This is the third post in our Retirement Investing 101 series written by Amanda Smith, Client Services Specialist at CESI. Check out Part 1 or continue on to Part 4.
Do you know the benefits of having a Roth 401(k)? Many people are not sure what exactly a Roth 401(k) is and how it can benefit them. A Roth 401(k) is an employer-sponsored savings account that, unlike the traditional 401(k), saves after-tax money remember that traditional 401(k)s use pre-tax money). If given the opportunity, a Roth 401(k) is in your best interest to participate in, simply because of the tax benefits.
While saving in a 401(k) will reduce your taxable income now, the taxable savings in the long run for a Roth 401(k) is outstanding. Here are a few basics regarding the Roth 401(k):
Savings are made with after-tax money
- Savings grow tax-exempt
- RMDs (Required Minimum Distributions)* are not required
- All withdrawals are made tax-free
- Must be 59 ½ or older
- Must have account 5 years after first deposit
Yes, unlike with the traditional 401(k), all withdrawals are tax-free. This means, when you are older and want to go on vacation to Hawaii, you can withdraw from your Roth 401(k) tax-free, hop on the plane and soak up the sun. You can’t tell me this idea doesn’t rock your world! You may hear controversy regarding this option because it does not reduce your taxable income at the time you’re working. However, this idea is irrelevant to the enormous tax savings you receive at the end of your employment, combining earnings and growth over many years.
The downside of the Roth 401(k) is that many companies are not currently offering it to their employees. The Roth 401(k) has not been around as long as the traditional 401(k) but the savings vehicle is certainly making strides.
The investment options within the Roth 401(k) are the same as a regular 401(k). These saving vehicles work the same way but offer different tax benefits. If you’re fortunate enough to have the Roth 401(k) as an option, take advantage of it today!
If your company matches your contributions for a traditional 401(k), they will match the Roth 401(k) as well. One thing to be made aware of is the matching contributions made by your employer are pre-tax dollars. This means these contributions will grow tax deferred and will be taxed upon withdrawal. Please do not let this information mislead you into thinking participating in a Roth 401(k) is not a viable retirement savings option: it is! You will still have an amazing tax savings regardless.
But wait! There are two other saving vehicles that are available to you in addition to your employer-sponsored plan. We’ll cover those in the next post.
*What are RMDs?: The government requires individuals with IRAs and/or 401(k)s to withdraw from these accounts at the age of 70 ½. If you do not withdraw from these accounts, stiff penalties are given by the IRS. The fact that Roth accounts do not require withdrawals is a big deal – maybe not when you’re in your twenties, but one day you’ll be 70 ½ with grandkids and grey hair and this requirement will pertain to you.
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This article was syndicated and originally appeared on the CESI Debt Solutions website.
