As of January 1, 2006, U.S. employers have been free to amend their 401(k) and 403(b) plan documents to allow employees to elect Roth IRA type tax treatment for a portion or all of their retirement plan contributions. This type of plan is called a Roth 401(k).
Similar to Roth IRAs, these Roth employersponsored plans allow you to contribute money on an aftertax basis, so you do not have to pay taxes when you begin withdrawals during retirement. In addition, the earnings within the plan have the potential to grow tax-free.
Distributions from your Roth elective deferral contributions will generally be tax free in retirement, if you have met the qualified distribution requirements of being at least 59 1/2 years old and have maintained the Roth elective deferral account for at least five years.
Sounds great, right?
Let’s look into some of the pros and cons to see if a Roth 401(k) is right for you.
Essentially, the major difference between a traditional 401(k) and a Roth 401(k) is the affect it has on your paycheck. Contributions to regular 401(k) plans are made with pretax money, which means that your taxes are based on your salary minus your contributions, instead of your full salary. So, your taxes are lower, and your take home pay is higher.
By comparison, Roth 401(k) contributions are made with aftertax money, which means that you do not receive this tax break during your working years. So, your taxes are higher, and your take home pay is lower. But, when you retire, your contributions have grown tax-free.
Today’s businesses have a variety of workers and having a choice for contribution plans just makes sense. Not every method of saving for retirement is right for every employee. If your current 401(k) provider doesn’t offer a Roth 401(k) plan option, ask your administrator to add it.
Remember it’s YOUR retirement we’re talking about. The more you know and understand, the better off you will be. And, as always, please speak with your financial advisor to discuss which options are best for you.
MBA, QKA, CBC