumably at a lower rate).
April 26th, 2009 at 12:55 pm
One thing everyone is failing to mention is that the interest/dividends earned are also tax free in a ROTH 401(k). It is important to consider that factor also when doing your planning. Personally being a younger employee, I have a ROTH 401(k). I expect the interest earned off my investments to trump the initial investment.
July 7th, 2009 at 12:53 pm
With the enormous debt that our country is building up, what’s to s to say that your Roth 401k won’t be taxed? Laws can be changed and thereks nothing preventing congress from taxing you twice on the same money if they think they need it.
I
December 23rd, 2009 at 12:37 pm
If congress decides to do tax roths there will be a revolution.