When considering retirement savings methods, the most common option people consider is their employer-sponsored 401(k). Although not as often utilized, a Roth 401(k) is another beneficial way to plan for retirement. Unlike the traditional 401(k) that funds an investment account with pre-tax dollars, this employer-sponsored account allows income to be invested after tax. Here are highlights of this vehicle if the Roth 401(k) is a route you are considering.
Is a Roth 401(k) for Me?
“Will you be in a higher tax bracket in the future than you are currently?” This question can be a fundamental first step when considering if a Roth 401(k) is the right option to meet your goals. If you answered yes, a Roth 401(k) may be a route to consider taking because it will allow you to pay income tax today on your contributions at a lower tax bracket -- rather than pay higher income taxes in the future like a traditional 401(k).
Typically, a Roth 401(k) is more beneficial to those who are younger because they are likely to be categorized in a lower tax bracket. Roth 401(k)s are also beneficial for high-income earners because they are unable to contribute to a Roth IRA. Utilizing a Roth 401(k) provides them with the ability to have a tax diversified portfolio.
Benefits of a Roth 401(k)
Opting to contribute to a Roth 401(k) allows investors to have a tax diversified portfolio. Tax diversification refers to the method of allocating funds in differing account types – taxable accounts and tax-deferred accounts – to reduce risk for investors. When individuals reach age 59.5, distributions from a Roth 401(k) are tax-free, unlike traditional 401(k) distributions that are taxed as regular income after age 59.5.
Many people believe that tax rates will be higher in the future and, therefore, prefer to have their accounts taxed now. Additionally, Roth 401(k)s leave tax-free money to beneficiaries upon the passing of the account owner.
Roth 401(k)s are also beneficial as they reduce the probability that distribution in retirement will bump someone into a higher tax bracket. If this were to happen, it could impact the taxes they pay on their social security benefits or increase their Medicare part B premiums.
Downside of Using a Roth 401(k)
Contributing to a Roth 401(k) means an individual can potentially miss out on current tax benefits that would benefit them if they have used a Traditional 401(k). For example, they would not be eligible for tax deduction that may lower their current tax liability.
Consider the pros and cons when determining whether or not to contribute to a Roth 401(k) and keep in mind the importance of tax diversification when reviewing your investments.
Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.
Ben Soccodato is a registered representative of and offer securities, investment advisory and financial planning services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000 CRN202208-269345