Over the past decade, more and more employers are offering a Roth option with their employee 401k plan. This might not be publicized as many individuals tend to look at the tax deduction of contributing to a Traditional 401k plan. But with tax rates at historical lows, it might be beneficial to contribute a portion of your 401k contribution to a Roth 401k and pay the tax on that contribution now.
The difference between a Traditional 401k and a Roth 401k is similar to the differences between an IRA and a Roth IRA, it comes down to when the tax is paid.
A Traditional 401k allows you to take a portion of your income and contribute to your retirement plan, this contribution is tax-free and reduces your taxable income that is reported at the end of the year. The Traditional 401k funds then grow tax-free over the course of time and when you withdraw funds during retirement, you then pay tax on those distributions.
The Roth 401k is taxable income during the year that you contribute to a retirement plan. Once in the Roth 401k, the funds grow tax-free and when you reach retirement you can withdraw the funds without any tax consequence.
If your company has a 401k match program, that matching contribution would go into the Traditional 401k even if you contribute 100% into a Roth 401k. What is nice is you can decide what percentage you wish to contribute to each as many opt for a 50/50 split between the Roth and Traditional 401k contribution.
Nobody has a crystal ball as to what tax rates will be in 5 years much less when you retire, although rates will likely increase and depending on your income level, you may pay a higher tax in retirement than you do now. Having a mixture of Roth and Traditional 401k funds in your retirement nest can also be beneficial as you can withdraw funds from a Roth without triggering a large tax for purchases in retirement such as a vehicle or vacation.
The difference between a Traditional 401k and a Roth 401k is similar to the differences between an IRA and a Roth IRA, it comes down to when the tax is paid.
A Traditional 401k allows you to take a portion of your income and contribute to your retirement plan, this contribution is tax-free and reduces your taxable income that is reported at the end of the year. The Traditional 401k funds then grow tax-free over the course of time and when you withdraw funds during retirement, you then pay tax on those distributions.
The Roth 401k is taxable income during the year that you contribute to a retirement plan. Once in the Roth 401k, the funds grow tax-free and when you reach retirement you can withdraw the funds without any tax consequence.
If your company has a 401k match program, that matching contribution would go into the Traditional 401k even if you contribute 100% into a Roth 401k. What is nice is you can decide what percentage you wish to contribute to each as many opt for a 50/50 split between the Roth and Traditional 401k contribution.
Nobody has a crystal ball as to what tax rates will be in 5 years much less when you retire, although rates will likely increase and depending on your income level, you may pay a higher tax in retirement than you do now. Having a mixture of Roth and Traditional 401k funds in your retirement nest can also be beneficial as you can withdraw funds from a Roth without triggering a large tax for purchases in retirement such as a vehicle or vacation.
If you have questions regarding tax or estate planning, please feel free to contact Glick and Trostin, LLC at 312-346-8258.
Disclaimer: The materials on this website are provided for informational purposes only and do not constitute legal advice. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship between any attorney and any other person, group or entity. No representations or warranties whatsoever, express or implied are given as to the accuracy or applicability of the information contained herein. No one should rely upon the information contained herein as constituting legal advice. The information may be modified or rendered incorrect by future legislative or judicial developments and may not be applicable to any individual reader's facts and circumstances.
Disclaimer: The materials on this website are provided for informational purposes only and do not constitute legal advice. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship between any attorney and any other person, group or entity. No representations or warranties whatsoever, express or implied are given as to the accuracy or applicability of the information contained herein. No one should rely upon the information contained herein as constituting legal advice. The information may be modified or rendered incorrect by future legislative or judicial developments and may not be applicable to any individual reader's facts and circumstances.
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