What You Should Know About the Roth 401(k)

Determining when to pay taxes could make all the difference in your retirement nest egg

You’ve heard about the traditional 401(k) and the Roth IRA, but you may not know much about its hybrid—the Roth 401(k). This article will tell our readers what they need to know if they are considering this retirement savings vehicle. When Candi Sparks began saving for retirement, she chose not to participate in her company’s 401(k) plan because she didn’t want to pay taxes during retirement. Since her company did not offer the Roth 401(k) at the time, she chose the Roth IRA instead. With the Roth, she likes that she can pay taxes on the money upfront, but when she retires, she’ll be able to withdraw her money tax-free. The only thing she doesn’t like about the Roth IRA is that it has lower contribution limits than the 401(k). Sparks is interested in the Roth 401(k) because it offers the best of both worlds: no taxes during retirement, yet higher contribution limits.

Author Candi Sparks opts for the Roth 401(k)

While many people save for retirement in a 401(k) plan because it lets them defer paying taxes until they withdraw the funds, that approach didn’t appeal to Candi Sparks.

“Everyone assumes they’ll be in a lower income tax bracket when they withdraw the money after retirement, but you might not be,” says the New York-based author of Can I Have Some Money?, a series of financial books for children. “I wanted to save myself from having to pay taxes during my golden years.”

So when Sparks began saving for retirement, she chose not to participate in her company’s 401(k) plan but to save in a Roth IRA instead. With the Roth, she paid taxes on the money upfront, but when she retires, she’ll be able to withdraw her money tax-free.

The only downside in her eyes: The Roth IRA had lower contribution limits than the 401(k) plan so she couldn’t save as much money in the account as she would have been able to with the 401(k). If she could have paid her taxes upfront and enjoyed the higher contribution limits of the 401(k) plan, she would have embraced that option. Today, many employees are enjoying the best of both worlds as more companies are offering a relatively new hybrid between the two called the Roth 401(k).

In 2006, the Roth 401(k) was introduced as a way for Americans to make after-tax contributions to their 401(k) plans. Since the taxes on your contributions are paid up front, the money grows tax-free, so you can make withdrawals once you’re 59 ½ without paying income tax on it. It’s important to note that if your company matches your Roth 401(k) contributions, the taxes are not paid on that portion up front. It’s stored separately from your contributions, and when you withdraw the money that was contributed by your employer, you’ll have to pay taxes on it.

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