What is a Roth 401(k), and how does it differ from a traditional 401(k)?\u00a0<\/p>\n
One of the many challenging aspects of retirement planning is picking the smartest vehicles in which to save and grow your funds. Most people are familiar with traditional 401(k) accounts, typically offered through an employer<\/a>.<\/p>\n For You: 25 Cities Where You Can Retire in Great Weather for $2,000 a Month<\/a><\/p>\n<\/p>\n Learn More: 3 Advanced Investing Moves Experts Use to Minimize Taxes and Help Boost Returns<\/a><\/p>\n However, many people are skipping over the Roth 401(k)<\/a> \u2014 if they even realize it\u2019s an option. So what\u2019s the difference, and why might you choose one over the other?<\/p>\n To explore the distinctions, GOBankingRates spoke with Jamie Hopkins<\/a>, CEO of Bryn Mawr Trust Advisors<\/a> and chief wealth officer for WSFS Bank. He is also a financial services industry advocate, a Wall Street Journal best-selling author, and founder of the FinServ Foundation<\/a>, a nonprofit dedicated to helping college students reach their full potential through coaching, mentorship and community.<\/p>\n Hopkins said it\u2019s a little \u201cmisleading\u201d to think of Roth and traditional 401(k) plans as entirely separate savings vehicles. They\u2019re fundamentally the same type of account \u2014 employer-sponsored retirement plans<\/a> \u2014 but they differ in how your contributions and withdrawals are taxed.<\/p>\n A traditional 401(k) is an employer-sponsored retirement savings plan that allows for salary-deferral contributions from employees and matching contributions from employers. That means you put money into this type of account before you pay taxes on it, which reduces your taxable income in the year you contribute. You then pay taxes on the money when you withdraw it in retirement.<\/p>\n A Roth 401(k), in contrast, is funded with after-tax dollars. Hopkins explained, \u201cThis means taxes are paid before the money is contributed to your retirement account.\u201d<\/p>\n The major benefit of a Roth 401(k) is that the money grows tax-free, instead of tax-deferred. Withdrawals in retirement are also tax-free, as long as two conditions are met:<\/p>\n The account must be open for at least five years<\/p>\n The withdrawal must occur after a qualifying event, typically reaching age 59\u00bd<\/p>\n \u201cWhile there are other slight differences, the core distinction between a Roth account and a tax-deferred traditional account is when you pay taxes,\u201d Hopkins said.<\/p>\n Read Next: Suze Orman: 4 Tips To Protect Your Finances in Retirement<\/a><\/p>\n One of the best reasons to open a Roth 401(k) is to get your taxes out of the way before retirement, Hopkins said. Doing so can reduce your taxable income in retirement<\/a>, and may also help you avoid or minimize taxes on Social Security and reduce your Medicare premiums.<\/p>\n Story Continues <\/p>\n \u201cIf most of your income outside of Social Security<\/a> comes from a Roth account, you may be able to avoid taxation on Social Security benefits and stay within the lowest Medicare premium tiers,\u201d he explained.<\/p>\n Traditional 401(k) withdrawals, on the other hand, defer your taxes on the front end and place the burden of taxation on you in retirement \u2014 increasing your overall taxable income at a time when you\u2019d prefer to keep it low. This could mean paying higher Medicare premiums, partial taxation of Social Security benefits and reduced eligibility for need-based programs like Medicaid.<\/p>\n If you\u2019re still not quite sure which one to go with, here are some of the standout benefits of a Roth 401(k), according to Hopkins:<\/p>\n Tax Diversification: Having money spread across taxable, tax-deferred, and tax-free (Roth) accounts gives you more flexibility. Hopkins emphasized that tax diversification<\/a> helps you manage changing tax rates throughout retirement. \u201cIf tax laws or your personal situation shift, you\u2019ll have more control over how and when you pay taxes,\u201d he said.<\/p>\n No RMDs for Roth IRAs: While Roth 401(k)s are subject to required minimum distributions (RMDs)<\/a> beginning at age 73, you can avoid those by rolling your balance into a Roth IRA before that age. \u201cThis gives you more control over when you withdraw funds and allows your money to continue growing tax-free,\u201d Hopkins said.<\/p>\n Greater After-Tax Savings Power: On an after-tax basis, Roth contributions may give you more net retirement income. For example, if you contribute $5,000 pre-tax into a traditional 401(k) and your tax rate is 20%, you\u2019d end up with $4,000 after taxes at withdrawal. If you contribute $5,000 after-tax into a Roth 401(k), the full $5,000 can be withdrawn tax-free.<\/p>\n However, it would have taken $6,250 in pre-tax income to net that $5,000 in a Roth \u2014 so it\u2019s important to understand the real trade-offs.<\/p>\n When weighing whether a Roth 401(k) is the right fit for your retirement strategy, Hopkins recommends asking the following:<\/p>\n Do you expect your personal tax rate to rise over time \u2014 due to income growth, policy changes, or reduced deductions? Paying taxes now via Roth contributions might be the better choice.<\/p>\n \u201cOn the flip side, if you expect to be in a lower tax bracket<\/a> in retirement, deferring taxes with a traditional 401(k) may be more advantageous,\u201d Hopkins noted.<\/p>\n If you\u2019re still not decided, don\u2019t stress about choosing between the two accounts. \u201cAt the end of the day, the most important thing is to save and invest consistently,\u201d Hopkins said. \u201cThere\u2019s no perfect answer.\u201d He often advises splitting contributions between both types of accounts to enjoy the benefits and flexibility of each.<\/p>\n This article is part of GOBankingRates\u2019\u00a0Top 100 Money Experts\u00a0series, where we spotlight expert answers to the biggest financial questions Americans are asking. Got a question of your own? You could win $500 just for asking \u2014 learn more at\u00a0GOBankingRates.com<\/a>.<\/p>\n More From GoBankingRates<\/p>\n This article originally appeared on GOBankingRates.com<\/a>: The Retirement Account That Could Cut Your Taxes \u2014 Forever, According to a CFP\u00a0<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"What is a Roth 401(k), and how does it differ from a traditional 401(k)?\u00a0 One of the many…\n","protected":false},"author":2,"featured_media":78696,"comment_status":"","ping_status":"","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[39],"tags":[28,55472,147,530,1666,732],"class_list":["post-78695","post","type-post","status-publish","format-standard","has-post-thumbnail","category-personal-finance","tag-business","tag-jamie-hopkins","tag-personal-finance","tag-personalfinance","tag-retirement","tag-retirement-planning"],"_links":{"self":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts\/78695","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/comments?post=78695"}],"version-history":[{"count":0,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts\/78695\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/media\/78696"}],"wp:attachment":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/media?parent=78695"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/categories?post=78695"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/tags?post=78695"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}