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How A Roth 401(k) Could Keep You Wealthier In Retirement

How A Roth 401(k) Could Keep You Wealthier In Retirement

What is a Roth 401(k), how taxes differ from the traditional 401(k), and other considerations for your retirement savings. 

There are many retirement savings options for people today. One of the lesser-known options is the Roth 401(k). Since January 1, 2006, U.S. employers have been allowed to amend their 401(k) plan document to elect Roth IRA type tax treatment for a portion or all of their retirement plan contributions.

Let’s cover why a Roth 401(k) may be right for your situation. Special thanks to NerdWallet for some of the details on this article.

What Is A Roth 401(k)?

According to Investopedia

A Roth 401(k) is an employer-sponsored investment savings account that is funded with after-tax money up to the contribution limit of the plan. This type of investment account is well-suited to people who think they will be in a higher tax bracket in retirement than they are now. 

The Roth 401(k) can be a great investment vehicle for the right person. The key is whether you want to pay taxes on your contributions now or on your distributions during retirement. The contribution rules for a Roth 401(k) are exactly the same as for a traditional 401(k). Currently that limit is $18,000/year or $24,000/year for those 50 or older – indexed each year (n

Note: that this is the maximum contribution for either or a Traditional and Roth 401k; in other words, you cannot fund $18,000 into a Roth 401k and also $18,000 into a Traditional 401k).

More Money Now Or Later?

Contributions to a Roth 401(k) can hit your budget harder today because of the additional tax withholdings. That’s because after-tax contribution takes a bigger chunk of your current paycheck than a pretax contribution to a traditional 401(k). So it often costs you more to use a Roth 401(k) on the front end.

On the back end, the Roth account can be more valuable in retirement. That’s because when you pull a dollar out of that account, you get to keep that entire dollar. In addition, growth is compounded tax free in a Roth. However, when you pull a dollar out of a traditional 401(k), you only keep the after-tax value of the dollar. 

Pros & Cons of the Roth 401(k)

One reason to opt for a Roth 401(k) relates to tax rates before and during retirement. If your tax rate is low now and you expect it to be higher in retirement, you can make contributions with after-tax dollars — which you can do with a Roth 401(k). At that point, you won’t pay taxes at that higher rate when you take qualified distributions in retirement. 

Another reason to go with the Roth 401(k) is the potential for tax rate increases. Because government expenses tend to continue to grow, there’s a possibility of future legislative tax increases; current tax rates are low historically-speaking. That would be an incentive to pay taxes now in a Roth account compared to later with a traditional 401(k).

A final reason to go with a Roth 401(k) is you can roll your funds into a Roth IRA which is not subject to Required  Minimum Distributions (RMDs). With a traditional 401(k), you are required to take distributions at age 70 ½. Not so with the Roth 401(k) if it’s properly managed.   

However, if your tax rate is higher now than you expect it to be in retirement, then a traditional 401(k) may make more sense. You’ll then pay taxes at that expected lower rate when taking distributions in retirement. Many retirees often live frugally, resulting in a lower tax burden so the traditional 401(k) is often the best option.

Roth vs. Traditional 401(k)

Image from NerdWallet

Check With An Experienced Advisor To Discuss Your Options

If you anticipate higher income in your retirement years because of deferred compensation or other income you’re expecting, it might make sense to start contributing to a Roth 401(k). There are several options to consider besides current tax rates, and because future assumptions are unknown, there is not a simple or “right” answer. 

To chat with an experienced advisor at Republic Wealth Advisors about whether contributing to a Roth 401(k) may be appropriate for your situation, please reach out today. We’ll be happy to walk you through the pros and cons of different retirement savings options, including the Roth 401(k).

 


 

IMPORTANT DISCLOSURE INFORMATION: Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Republic Wealth Advisors), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Republic Wealth Advisors.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Republic Wealth Advisors is neither a law firm nor a certified public accounting firm and no portion of this blog content should be construed as legal or accounting advice.  If you are a Republic Wealth Advisors client, please remember to contact Republic Wealth Advisors, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Republic Wealth Advisors’ current written disclosure statement discussing our advisory services and fees is available upon request.

 

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When to Rollover That 401K - And When Not To

When to Rollover That 401K - And When Not To

If you work in the private sector, your 401K plan likely holds most of your retirement savings. Congratulations if you are socking away as much as possible. It will come in handy when you reach retirement age.

The days of staying with the same company for decades are long gone, however. Each time you change jobs, you also need to make some decisions about your 401K account. Your choices now can make a huge difference down the road.

When you leave an employer – voluntarily or not – you can pick from four options for your 401k or other qualified plan balance. You don’t have to act the same day you leave, but you should decide soon after. You can either:

1.    Stay in your old employer’s plan,
2.    Rollover your 401K balance to your new employer’s plan,
3.    Transfer the 401K balance into an IRA, or
4.    Cash out the 401K money and pay tax on it.

For more on these choices, read our Career Change and Your 401K article. You’ll also find a short video on that page. In most cases, transferring the balance into an IRA is the best choice.

Cashing out your 401K money before retirement age is almost never a good idea. A startlingly high number of people do it, though. This graph from AON Hewitt shows what job-changers did with their 401K money in 2011 (the latest data available).

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The 42% who cash out their 401K money have to pay regular income tax on it plus a 10% penalty in most cases (penalty applies if you are under 59 ½ in the year the withdrawal is made). The data doesn’t show, but we suspect most of these are low-wage workers with small balances. They need to save for retirement as much as anyone but may have more immediate needs. The 29% who leave their 401K balance with their ex-employer made a better choice, but it still isn’t optimal in most cases.

