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My Wife’s Company Will Begin Offering the Roth 401(k) Next Year
By JLP | July 17, 2007
I found out yesterday that my wife’s company will begin offering the Roth 401(k) in January, 2008. Immediately I started thinking about whether or not it is a good deal for us. Believe it or not, it’s not a simple decision because there are numerous variables to consider.
NOTE: It’s important to keep in mind that I am NOT a tax expert. So, if some of my thought processes don’t make sense here, that’s why.
So, here are some PROS and CONS (if I missed any, please let me know by leaving a comment) of the Roth 401(k):
PROS to the Roth 401(k):
1. Roth 401(k) offers the ability for tax-free income at retirement.
2. Roth 401(k) can be rolled into a Roth IRA. For those who make a lot of money, this could be an easy way to move money into a Roth IRA.
3. As of right now, income received from a Roth IRA during retirement does not count when figuring the taxation of Social Security benefits.
4. Unlike other accounts during retirement, there are no required minimum distributions with a Roth IRA.
5. Tax rates could be higher in the future, which would make tax-free income in the future, more valuable.
CONS to the Roth 401(k):
1. A Roth 401(k) is funded with after-tax money, which means higher tax bills now and could possibly subject you to the dreaded Alternative Minimum Tax. I did a quick calculation and figured that our tax bill for 2006 would have been around $2,000 higher had we gone with the Roth 401(k).
2. Along the lines with number 1, Roth 401(k) contributions will mean higher taxable income now. This could affect deductions.
3. There’s really no guarantee that lawmakers won’t change their minds and begin taxing Roth IRAs at some point in the future.
4. The employer match is put into a separate account, which will then be fully taxable at retirement. This is a wash since you don’t pay taxes or get a tax benefit from an employer match.
Those are the pros and cons that I can think of. I’m sure there are lots more that I just haven’t thought of. If I missed some, let me know and I’ll add them to the list.
For me, the jury is still out on whether this is a good deal for our family. I’m thinking about going half and half and trying it out.
Topics: 401(k), Investing, Retirement Planning, Roth 401(k), Roth IRA |
July 17th, 2007 at 12:39 pm
It all depends on your expectations for the future of taxes and how much income you plan to have. For me, it makes the most sense to get as much in ROTH accounts as I can.
Right now, I have a lot of deductions
1) 401k - $15500 in deductions
2) 2 kids (won’t be deductible when i retire)
3) mortgage interest (don’t plan to retire with a mortgage)
4) HSA - $5650 annual deductions
So, my taxable income is about 65% of the gross now but will be about 90% of my gross at retirement and the gross will be quite a bit more.
Since I don’t get the ROTH 401k, I want to get as much in the ROTH IRA as possible. So, I am slowly moving my rollover IRA money from a previous employer to my ROTH (and paying tax on the ammount)
If I had the ROTH 401k option, I think I would go 50/50 to split the risk.
July 17th, 2007 at 12:51 pm
Once I’m married and our combined income exceeds Roth IRA limits, I plan to move my contributions into the Roth 401(k). This year, I’m maxing out the regular 401(k) and the Roth IRA while I still have access to it.
July 17th, 2007 at 1:10 pm
Since I’m in the beginning on my career, I will definitely be in a higher tax bracket later on (and probably in retirement). I would be thrilled if my company offered a Roth 401K!
July 17th, 2007 at 1:14 pm
Due to income levels, I wasn’t eligible for roth ira. I used to fully fund my 401k for the tax benefit. Last yr was the first yr company offered roth 401k. I fully funded roth 401k last yr and gave up the tax advantage b/c I know my income with bonus is going to increase this yr. This yr I went with 60/40 b/c I will transfer ira to roth ira in 2010.
July 17th, 2007 at 2:17 pm
Another con is that, although there is a phase-out on the deductability of a traditional IRA, there isn’t one on the traditional 401k reduction in taxable income.
I was thinking that it would be a pro to contribute a lot more to a Roth plan and you could ease (somewhat) the tax hit by contributing to a deductable IRA (instead of the Roth) but you might be phased-out. $2000 isn’t peanuts.
July 17th, 2007 at 3:05 pm
I am taking advantage of my employer’s Roth 401k starting this month for 3 reasons.
1) Tax diversity. I have much more money in traditional 401k/IRAs thasn I do in Roth accounts. Using the Roth 401k will balance that a little. I think tax diversity is good because it’s somewhat foolish to take a gamble based on future taxes.
2) Despite that foolishness, I have to expect the federal gov’t to raise, not lower taxes overall. My bracket may change up or down, but I’m banking on rates going up for ALL brackets far sooner than it would go down.
