Quick poll: Do you work for an employer that offers a Roth 401(k)?
Don’t feel bad if you don’t know the answer. These types of retirement accounts have only been around since 2006. And while more than half of retirement plan sponsors now offer the Roth option, less than 10% of plan participants who can contribute to a Roth 401(k) actually do it, according to a survey by the benefits consulting firm Willis Towers Watson.
Like a traditional 401(k), a Roth 401(k) is a retirement savings plan sponsored by an employer. You can invest the money in your 401(k) account, so there is risk involved but also reward in the form of potential investment growth that can help you keep up with our even outpace the rate of inflation.
The differences between a traditional and Roth 401(k) boil down to the potential tax benefits.
Traditional vs. Roth 401(k)s
With a traditional 401(k), you can get one tax benefit right away. It works like this: You tell your employer to contribute a portion of your pre-tax pay to your 401(k) account, and you don’t have to pay taxes on that money until you withdraw it much, much later. Because you contributed money straight from your pay to your 401(k), your take-home pay is smaller, so there’s less money for the government to tax.
With a Roth 401(k), you don’t get any tax breaks for contributions. But you won’t be taxed on your withdrawals as long as you’ve had your account for five taxable years and wait until you’re older than 59½ to withdraw. Withdrawals from a traditional 401(k), on the other hand, are taxed like ordinary income.
If both a traditional and a Roth 401(k) are available to you, you can contribute to both. Just know that in 2017, you can contribute a total of $18,000 across any traditional and Roth 401(k)s you own (plus an extra $6,000 in so-called catch-up contributions if you are at least age 50). Contributing more than that isn’t allowed and comes with its own tax penalties.
If you are familiar with a Roth IRA (Individual Retirement Arrangement), you may be happy to know that unlike a Roth IRA, there is no income limit for contributing to a Roth 401(k).
Neither Transamerica nor its agents or representatives may provide tax, investment or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors and financial professional regarding their particular situation and the concepts presented herein.
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