Should I Contribute To My Roth 401(k)?
Roth 401(k)s have become an increasingly popular alternative to traditional 401(k)s, allowing participants to make after-tax salary deferrals to their employer plans. Many people may have the opportunity to contribute to a designated Roth account in their 401(k), but are uncertain about the best savings strategy for their personal circumstances.
What is a Roth 401(k)?
Before we answer the big question of whether or not you should contribute, let’s take a second to discuss the difference between a traditional 401(k) and a Roth 401(k). The basic difference between a traditional and a Roth 401(k) is when you pay the taxes. With a traditional 401(k), you make contributions with pre-tax dollars, so you get a tax break up front, helping to lower your current income tax bill. Your money—both contributions and earnings—grows tax-deferred until you withdraw it. At that time, withdrawals are considered to be ordinary income and you have to pay Uncle Sam his due at your current tax rate; there may be state taxes as well.
With a Roth 401(k), it’s basically the reverse. You make your contributions with after-tax dollars, meaning there’s no upfront tax deduction. However, withdrawals of both contributions and earnings are tax-free at age 59½, as long as you’ve held the account for five years.
So the difference really comes down to when you pay the taxes—now or later. While a Roth 401(k) is generally considered to be a better option, it really depends a lot on your timeframe as well as what the future may look like.
How To Make Your Decision
This flowchart help guide you through a series of considerations that will inform your decision whether to contribute to a Roth 401(k), and covers:
- Future tax rate expectations
- Roth IRA eligibility
- Employer matching considerations
- RMDs and future rollover options
- Additional savings opportunities through backdoor Roth contributions
As always, if you have any questions, fell free to reach out or click here to schedule your introductory consultation.