A Roth 401K option is something offered by employers and something you should consider.
Investments, Retirement, Strategies & Tips

Why Don’t More People Take Advantage of the Roth 401(k)?

What is a Roth 401k?

Since January 1, 2006, U.S. employers have been able to amend their 401(k) plans to allow employees to take advantage of Roth plan tax treatments. According to the Plan Sponsor Council of America, over 70% of corporate retirement plans offered a Roth 401(k) in 2017. Yet despite this number, more than 80% of participants made pre-tax deferrals rather than a Roth 401(k) contribution. Why don’t more people take advantage of the Roth 401(k)?

Like the Roth IRA, the benefit of making Roth 401(k) contributions is that by paying taxes today, you receive tax-free growth in the future. This compares to pre-tax contributions which avoid taxation today, grow tax-deferred, and are fully taxed at the then current marginal tax rate at future withdrawal.

Roth 401K Employer Benefits

Many employees may not be aware their companies even offer such a plan feature. To see if your company offers the Roth 401(k), simply look on your 401(k) website under payroll deferral options or speak with your HR group. Keep in mind that deferral options are not all or nothing; you can defer a portion of your paycheck pre-tax and a portion Roth if you so choose. If the Roth feature is offered, here are some important things to consider:

If you are married filing jointly and earn over $199,000 in modified adjusted gross income in 2019, you are not eligible to contribute to a Roth IRA. This does not mean you are ineligible to contribute to a Roth 401(k): there is no income limit to a Roth 401(k) contribution. You can also save more. You can only contribute $6,000 to an IRA (Traditional or Roth) for tax year 2019 (or $7,000 if you’re age 50 or older). 401(k) contributions allow you to defer up to $19,000 in 2019 (or $25,000 if you are over age 50). This limit does not include an employer match or profit sharing contribution.

If your employer does offer matching funds, keep in mind that the match is always pre-tax. We advocate for diversification of your investments and in a similar vein, we also believe you should diversify your retirement savings sources. If you have meaningful savings in both pre-tax and Roth sources, you will be able to choose in any given year in retirement how much, if any, you withdraw from each. This flexibility certainly offers the potential for a lower marginal tax rate in retirement compared to taking 100% of your income from pre-tax sources.

In conclusion, many people do not take advantage of the Roth 401(k) despite its many benefits. There is no way to know what your tax bracket or for that matter tax rates in general will be in the future, especially if you’re still decades away from retirement. The benefits of tax diversification upon retirement can’t be understated. With the ability to contribute regardless of your current income, if you’re not already, consider taking advantage of all a Roth 401(k) has to offer. If you’d like to discuss your specific situation in greater detail, don’t hesitate to reach out.

 

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