3) I won’t be at this job forever, and future employers are not likely to offer the Roth. So I need to take as much advantage now as I can, for reasons 1 and 2 above.
July 17th, 2007 at 6:46 pm
Just want to add another voice to the “yay tax diversity” crowd. Until I learn how to predict the future, I won’t know what is optimal, so spreading the tax burden seems like a good idea.
July 17th, 2007 at 7:10 pm
According to this site http://www.research401k.com/roth-401k.html, the Roth 401k is subject to Required Minimum Distribution.
But it also says that it can be rolled over to a Roth IRA, which is not subject to RMD. Sounds like a loophole to me, one that may be closed later. Probably by making the Roth IRA also subject to RMDs ;(
Otherwise good points. Except that I think that tax rates could increase in the future — I think they most likely will increase.
July 17th, 2007 at 7:28 pm
Without making the prediction that taxes will be higher in the future (which is probably a reasonable prediction), I believe that the clearest benefit choosing the new Roth 401k plans is for people who are maxing out their current 401k limits.
I look at a contribution of $15,500 to a traditional 401k plan as really a contribution of $15,500 * (1 - .28) for someone in the 28% tax bracket. The difference (28%) is actually a contribution to the Federal Government’s investment account. Why? Because after a lifetime of doing these types of contributions, you will end up with the financial a lump sum minus 28%. I’m not at all suggesting that this is a bad choice. I do it.
However, most of the comparisons being done are comparing a maximum contribution into a traditional 401k plan with the reduced post tax comparable amount in a Roth plan.
In this analysis, if one’s tax rates stay the same when contributing and withdrawing, then the two methods are identical.
But what if one of our goals is to maximize our retirement accounts. Even though it will hurt more to contribute to a Roth 401k plan, in the long run we will have an investment account that is larger because there isn’t any government share. And isn’t that the primary goal why we started these retirement accounts?
This benefit of the Roth 401k kicks in when someone contributes to a Roth 401k any amount that is greater than (Max Allowed Contribution * (1 - .28)) up to the Max Allowed Contribution. In the long run, you will have sheltered more of your income to your retirement plan.
July 17th, 2007 at 7:47 pm
Given the uncertainty of future tax laws, I really like the idea of diversifying my tax situation. Just have a look at the tax rate rollercoaster over the last few decades. I think there is a tendency by most people to make savings decisions based on today’s income, long-term capital gains, or dividend rates, but it is much more important to consider the rates at the time you’re taking the money out.
Since we don’t really know what that will actually look like, it would be nice to have as much choice as possible in the future, not only when we start spending our savings, but as the tax landscape continues to change over the course of the rest of our lives. With each passing year we can look to pay ourselvs from the most advantages source at that point in time.
July 18th, 2007 at 8:37 am
My company starting offering the Roth 401(k) July 1. For some of the reasons mentioned above (e.g. tax diversity) I decided to split my contributions as well. Interestingly our plan doesn’t make clear what happens with the employer match, and the call I made to HR July 1 landed me with someone who wasn’t sure either.
I’ve left the 6% contribution required for employer match in the regular 401(k) and moved the 4% over (I contribute 10% of my salary in total) to the Roth. I don’t yet know if the employer match stays with the regular 401(k) or gets split 60/40. We’ll find out in early August!
July 18th, 2007 at 8:47 am
EA,
I’m almost positive that the employer match would have to go in a separate account that is taxable upon retirement. Why? Because your company gets a tax deduction wehn they make contributions to your 401(k).
July 18th, 2007 at 9:48 am
EA and JLP,
Company matches do indeed have to go into a “Rollover IRA” and not a Roth IRA. I just went through the process myself, and I will have to say it is a bit of a pain because not many people have done this yet, as the Roth 401k is still so new. When I asked for the forms, the administrator did not send forms for me to handle both, and I didn’t really feel comfortable making a copy and modifying it (by hand, crossing stuff out and writing stuff above it), but that is what they told me to do.
My gut instinct may have been right, though. My employer match transfered into my Rollover IRA last week. As of yet, my contributions have not made their way into my Roth IRA. I am calling them today to find out what is up.
July 19th, 2007 at 10:26 pm
I just switched to a roth 401k and the impact is hardly noticed in my paycheck. The end result will be much better than the traditional 401k.
I don’t think gov’t will change the policy on the Roth - unless those politicians don’t want to be reelected.
July 20th, 2007 at 12:15 am
I agree with John — a big benefit of the roth 401(k) for me is the ability to save significantly more (net) each year for retirement.
July 20th, 2007 at 5:19 am
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