Is the Roth 401(k) Right for You?
The newest retirement savings vehicle isn't always the best option for middle-income employees
Every financial adviser will tell you to stash enough of your cash in a 401(k) retirement savings plan to get your employer's full match. But now workers face an additional choice. Should you park a portion of your salary in a traditional 401(k) and be freed from paying taxes on that portion of your income now? Or would it be better in the long run to invest in a Roth 401(k)? You pay taxes now, but you can take your money out tax free in your golden years. Here's a blueprint for deciding.
Find out if your company offers a Roth 401(k)—or might soon. Roth 401(k)'s were created by the Economic Growth and Tax Relief Reconciliation Act of 2001, which allowed companies to begin offering them on Jan. 1, 2006. About 12 percent of companies reported they already offer a Roth 401(k), according to a Hewitt Associates survey of employers done this year, and 32 percent were likely to add the feature at some point in 2007. So far, early adopters seem to like the new 401(k). Approximately 14 percent of participants in their 20s selected the Roth 401(k) option, and nearly a quarter of employees first enrolling in the 401(k) plan made theirs a Roth, Hewitt found. The average contribution rate was about the same as before the Roth option was available.
Get to know the basics. A Roth 401(k) is a cross between a Roth IRA and a traditional 401(k) plan. Like a Roth IRA, contributions are made with after-tax dollars, which will grow tax free. Withdrawals are tax free if taken at age 59½ or later from an account held for at least five years. As with a traditional 401(k), the Roth 401(k) is offered by employers that may or may not match a certain percentage of your contribution. However, only the employee contributions will be allotted to the Roth account. Any matching contributions are allocated to a pretax account, just as with traditional 401(k)'s.
A Tale of Two 401(k)'s
Here is a comparison of the main features of traditional and Roth 401(k) accounts.
|Traditional 401(k)||Roth 401(k)|
|You invest||Pretax dollars||After-tax dollars|
|Account grows||Tax free||Tax free|
|Withdrawals||Taxed||Tax free if you're 59½ and have held the account for five years or more|
|Contribution limits||$15,500 in 2007 plus an additional $5,000 in catch-up contributions if age 50 or older||$15,500 in 2007 plus an additional $5,000 in catch-up contributions if age 50 or older|
|Employer match||Made with pretax dollars to accumulate in the same account||Made with pretax dollars to accumulate in a separate account and be taxed as income at withdrawal|
|When switching jobs||Roll over into an IRA||Roll over into a Roth IRA|