The Roth 401k was designed by Congress in 1998 to allow employees another alternative to save for retirement. It shares similar aspects to a traditional 401k with a few advantages. The Roth 401k has become more popular in recent years with more and more companies adopting them. Your particular company must offer them in order for you to take advantage of them. Here are a few aspects of the Roth 401k that you should consider.

After Tax Contributions

The biggest difference between a Roth 401k and a 401k is when the taxes come out. With a regular 401k plan, you deduct a certain percentage of your paycheck before taxes are taken out. The money goes into your 401k and lowers your taxable income. Then when you become 59 1/2, you can start to take out the money and pay taxes on it. You will be responsible for paying regular income tax on the money as long as you receive it.

With a Roth 401k, the entire process is backwards. You get your paycheck with all of the taxes already taken out. Then you decide how much to contribute to your Roth 401k. The money goes into the retirement account and grows until you are 59 1/2. Then when you take out the money, it is tax free. You pay no more tax on the contributions or the earnings. If you have earned quite a bit of money, this can be a large amount of tax free money at your disposal.

Advantages

This type of account is great for younger people who expect to be in a higher tax bracket when they are older. If you are in your 20's and just starting out in the workforce, you will most likely be making less money every year than you will be when you are 50. By climbing the corporate ladder, you will also climb into a higher tax bracket as you go. With a Roth IRA, you pay taxes on the money when you are paying in the lowest tax bracket. Then when you retire, all the money will be tax free. This can result in a huge savings for you overall on taxes.

Another advantage is in the area of increased taxes. Income taxes usually tend to go up slowly over the years. Barring any unusual changes in the way we are taxed, we have every reason to believe that taxes will be higher in general 40 years from now. Our society might require more taxes in order to support the growing demands on it. Therefore, if you get the taxes out of the way when you are young, you will not have to worry about this issue when you retire.

In addition to these advantages, you can choose to contribute some of your paycheck to a Roth 401k and some to a traditional 401k. This way, you are diversified and can take advantage of both tax scenarios.



What are the Roth 401k contribution limits?



Understanding the Roth 401k contribution limits is important because it helps you to avoid getting penalized for contributing too much money. As of 2010, you can contribute as much as $16,500 per year to your Roth 401k account. If you are over the age of 50, you can make an additional contribution of $5500, which makes your total $22,000 that you can save. In addition to the money that you put into your account, your employer can make contributions to it. The employer gets a tax deduction for contributing money, so they will often be able to help your account grow substantially.



What are the Roth 401k withdrawal penalties?



If you are interested in a Roth 401k withdrawal, you may be concerned about the money that you have to pay in penalties. One of the great things about the Roth 401k is that you can withdraw any of the money that you contributed to the account at any time without penalty. With the Roth 401k, you are not getting any tax advantages when you contribute on the front end. You are contributing with after-tax money, which means that you should have access to it if you need it. If you withdraw money that was earned from investments, however, you will have to pay a 10 percent early distribution penalty.

blog comments powered by Disqus