Have you noticed a new option popping up in your retirement benefits package lately? Almost half of US employers— including Aliat —now offer the Roth 401(k) in addition to the traditional 401(k). If you’re wondering which type of retirement savings account to choose, here’s a primer on the two types so that you can make an informed decision that’s right for you.
How the Two Accounts Differ
The key difference between these two types of 401(k) accounts is when you pay taxes on your contributions.
Traditional 401(k)s, created in 1978, allow you to defer income tax on your contributions as well as tax on growth along the way. All money taken out of the account is taxed at ordinary income rates at the time of withdrawal.
Roth 401(k)s, created in 1998, require that you pay income taxes on anything you contribute now (not including employer matching funds). They allow you to defer tax on growth along the way, and to take the money out tax-free in the future if you follow the rules.
What Isn’t Different
For both types of accounts, you must be older than 59½ in order to access the funds without a tax penalty. And you must start taking taxable withdrawals, called required minimum distributions, out of the account by age 70½ if you’re retired.
The 401(k) contribution limit also applies to both accounts. You can contribute up to $18,000 per year, or $24,000 if you’re 50 or older. You can contribute to both accounts in the same year, as long as you keep your total contributions under that cap.
Which Account Type Is Right for Me?
Ian Rice, Managing Partner at Rice Financial Group, advises choosing a traditional 401(k) if you believe you’ll be paying lower tax rates in the future, or if you believe the government will decrease taxes down the road.
But a Roth 401(k) is the way to go if you anticipate being in a higher tax bracket when you retire, or think the government will increase taxes in the future. “And if you stay at the same tax rate, it’s irrelevant which one you choose,” he says.
Don’t Put All Your Eggs in One Basket
Because your future income and tax rates are relatively unknown, it could be prudent to invest in both a traditional 401(k) and a Roth 401(k) if you have the choice.
In fact, Rice recommends diversifying your retirement investments across the board as a way to reduce risk and potentially increase your rate of return.
“Ideally, at retirement you’ll have multiple buckets. A general rule of thumb is to have 25 percent of your wealth in each of four categories,” he says.
Rice defines these categories as:
- Traditional 401(k) money
- Roth 401(k) money
- After-tax privately owned assets or investments
- Non-correlated assets (assets that don’t move in the same direction at the same time)
Start As Early As You Can
Regardless of which account type you choose, Rice emphasizes the value of contributing to a 401(k) as early as you’re able to. “Waiting 10 years to begin saving can cut your future account balance significantly,” he says.
For example, a 30-year-old who makes $50,000 a year and begins saving 5 percent of her pay each month to a retirement account will accumulate $295,302 by age 65. But if she starts contributions at age 40, she’ll yield far less: $145,391.
We Prioritize Your Financial Health
At Aliat, we care about your financial health. Our retirement plans includes benefits such as:
- Three percent profit-sharing contribution to a traditional 401(k).
- The ability to contribute up to $18,000 per year into this plan if you are under 50, and up to $24,000 per year if you are over 50.
- Access to local financial advisors and certified financial planners free of charge to help you create the best strategy for your specific situation.
For more information about our retirement plans, or for assistance in navigating your benefits, get in touch with us.