Do you expect tax rates to be higher when you retire than they are right now? Do you think you will be earning more at retirement than you do today?
If you’ve answered yes, you should probably opt for a Roth 401(k) if your employer offers one.
The difference between Roth and traditional 401(k)s isn’t particularly complicated, observes Certified Financial Planner Todd Rustman, the president of GR Capital Asset Management LLC in Newport Beach, Calif. It boils down to this, he says:
- With a traditional 401(k), contributions are made up of pre-tax dollars, the account grows on a tax-deferred basis and you pay tax on the account when you withdraw the money. That can take place as early as age 59 1/2, or as late as age 70 1/2.
- With a Roth 401(k), what goes into the account are after-tax dollars. Your contributions will be taxed at current rates, for the years when contributions are made, and when you take the money, again, no earlier than age 59 1/2 with a required minimum distribution by 70 1/2, all of the money comes out tax-free.
Among those companies that do not currently offer a Roth 401(k) alongside a traditional 401(k) option, 12% said they are very likely to do so in 2009, Hewitt says, adding that where companies still do not offer a Roth, lack of evidence of significant employee usage has been the main obstacle.
Given its advantages to younger workers in particular, the problem most likely comes down to how well workers understand the Roth option, first launched in early 2006.
As Hewitt explains in its recent report, entitled “Hot Topics in Retirement,” participants who believe they are in a lower tax bracket now than they will be at the time they retire—which is generally the case for younger employees, as well as many others—may find Roth 401(k) accounts to be advantageous.
People should also ask themselves “Will taxes be higher now or when I retire?” says Rustman.