The Roth 401(k) and Roth IRA: Pay Now or Pay Later
In 2001, when I joined this industry, Roth 401(k)’s just came into existence. Unlike a traditional 401(k), contributions to a Roth 401(k) aren’t tax-deductible, but the upside kicker is this: withdrawals are tax-free in retirement. A Roth 401(k) offer an after-tax contribution option with tax-free withdrawals provided these withdrawals are ‘qualified distributions’ made after a 5-taxable-year period of participation. Got that? It’s “a 5-taxable-year period”. This is a critical number. Also, if qualified distributions are either made on, or after the date participants attain age 59½, made after death, or attributable to a participant being disabled, it is entirely tax-free. (As a planning side note: If you’re a business owner or plan sponsor, a Roth 401k option opens up another cool feature that allows participants to take advantage of another—often overlooked and underutilized—tax strategy, that is, the “in-plan” Roth Conversion. (Ask your financial advisor about this unique strategy if it make sense for your entity).
By the way, did you hear? We got good news from the IRS. Well, a relatively positive outcome, anyway. For 2023 the 401(k) limit has increased to $22,500 (plus an add’l $7,500 ‘catch-up’ provision for those of us age 50+). In lockstep, the IRA limit has now risen to $6,500 (+$1k ‘catch-up’ rider). Changes mean that retirement savers, 50+ years old can now sock away a combined $30k/year in their 401(k)’s. Yep, $30,000! If offered at their workplace (in fact, an estimated 70% of 401(k)s now have a Roth feature), I think younger workers (<50) should seriously consider a Roth 401(k) to help minimize taxes in the long run. As you may know, there are no income limits for a traditional IRA, but how much you make has a direct bearing on how much you can contribute to a Roth IRA. However, Roth 401k’s are different. High earners can actually take advantage of the Roth option in their employer’s retirement plan, if they choose. The fact is, there is no income limit for Roth 401(k) contributions. At the same time, it is worth noting that there’s no income limit on deducting contributions to a traditional 401(k) account, either. So, when you get down to it, high income earners may be better off contributing to the traditional 401(k) and taking the tax deduction now at their high marginal tax rate than saving in a Roth account. It comes back to the old, “Now or later” issue, that is the question. No one can foretell the future. So you’ll need to decide. Of course, let’s not forget about Roth IRA’s. They have a place to play in the retirement planning world too.
If you want to take a deeper dive into Roth IRAs, or review your existing 401(k) plans and their benefits, please reach out to us. Because whether you’re feeling bearish or bullish, enlisting the guidance of a licensed “fiduciary” level financial advisor can help you make sense of it all. When you get down to it, it is more than retirement planning. You need a trustworthy, tax advisor. Because as they say, the day will come when Uncle Sam (aka the IRS) wants his pound of flesh. Just remember, you have (or at least, had) a choice in the matter. So, pay now or pay later. That’s for you to decide. Plan well, g.