Retirement

Why 2006 was an important year for your 401(k) plan and why you may be missing out on this valuable option – think Roth.

Senator William V. Roth, Jr. (R-DE), c. 2000

Senator William V. Roth, Jr. (R-DE), c. 2000 (Photo credit: Wikipedia)

2013

If you are funding your own retirement, you have former Senator William V. Roth, Jr. to thank for a valuable, but greatly underused financial tool; the Roth 401(k). The Roth 401(k) became available in 2006 several years after his death but nevertheless as a result of his legislation.

The Roth 401(k) option differs in one major way from the traditional 401(k) in that your contributions are made on an after-tax basis, but your contributions and earnings on contributions are withdrawn from the plan tax-free. In addition, if you roll your 401(k) into a Roth IRA there is no minimum distribution required. So why don’t more people use the Roth option and should you?

My personal opinion is that 401(k) savers should absolutely be using the Roth 401(k) for one good reason. That reason as one expert recently put it on a webinar I attended is, “stuff.” That simply means that your real goal is to have as much spendable money in retirement as possible, spendable money is after you pay taxes, the money you actually have to buy the “stuff” you need and want. With Roth saving you know exactly what you will have to spend because regardless of your tax bracket, you still keep it all.

Not all experts agree on the value of the Roth 401k, some argue that the tax advantage of the traditional 401k outweigh the tax-free aspects of the Roth. You can pull out your spreadsheet and do all the calculations you wish trying to determine what your tax bracket will be in thirty years or what tax rates will be. Your guess is as good as anyones. One thing is a good bet though, if you are say thirty years old the chances are pretty good that even without an increase in tax rates, you will be in a higher bracket in the years ahead.

Foregoing lower taxes today by saving on an after-tax Roth basis, may pay big dividends in the future when what really matters is the cash you have to spend. In any case, if your 401k plan offers a Roth option, it is definitely worth serious consideration.

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