Roth 401k’s are becoming more common place in employers retirement plans. If you have a Roth 401k as an option at your job, which one do you choose? Trying to decide whether the Roth 401k vs. the Regular 401k is best for you first requires to understand the basics.
Basics of the 401k
A 401K plan is a salary reduction plan that allows employees to defer a portion of their salary (through payroll deductions) towards retirement. For 2009, employees are limited to salary reduction contributions of $15,500. For employees over the age of 50, the law now permits “catch up” contributions of an additional $5,500 for 2009.
Keep in mind, the above paragraph describes the general characteristics of any 401K. The way your salary reduction contribution is treated (from a tax standpoint) is what determines whether it’s a regular 401K contribution or a Roth 401K contribution.
Regular (traditional) 401K
A regular 401K contribution (which is the payroll deduction that the overwhelming majority of Americans make) is a pre-tax contribution. So if you contribute the maximum for 2009 ($16,500) you are not paying any taxes on this money, therefore reducing your taxable income by that amount for 2008.
You will pay taxes on this money when you take it out in the future; these future distributions will be included as ordinary income.
In a Roth 401K, you are making an after tax contribution. You are entitled to make the same salary deferral contribution ($16,500 for 2009) but the monies you contribute are included in your taxable income for that year. Since you are foregoing the tax break now, you will pay NO TAXES on future distributions.
How Does Your 401k Stack Up?
Unfortunately, you can’t just tell your employer which way you’d like your contribution treated, at least not yet. Your employer has to have an existing Roth 401K alternative in place, in order for you to be eligible to contribute.
Since most employers (to their detriment) are not very proactive with retirement plans, many do not offer employees the Roth 401K option (only the traditional 401K). If you’re frustrated by this fact, then start off by contacting someone in your HR department to do something about it.
A few closing observations:
- A traditional 401K has many of the same characteristics as a traditional IRA
- A Roth 401K has many of the same characteristics as a Roth IRA
- 401K payroll deductions are automatic
- An employer matching contribution can’t be added to your Roth 401K, it must be made to a regular 401K
- The total employee contribution for 2009 is $16,500 ($20,500 for those 50 or older), no matter how you divvy it up between a regular 401k and a traditional 401k