So, you’ve had a Roth 401(k) this whole time and didn’t even realize it! Well, I think that’s pretty common. Not a lot of people know that it’s available…or even what it is…or if they should use it…or why should they use it. That’s OK. It’s never too late to learn something new. I’m going to answer your burning questions, right now!

What Exactly is a Roth 401(k)?

Some Brief History

Before we get to that, let’s start with a different question…why the term “Roth”? Well, as you could predict, it’s someone’s last name. Delaware Senator, William Roth, Jr. helped establish the Roth IRA in 1997. As of 2001, we now have the Roth 401(k). I won’t bore you with anymore history than that.

What’s important is that this vehicle could possibly be the most powerful retirement tool available…for some. Let’s look at it by comparing it to the traditional 401(k).

Traditional vs. Roth 401(k)

When you contribute to a traditional 401(k), your money goes in BEFORE it’s taxed. The investments within the account now can grow tax DEFERRED (or delayed) until the money is taken out in retirement. Every dollar that comes out, is now taxed as if you earned it by working.

The Roth 401(k) has two major differences that give it such great potential. First, your money is taxed up front. You pay income taxes on it just like the rest of your earned income. Second, after meeting a few criteria, when the money comes out in retirement, it’s TAX FREE!

Let me say that again. The money comes out tax free!

Easy Requirements

So, what are those criteria? I’ll tell you.

  1. The account must have been opened for 5 years, and…
  2. You must be over 59 1/2, or…
  3. You must be either disabled or inheriting it from someone else.

I’ll get into some of the differences between the Roth IRA and Roth 401(k) a little later.

Does a Roth 401(k) Make Sense for Me?

How Old Are You?

Kiplinger points out that younger workers stand to gain the most from investing in a Roth 401(k) because they will enjoy many years of tax-free growth.

When the Roth IRA (and eventual Roth 401(k)) was created, it was because there were growing concerns of the lack of savings in our country. Senator Roth wanted to create something that would give more incentive for the younger generations.

The longer you have for this tax fee growth, the better off you’ll be.

Will You Pay Higher Taxes In Retirement?

Another “test” is your tax bracket. If you expect to be in a higher tax bracket in retirement, the Roth 401(k) makes sense.

Now, how the heck are you supposed to know what your tax bracket will be? Good question. You can’t. With tax law constantly changing and the shear amount of time you have until you retire, you can’t possibly know.

Keeping Your Options Open

Retirement Options

This makes another case for taking advantage of your Roth 401(k), at least for some of your savings. By have multiple sources of retirement income, some taxable and some tax free, you will have given yourself something very powerful…options.

Having the ability to CHOOSE from which account type to draw your income from at any given time will allow you to cater your retirement to the tax laws in place when you retire.

What Makes the Roth 401(k) So Great?

There are a few other features that I want to highlight briefly for you.

It Doesn’t Matter How Much You Make

Once your income reaches certain levels, you can no longer contribute to a Roth IRA. The Roth 401(k) does not have these limits, no matter how much you make.

You Can Contribute More

This year, in 2018, you can contribute up to $18,500 to your 401(k), whether it’s Roth or Traditional. The Roth IRA only allows you to contribute $5,500.

Another Case For Flexibility

It can serve as an “emergency fund” in retirement. A recent Forbes article points out a great example of this scenario, “Consider a retiree who encounters the need for a new roof and assumes a replacement cost of $20,000. If he or she desired to use 401(k) plan assets to pay for the new roof, he or she could withdraw $20,000 from a Roth contribution account.”

All in all, the Roth 401(k) has quite a lot of benefits. Whether you’re just starting out, or closer to the halfway point, there seems to be a case for it. Now that you’ve brushed up a little, it might be a good time get started.

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About Matt & Brad

They are identical twins and money experts.  Matt and Brad Ruttenberg have, combined, over 2 decades of experience as financial planners.  They are known for simplifying money and helping others go from living paycheck to paycheck to thriving financially.

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