Most employers now offer the Roth 401k as an option for their employees. The tax-free benefits of the Roth 401k should not be overlooked. But like everything that has tax advantages, there are some downsides too. I’ll answer some of the most common questions I get regarding Roth 401ks in this blog post and hopefully help you make an informed decision.
Can I have a Roth 401k and a Traditional 401k
Yes! In fact, if you have a ROTH 401k and your employer offers a match or profit sharing contribution, you WILL have both, a Roth 401k AND a Traditional 401k.
How it works is your employer’s contributions automatically go into the pre-tax/Traditional portion of your 401k. If you decide to contribute to the Roth 401k, your contributions will go to the after tax side of the 401k. Essentially, you’ll have two accounts; one a TAX-DEFERRED Traditional 401k and the other a TAX-FREE Roth 401k.
Which is better completely depends on your tax bracket now vs your tax bracket in the future. If you are married and in a 24% or lower tax bracket, I’d argue you’d most likely be better off contributing to the Roth 401k.
If you are single and in a higher tax bracket, it’s hard to make a case for paying high taxes today when you will most likely be in a lower tax bracket in the future when you stop working.
Obviously, each situation dictates. Just remember, you don’t want to pay higher taxes today to avoid lower taxes in the future. That is a strategy that doesn’t make a lot of sense.
How much can I contribute to my Roth 401k in 2019
If you are under the age of 50 you can contribute $19,000 to your Roth 401k. If you are 50 years or older you can contribute $25,000 to your Roth 401k.
This means if you’re married and both spouses are 50 or older you can contribute $50k to your Roth 401ks! That’s a lot of money, indeed. But remember, that’s $50k you’ll be paying taxes on in this calendar year.
Can you have a Roth 401k AND a Roth IRA
YES!!! As long as you have earned income you can contribute to a Roth IRA. So, if you’re able to contribute to a Roth 401k, inherently you are working and have earned income, thus you can definitely do both. Consider this, you’re married, both you and your spouse are 50 years old, and your total income is $150k, you could contribute $64k to your Roth accounts, $25k each to the Roth 401k and $7k each to the Roth IRAs.
For simplicity say you were to invest in nothing else but these two Roth accounts until you were both 60 years old. Also say you are able to capture a 6% annual return. In ten years time, you’d have nearly 900k, all TAX FREE!
Not too shabby, if I do say so myself.
Obviously, being able to squirrel that kind of money away into the Roth accounts is not an easy task. But even if you were able to do just one quarter of the above example, you’d still have over 200k set aside, again, TAX FREE.
No one is going to give you a hard time with that kind of money socked away in tax free accounts.
Do employers match a Roth 401k
Your employer contributions to your 401k will ALWAYS go to the pre-tax side of the account. Only your contributions, if you so decide to go the Roth 401k route will go the tax free side. This is one of the main benefits of you contributing to the Roth 401k in fact, is you’ll be tax hedging. Your Roth 401k will be tax free, your employer contributions will be taxable, meaning when it comes time to take distributions you’ll be able to choose from which account to draw from first, in the most tax efficient manner.
Should I convert my 401k to a Roth
I get this question a lot. My default answer is YES! CONVERT AWAY! But there are caveats. What is your tax bracket now? What is your expected future tax bracket? Are you married? Will you have a pension? When will you take Social Security? How old are you?
There are way, way too many questions that need to be answered before you start converting. Someone should write a book on this. Oh wait, I did! You can find my book “The Tax Bomb In Your Retirement Accounts” here.
How should I invest my Roth 401k
If you’re going through the trouble of paying tax now in order to have TAX FREE growth for decades to come, it only makes sense to invest your money for growth, no?
Thus NO BONDS IN YOUR ROTH! Bonds do not grow. Bonds provide you interest, limited in today’s current market.
Say it with me,will you? BONDS DO NOT GROW!
Now we’ve got that established, to use the Roth most effectively, you need to invest it in stocks. What types of stocks are beyond the scope of this article. But suffice it to say hard to go wrong with an index fund that mimics the S&P 500 or the Total Stock Market.
Whatever you choose, remember, the point of the Roth is the tax free GROWTH. Thus to invest in anything that doesn’t grow defeats the whole point of the Roth. Don’t do that!