&l;p&g;&l;img class=&q;dam-image getty size-large wp-image-1127011276&q; src=&q;https://specials-images.forbesimg.com/dam/imageserve/1127011276/960×0.jpg?fit=scale&q; data-height=&q;640&q; data-width=&q;960&q;&g; Does a Roth 401(k) make sense for you?&a;nbsp;
First off,&a;nbsp;only about half of employers, mainly large ones, offer Roth 401(k) plans currently, so check if you can access a Roth 401(k) before deep exploration here. However, there are a number of cases where Roth 401(k)s can make sense especially if you&s;re younger and see your taxes rising in future.
There are two basic elements to understand with Roth 401(k)s. First is the basic &l;a href=&q;http://www.forbes.com/sites/simonmoore/2018/08/28/tips-for-making-better-use-of-your-401k/&q;&g;401(k) choice&l;/a&g;, which is a way to tax-efficiently for retirement from your paycheck, perhaps with a employer contribution to help too. Secondly, there is the Roth aspect, which determines when you pay tax on those retirement dollars. So the first question is, are you saving for retirement? That&s;s the 401(k) decision and hopefully the answer is yes.
The second piece is how you want the tax payment to work. That&s;s the Roth vs. Traditional decision. Now, of course, ideally you might wish to pay no tax, but there&s;s no option for that here. It&s;s really a question of whether you want to pay the tax on the money coming in to your retirement savings, or the money coming out of it in retirement.
Just as with a traditional IRA and a Roth IRA, a Roth 401(k) likely means less tax payments than with a basic investment account because the government wants to encourage retirement saving. Though both a Roth and Traditional IRA can be useful ways to save, neither avoids taxes entirely. With a traditional 401(k), your retirement savings are generally tax-deferred, which means the money goes in tax-free, grows tax-free but then may well be taxed in retirement.
With a Roth 401(k), the tax is paid before the money goes into the retirement savings account, but if the rules are followed and don&s;t change will generally never be taxed again. So with a Roth 401(k), tax is paid early and then you&s;re done with tax on that money, assuming circumstances play out as expected.
Roth and Traditional 401(k)s are quite similar in many ways. Both have contribution limits of $19,000 for 2019, or $25,000 if you&s;re 50 or over. Both are workplace savings plans for retirement. Employers typically treat contribution matching the same way too. In some ways just having any sort of 401(k) is the critical part. This means that you&s;re saving for retirement. Whether you pick a Traditional 401(k) or a Roth 401(k) is then icing on the cake.&a;nbsp;Also, remember,&a;nbsp;with both 401(k) variants, this is a way to save for retirement, so using the money for something other than retirement can hit you with taxes and penalties.
Roughly speaking a 401(k) gives a way to cut your tax-bill now, whereas a Roth provides a way to cut your tax bill in future. So if you see your tax rate, or tax rates in general rising when retirement hits then that&s;s a reason to consider a Roth 401(k). Yes, you pay tax now, but you may save on taxes in future and your tax bill overall. In fact, if you&s;re in a low tax bracket right now, then &l;a href=&q;http://www.forbes.com/sites/simonmoore/2018/10/09/how-your-teenagers-part-time-job-could-make-them-a-millionaire/&q;&g;a Roth structure can be a great way to build up a retirement nest egg&l;/a&g;. So if you&s;re young and expect to see your tax bracket go up over your life, then a Roth 401(k) can be a smart move. If you&s;re earning a lot of income now, but see it falling in future years, then maybe a Traditional 401(k) makes more sense. Robert Shaye of Fireside Finances who has researched &l;a href=&q;https://www.firesidefinances.com/uploads/8/3/2/6/83263432/bulletin_tsp_traditional_vs_roth_apr_15__1_.pdf&q; target=&q;_blank&q;&g;Roth structures&l;/a&g;&a;nbsp;for federal employees find that. &q;&l;span&g;Typically, I recommend the Roth option in a 401(k) when a client believes he or she will be in a greater tax bracket in retirement, or they are living in an income-free tax state now&q;&l;/span&g;
&l;strong&g;A Few Other Edge Cases&l;/strong&g;
Here are a few other aspects to consider:
&l;/p&g;&l;ul&g;&l;li&g;If you think the government will dramatically raise tax rates then a Roth 401(k) may be prudent. Even being a relatively high tax bracket now may be small beans if taxes were to ramp up to in coming decades. It&s;s of course hard to forecast where tax rates may go, but taxes in the U.S. are currently low compared to post-war history. Actually, in the early 1950s the top rate of tax in the U.S. was over 90% for the highest bracket. That&s;s extreme, of course, but it happened.&l;/li&g; &l;li&g;If your employer matches your 401(k) contribution, then you will still typically pay tax on those matching dollars in retirement with a Roth 401(k). This generally means that any employee matching of a Roth 401(k) basically goes into a Traditional 401(k) account.&l;/li&g; &l;li&g;It also matters where you live now, and plan to live in retirement, as Robert mentions above, if you&s;re in an income-free state now such as Washington&a;nbsp;or Nevada but plan to retire somewhere else, then that&s;s another reason to consider a Roth 401(k) as you&s;ll have state taxes to consider in retirement, but not now.&l;/li&g; &l;li&g;Also, if you compare a Roth 401(k) savings balance and a Traditional 401(k) balance, a dollar of Roth 401(k) saving is likely worth more when retirement comes. This is because in retirement as no taxes will be paid on the Roth 401(k) dollar, so it&s;s a dollar that can be fully spent, whereas a dollar of Traditional 401(k) savings may actually be worth say eighty cents in retirement after all taxes are paid.&l;/li&g; &l;/ul&g;&l;strong&g;A Mixed Approach?&l;/strong&g;
The right Roth vs. Traditional choice for you may change over your lifetime. Perhaps it makes sense to use a Roth 401(k) when you are young, but then a Traditional 401(k) makes more sense as you age and your tax bracket rises. Again, Robert Shaye&a;nbsp;finds that.&a;nbsp;&l;span&g;&q;Having a mix or Roth and Traditional dollars is a great way to enter retirement, because it allows you&a;nbsp;&l;/span&g;flexibility&l;span&g;. You can pull from either account depending on your other income and tax situation each year.&q;&a;nbsp;&l;/span&g;
Saving for retirement is the first challenge, so if you&s;ve made it to a Roth vs. Traditional decision, congratulations! You&s;re making real progress on retirement preparation. Nonetheless, if you&s;re younger, living in a state without income tax and expect your tax rate, or tax rates in general, to rise in future, then putting at least some of your 401(k) contributions into a Roth could be prudent.