The decision isn’t always so clear in some special situations. Think twice if you fall in any of these groups. 

If you are between ages 55 and 59: Special rules apply if you lose or leave a job at age 55 or older. In this case, you can take withdrawals from your 401K with your last employer and not have to pay the usual 10% penalty. You’ll lose this protection if you rollover the money to a new employer’s 401K.

If you plan to work past 70½ and are not self-employed: Normally you have to start mandatory withdrawals from your 401K and IRA accounts at age 70½. You can delay them indefinitely as long as you remain employed and you don’t own 5% or more of the company.

Note that this applies only to the 401K account tied to your current job. You will have to make mandatory withdrawals for 401K and IRA accounts from previous jobs once you reach age 70½.

If you have company stock in your 401K plan: If you have company stock in your 401K that has appreciated in price, it may qualify for long-term capital gains treatment. This could be more favorable than the ordinary income rate you would pay if you move the company stock to an IRA and eventually withdraw from there.

What should you do in this situation? The best bet is to withdraw from the 401K but split the assets into two accounts. Transfer the company stock to a regular, taxable brokerage account, while moving the remainder of your 401K assets into an IRA. This preserves the company stock’s favorable tax treatment while letting you keep your other retirement assets growing.

If you do this, note that you must realize the gain in your company stock and roll over the non-stock assets at the same time. You can’t wait for the stock to go higher, unless you leave it in the employer’s 401K.

(For more on company stock in a 401K, see my previous article: Charge Up Your Retirement with Little-Known NUA Rule. NUA stands for “Net Unrealized Appreciation.”)
 
If your 401K plan has low fees or uniquely attractive features: If the company you left had particularly low fees or investment options that aren’t available through your new employer’s plan, it might make sense to leave your balance there. Just keep in mind that transferring the balance to an IRA might be less expensive and give you more choices than either 401K plan does.

Other reasons to leave your 401K balance with the employer might be to take advantage of the plan’s 401K loan feature or to take advantage of the “backdoor Roth” strategy.

Another important consideration is asset protection. 401K plan assets are legally separate from both the sponsoring employer and the workers. Under federal law, creditors will have no claim on them if the company goes bankrupt – or if you go bankrupt individually.

However, if you move the money from a 401K into an IRA, it loses that federal protection and becomes subject to state law. Some states protect IRA accounts from seizure, some protect it under certain conditions, and others don’t protect it at all.

All these factors can be confusing. If you anticipate a career change or have 401K assets still with former employers, talking to an expert is a good way to learn what is best in your situation. Feel free to call on us at Republic Wealth. We’ll help you evaluate the options.
 

IMPORTANT DISCLOSURE INFORMATION: Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Republic Wealth Advisors), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Republic Wealth Advisors.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Republic Wealth Advisors is neither a law firm nor a certified public accounting firm and no portion of this blog content should be construed as legal or accounting advice.  If you are a Republic Wealth Advisors client, please remember to contact Republic Wealth Advisors, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Republic Wealth Advisors’s current written disclosure statement discussing our advisory services and fees is available upon request.



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Supreme Court Changes 401K Landscape

Supreme Court Changes 401K Landscape

A 401K account is the retirement saving cornerstone for millions of American workers. A Supreme Court decision last month could have a big impact on the way these plans work. Both workers and business owners should pay attention.

In a unanimous ruling, the court said 401K plan administrators have a continuing duty to “monitor trust investments and remove imprudent ones.” This may sound like a small change but it is actually very important.  Companies can’t just “set it and forget it.”

The case was against California utility company Edison International.  Workers claimed the company violated its fiduciary duties by making workers choose from a list of “retail” mutual funds when it could have used nearly identical “institutional” funds with lower fees.

This exposes a little secret of the 401K world. Large mutual fund companies sometimes encourage employers to use higher-priced funds and then use some of the extra fees to offset administrative fees. This effectively transfers some of the employer’s costs to the workers.

The Edison International case could change this practice. The opinion by Justice Stephen Breyer said plan administrators must follow fiduciary principles, acting with “care, skill, prudence and diligence.”

Specifically, sponsors like Edison must make sure their plan options are reasonable and cost-effective for workers – and that they stay that way. Companies can’t simply put the plan on autopilot and presume everything will be fine.

The ruling is a big win for retirement savers. Over time, it should encourage employers to offer more low-cost investment options including exchange-traded funds (ETFs). This should translate into better performance and ultimately higher balances for workers entering retirement.

On the other hand, the administrative costs that can no longer hide inside mutual fund fees won’t just go away. Companies may see their 401K costs rise as they lose rebates from fund sponsors, and some small businesses could make their plans less generous for workers.

If you are a business owner with a 401K plan, you may be one of the investors – but you also have an ongoing legal responsibility to every other participant. You have to design the plan so it is fair to them, and you have to make sure it stays that way.

At Republic Wealth, we’ve helped many professionals make the most of their 401K options. We’ve also helped business owners develop plans that help their workers build a solid future for themselves. In other words, we’ve seen it from both sides of the table. We are always happy to share our experience with Republic Wealth clients. Call us anytime for help with your 401K.


IMPORTANT DISCLOSURE INFORMATION: Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Republic Wealth Advisors), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Republic Wealth Advisors.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Republic Wealth Advisors is neither a law firm nor a certified public accounting firm and no portion of this blog content should be construed as legal or accounting advice.  If you are a Republic Wealth Advisors client, please remember to contact Republic Wealth Advisors, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Republic Wealth Advisors’s current written disclosure statement discussing our advisory services and fees is available upon request.



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