One of my favorite retirement savings vehicles for high-income earners is the Roth 401k. I love it because there are a handful of benefits that perfectly suit the situation most high-income earners are in. This episode is devoted to breaking down the beneficial aspects of the Roth 401k, helping you understand the situations where it might be a benefit to you personally, and looking at the things you need to consider to make your decision.
You will want to hear this episode if you are interested in...
Why the Roth 401K is such a high-value investing tool [0:14]
Should you participate in the Roth 401K through work? Here’s how [2:47]
The various things you’ll need to consider when making this decision [5:01]
The big issues when considering distributions that come out without taxes [7:42]
The sales tip of the episode: [10:25]
My flashback: The INXS concert in Richfield, OH [11:08]
The reason I love the Roth 401k
The way I see it, the Roth 401k is the happy marriage between the best of the 401k and the benefits of the Roth IRA. What are those characteristics? First, the Roth 401k allows higher contribution amounts. This year under certain circumstances you can contribute up to $19,500 and potentially as much as $26,000 if you qualify. Secondly, there is no income limitation for participation. Third, if you follow the rules you can take money out of your 401k tax-free, and there is no tax on growth, either.
60% of employer retirement plans offer the Roth 401k to their employees. If you’ve got the opportunity to contribute to a plan of this kind, it may be in your best interest to do so. Why? Because the amount of money you make has nothing to do with whether you can participate. The only consideration you have to be aware of is the limitation on how much you can contribute in a given year.
And, with the Roth 401k, you’re making those contributions after you’ve already paid taxes on them. So, your investment will experience no taxes on its growth — which could be amazing for you if your investment performs well — and you’ll pay no taxes on any of the money you take out of it if you do so within the right time frames.
How to utilize the Roth 401k wisely
If your employer offers a Roth 401k option, you can add it to your retirement fund mix in a number of ways. It’s OK to contribute to the Roth 401k option, the traditional 401k option, or both. But keep in mind that your total employee contribution amount, in total between the two, cannot exceed the total employee contribution amount allowed. That’s up to $26,000 this year in any combination.
And let’s not forget about the tax benefits of the Roth 401k. None of us should tip Uncle Sam by paying too much in taxes. To make the right decision about whether the Roth 401k is right for you, you have to do some educated guessing. Is your current tax rate higher or lower than what you predict your tax rate will be in the future? If you think it’s lower right now, it makes sense to go with the Roth 401k. This helps you avoid paying higher taxes during retirement. But if you expect your tax rate to be lower during retirement, you should probably take the traditional 401k route to lower your current tax bill.
You also need to consider how much you have already saved in tax-deferred accounts. At age 72 you’ll be required to take money out of those tax-deferred accounts. If you’ve loaded up your tax-deferred accounts, it’s possible that you could be taking out money during retirement that is in excess of what you’re earning now. That money would cause you to have a high income, thus increasing the rate at which you'd pay taxes on those withdrawn funds.
Listen to hear more details about how the taxes work on a Roth 401k and to learn how to take distributions from these investments wisely.