Why I Love my Roth 401k

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You 401k balance is not really all your money!

What?    

Your 401k statement balance is not what you really own.  You need to subtract the ordinary income taxes from the balance to get the real surrender/cash value of you 401k plan or IRA.

While most people will not cash out their 401(k) all at once. The fact remains that when you take money out of a 401k or IRA it is added to your other ordinary income and taxed at your marginal ordinary income tax rate.  Take out too much in one year and it may cause your social security income to be taxed.  This is another hidden penalty of relying on your 401(k) for retirement income.

Thanks to President’s Trump’s 2017 Tax Cuts and Jobs Act, tax rates are historically very low. Many people using a traditional 401k may be making  tax-deductible contributions at today’s low rate, only to pay at a higher tax rate when they pull the money out at retirement.

Consider switchhing to a Roth 401k.

The Roth 401k is a one of a kind investment wrapper.

What is a Roth 401k? – It’s almost identical to your traditional 401k. It’s an employer sponsored retirement plan that allows you to automatically contribute a portion of your income directly from your paycheck.

Who can contribute to it? – Any employee that has access to such a plan with no income limitations just like a traditional 401k. If your employer offers a traditional 401k, but not a Roth 401k, ask the person in charge to add this option. It should not be an additional expense for the employer.

How does it work? It’s a paycheck deduction plan just like a traditional 401k.  Unlike a traditional 401k, the contributions are NOT tax-deductible. Like a traditional 401k, the growth of the money is not taxed (tax-deferred). The big difference is that withdrawals after age 59 ½ are income tax-free!

Will I lose my employer matching contribution? No, it should not impact your match.

Why I contribute to a Roth 401k

The number one reason I contribute to a Roth 401(k) rather than a traditional 401k is that I am protecting myself from a confiscatory (taxes) government.  Our U. S. Government is currently $21,000,000,000+ in debt – (click amazing debt clock) and that number is growing by the thousands, literally every second of the day! This is due to the government spending more that it brings in via taxes. The 12/2017 Trump Tax Cuts and Jobs Act tax law lowered tax rates and increased tax revenues, but spending increased even more! In large part entitlement programs (social security, Medicare, etc.)  are largest out of control costs.

I believe there is a good chance income taxes will be raised substantially in the future in an attempt to pay for all these programs. Ideally, the promised entitlements would be reduced or put off as part of any long-term solution. This would be a needed reduction in government spending, but don’t hold your breath.

Contributing to a Roth 401k is a form of tax diversification in retirement.  At retirement, I’ll have the option of pulling money from a traditional IRA and pay tax then at my ordinary income tax rate. I’ll also have the option of taking from taxable investments and pay tax at a capital gain rate, or draw from my Roth IRA and owe $0 in federal tax. I look forward to being able to having this tax flexibility.

Key Points:

• Unlike a Roth IRA, there are not any income restrictions on a Roth 401k. The income cap keeps some people from being able to  contribute to a Roth IRA.
• The obstacle to having a Roth 401k may be that your employer does not offer this opportunity.  Most 401k plan providers will offer this option if your employer requests for their employees.
• You employer can still make matching contributions.  Those would go into a separate pre-tax basket within your plan and be taxable at distribution.
• The contribution limits are the same as a traditional 401(k), now $19,000 per year in 2019 and $25,000 for people over age 50. You can contribute this if you have “earned” income to contribute.
• Unlike a traditional 401(k), the contributions are NOT tax deductible when they are made.
• The account grows tax-deferred.
• WHEN THE MONEY IS WITHDRAWN AFTER AGE 59 1/2 IT IS NOT TAXED BY THE FEDERAL GOVERNMENT.
• Also, while with traditional 401k’s and IRA’s you are required to take an annual distribution after reaching age. 70 ½. With a Roth 401K if rolled over to a Roth IRA there is no required minimum distribution.
• Unlike a traditional 401k or IRA the money will pass to your beneficiaries TAX-FREE.

WHAT IF YOU NEED MONEY PRIOR TO AGE 59 1/2:

The are ways you can access your funds without a 10% early withdrawal penalty if under age 59 ½ if you need the money to do any of the following:

• Pay medical expenses.
• Cover the down payment or avoid eviction or foreclosure on your principal residence.
• Pay college tuition.
• Cover funeral expenses for a family member.

Click to Visit the IRS site for specific details

Bottom Line:

If you expect your tax rate to be the same or higher in retirement than it is now, you might be better off with a Roth 401k.   If you believe your tax rate will go down in retirement, you may be best off with the traditional 401k.  You may also like the idea of  diversifying and create the Roth 401 to give you more flexibility during retirement.

What You Need to Know About the Tax cuts and Jobs Act

Your IRA or 401k Balance is not Yours