What is Roth 401 (K) and how is it different from traditional 401 (k)?
One of the many challenging aspects of retirement planning is the selection of the smartest vehicles to save and increase your funds. Most people are familiar with the traditional 401 (k) accounts, usually offered through an employer.
For you: 25 cities where you can retire in a great time for $ 2,000 a month
Learn more: 3 Advanced investment moves experts use to minimize taxes and help increase returns
However, many people skip the Roth 401 (K) – if they even realize that this is an option. So, what is the difference and why can you choose one over another?
To explore the honors, Gobankingrates spoke with Jamie Hopkins, CEO of Bryn Mawr Trust Advisors and Chief Wealth Officer of WSFS Bank. He is also a defender of the Financial Services Industry, the best-selling Wall Street Journal and founder of the FinServ Foundation, a non-profit purpose dedicated to assisting students in college to achieve their full potential through coaching, mentoring and community.
Hopkins said it was a little “misleading” to think about Roth and the traditional 401 (K) plans as completely separate savings vehicles. They are essentially the same type of account-the retirement plans that have been discovered by the employer-but they differ in the way your contributions and withdrawals are taxed.
The traditional 401 (K) is sponsored by the employer a pension savings plan that allows contributions to delay salary by employees and coinciding contributions from employers. This means that you are investing money in this type of account before You pay taxes on it, which reduces your taxable income in the year you contribute. Then you pay taxes on money when you withdraw it at retirement.
In contrast, Roth 401 (K) is funded with after-Tax dollars. Hopkins explained: “This means that taxes are paid before the money is deposited into your retirement account.”
The main advantage of Roth 401 (K) is that money is growing without taxes instead of delayed taxes. Retirement withdrawals are also tax -free as long as two conditions are met:
-
Account should be open for at least five years
-
Withdrawal should occur after a qualification event, usually reaching the age of 59½
“Although there are other slight differences, the main distinction between Roth’s account and tax -deferred traditional account is when you pay taxes,” Hopkins said.
Read Next: Suze Orman: 4 Board for Protection of Your Finance at Retirement
One of the best reasons to open the Roth 401 (K) is to take your taxes out of the way before retirement, Hopkins said. This can reduce your taxable retirement income and can also help you avoid or minimize social security taxes and reduce your Medicare premiums.
“If the bigger part of your income outside the social security comes from Roth’s account, you may be able to avoid taxation on social security benefits and stay at the lowest Medicare Premium levels,” he explained.
Traditional withdrawals 401 (K), on the other hand, delay your taxes at the front end and place the weight of taxation on you when retirement – increasing the total taxable income at a time when you prefer to keep it low. This may mean payment of higher Medicare premiums, partial taxation of social security benefits and reduction of eligibility for needs-based programs such as Medicaid.
If you are still not quite sure who to go with, here are some of the distinctive benefits of Roth 401 (K), according to Hopkins:
Diversification of taxes: Having money, money distributed in taxable, delayed taxes and tax accounts (Roth) gives you more flexibility. Hopkins stressed that tax diversification helps you manage the changing tax rates throughout the retirement. “If your tax laws or your personal situation are shifted, you will have more control over how and when you pay taxes,” he said.
No RMD for Roth Iras: While the Roth 401 (K) S is subject to the required minimum distributions (RMD), starting at the age of 73, you can avoid those by overturning your balance into Roth Ira before this age. “This gives you more control over this when you withdraw money and allows your money to continue to grow without taxes,” Hopkins said.
Greater power after taxation: On the basis of taxation, Roth contributions can give you more net retirement income. For example, if you make $ 5,000 before tax in the traditional 401 (K) and your tax rate is 20%, you will receive $ 4,000 after withdrawal taxes. If you contribute $ 5,000 after a Roth 401 (K) tax, the full $ 5,000 can be withdrawn without tax.
However, it would take $ 6,250 in revenue before taxes to connect with $ 5,000 in the Roth-so that it is important to understand the real compromises.
When weighing whether the Roth 401 (K) is appropriate for your retirement strategy, Hopkins recommends asking the following:
“On the reverse, if you expect to be in a lower tax group upon retirement, the delaying of taxes with the traditional 401 (k) can be more profitable,” Hopkins noted.
If you are still not resolved, do not stress to select between the two accounts. “At the end of the day, the most important thing is to save and invest consistently,” Hopkins said. “There is no perfect answer.” He often advises the division of the contribution between the two types of accounts to benefit each.
This article is part of the Gobankingrats’ Top 100 Cash Experts A series where we project expert answers to the largest financial questions that Americans ask. You have your own question? You can win $ 500 just to ask – learn more at gobankingrates.com.
More from Gobankingrates
This article originally appeared on Gobankingrates.com: The Pension Account that can reduce your taxes – forever, according to CFP
