Is the New Roth 401(k) Right for Me?

When the Roth IRA first came on the scene a few years back, it created a great deal of excitement on the part of investors, and no small amount of confusion. The reaction to the new Roth 401(k) is likely to be much the same. This article is intended to be a quick guide to this new investment vehicle.

The new Roth 401(k) shares many similarities with the Roth IRA. Like the Roth IRA, the account grows tax free, and the withdrawals made during retirement are not subject to regular taxation as with the proceeds of a normal 401(k). Also like a Roth IRA, the deductions to a Roth 401(k) are made with after tax dollars. Investors forgo the up front tax break for a potentially bigger tax benefit down the road.

The Roth 401(k) may be a particularly good choice for high earners whose income makes them ineligible for a Roth IRA plan. The eligibility for a Roth IRA phases out at between $95,000 and $110,000 for single people and between $150,000 and $160,000 for married people who file jointly. Unlike the Roth IRA, there are no income restrictions for participation in a Roth 401(k).

While workers have the ability to contribute both to a regular and a Roth 401(k), the contribution limits apply to the combined accounts. The contribution limit is a straight $15,000 for the combined accounts. Workers cannot save $15,000 in a Roth 401(k) and another $15,000 in a regular 401(k).

The decision of whether to opt for a Roth 401(k), stay with a regular 401(k), or do a combination of both, can be a difficult one. Workers will have to decide whether to contribute to a Roth 401(k) and tax a cut in their take home pay or stay with a traditional 401(k), while hoping that your tax rate will be lower in retirement than it is now. Of course workers are free to contribute to both accounts and mitigate the risk.

The decision of whether to contribute to a Roth 401(k) or a traditional plan hinges on what you think your tax rate will be in retirement. Those who expect to have a higher tax rate in retirement will be better off with a Roth 401(k), while those who expect a lower tax rate in retirement would be better off taking the up front tax savings available with a traditional 401(k).

Of course, it is possible that your employer will make this important decision for you. Not all employers are expected to offer the new Roth 401(k). For those who have the choice, however, it is important to review the options carefully and determine if the new Roth 401(k) is a good choice for you.

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