Is A Roth 401K The Best Retirement Account For You In 2023?Mar 01, 2023
When it comes to retirement accounts, there is a host to choose from. Is a Roth 401k retirement account the right choice for you? Hello, I’m Elijah Bilel with financial anatomy, covering what a Roth 401k retirement account is. Prefer video? Scroll to the bottom to watch the video!
A Roth 401 K is a type of retirement account. A 401K is set up by your employer and has tax and savings advantages. Note that this article explains what a Roth 401k is from the perspective of an employee, not the employer.
I should also mention that the Roth 401 k is a type of 401k so things like the vesting period, withdrawal penalties and contribution limits still apply here. If you haven’t watched my what is a 401k video, you should do so before watching this as I will be referring to some of the info from that video.
With all that being said, let's go over what is exactly different in a Roth 401k. When you see the word.”Roth” before a type of retirement account, what it essentially means is that it is tax-free. The way this plays out is instead of paying taxes upon withdrawal after you retire, you pay taxes on the money upon putting that money in. This means when you withdraw it at retirement, it is tax-free.
To illustration this, we will go back to the example we used in the 401 k article. what a 401 k is, we will use an example. Here is John who just graduated from college and just got a job as a banker.
One of the advantages of this job is 401k matching. So how does 401k matching work? Let’s say John has 80,000 dollars before taxes. He is allowed to put up 6% of his salary into the company 401k program. The company agrees to match 50 cents for every dollar that he contributes.
If John contributes the full amount, he will have 4800 in the account. If the account he is contributing in is a Roth 401K, he will pay taxes on this money now. With his income being at 80,000 dollars, his tax bracket is 24%. It’s important to note that since he is paying taxes on this money now, contributions to this account are NOT tax deductible.
Continuing with the example, his company will match this and contribute 2400 dollars. This money that the company contributes IS taxable and is held separate so that when you do withdraw it when you retire, it can be taxed. On top of these differences, distributions or withdrawals from a Roth 401k are mandatory once you turn age 70 1/2.
If for some reason, you do not want this to happen, considering opening up a Roth IRA and transfer the funds from your Roth 401 k to the IRA. So what are the pros of a Roth 401K?
1.There is no getting around the fact that it is free money from your employer. Whether it is 401k matching or profit share, you are getting free money and that in itself is a pro.
2. A Roth 401k is also a way to make investing very autonomous. The money is taken out of your paycheck and put into any investment. For those that would rather not deal with the management of the investment, this is a good deal.
3. Lastly, A Roth 401k allows you to pay taxes now. If you are making more money when you retire, you could be in a higher tax bracket. Since you already paid taxes, you will effetely pay less in taxes since you paid them when you were in a lower bracket. On top of this, with inflation in effect, you are paying the taxes now with less money as opposed to paying them when you retire which would technically be more money coming out of your pocket.
1.A huge con is if you need the money in the account for whatever reason, you can end up paying a 10% penalty just like a normal 401k.
2. On top of this, all 401Ks are almost always composed of mutual funds which can present certain issues. It is important to note that your investment options will be limited to what your employer has listed. This can be a big con if they are investing in industries that will soon be obsolete.
3. With limited options also comes fees that mutual funds charge which can be steep. There is always the thought that you could invest yourself and not be paying these fees and even though it’s nice to pay taxes now, the drawback is your contributions are not tax deductible.
In summary, a Roth 401k retirement account is a great choice for those that want to get the free money from their employer who offers it and like the idea of their retirement getting managed for them. In addition to this, it is great for those that want to pay taxes now so that their retirement can have the opportunity to grow tax free.
If you’re looking for more information on personal finance for young adults, you can checkout my free E-book/Audiobook, Steal my financial blueprint. In it, I lay the blueprint that all young people need to implement to ensure that their money is going in all the appropriate places to take care of them, both today and later in life. You get the book here.