With the new year around the corner, many workers saving for retirement are wondering whether to make changes to their strategies. One common question will be whether to put money into a Roth 401(k) plan.
A little background information. The Roth individual retirement account (IRA) was created in 1998. Instead of offering a tax break when you contribute, the Roth only allows after-tax contributions; and instead of subjecting retirement-age withdrawals to income taxes, qualified Roth IRA withdrawals are tax-free.
Unfortunately, the Roth IRA limits contributions to $5,000 for those under 50 and $6,000 for those 50 and over. In 2011, eligibility to contribute starts to phase out for single filers with adjusted gross incomes of more than $107,000 and disappears altogether at $122,000. For joint filers, the income limits are $169,000 and $179,000, respectively. Since 2010, however, all taxpayers, regardless of income level, have been able to convert from a regular IRA to a Roth IRA. This gives higher-income individuals the means to effectively contribute to a Roth IRA, although it is not as simple as a direct contribution and gets more complicated when other funds are already in a traditional IRA.
The Roth 401(k) has no income limits for contributions and offers the higher 401(k) deferral limits as well. However, not all plans offer the Roth 401(k) option.
Some of the most important features of a Roth 401(k) plan include:
Should you contribute to a Roth 401(k) if your plan offers this option? The answer might be yes if:
On the flip side, contributions are made with after-tax dollars. Anyone contemplating a Roth 401(k) contribution should look at the value of a tax deferral now vs. some unknown tax savings down the road. This is a classic time value of money analysis. Factors such as your income and age will come into play here.
Access to the Roth 401(k) feature is a plus for those participants whose retirement plans offer it. However, the decision of whether or not to contribute to a Roth 401(k) plan requires an analysis of your situation and some number crunching.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Follow Roger on Twitter and LinkedIn. Roger also blogs at Chicago Financial Planner.