How you save for retirement can be as important as how much you save.
Should you save for retirement using only the pre-tax contributions in your 401k plan (or IRA for that matter)?
The answer is not simple and you have to take a long-term view because the implications extend into retirement. However, my quick response is no, you should also assure some investment withdrawals in retirement are tax-free and can be timed by you, not the IRS.
Second, always contribute the absolute maximum you can and start as early as possible and never stop.
Now, think about how to save.
If you are a relatively low income earner today, it may be better to save after-tax now in return for tax-free income later when you may be in a higher income bracket. This means a Roth 401k if available or a Roth IRA.
Keep in mind too that earnings on traditional 401k (and IRA) contributions are taxed later as ordinary income, not as investment income like capital gains and dividends. So you get to keep less. (This is also why I suggest some savings outside any qualified retirement vehicle … perhaps high quality dividend paying stocks or mutual funds.)
401k balances, pre-tax or Roth, are subject to the required minimum distribution at 70-1/2 while Roth IRA money is not subject to RMDs.
What you can do:
Roll over a traditional 401(k) into a traditional IRA, tax-free.
Roll over a Roth 401(k) into a Roth IRA tax-free thereby avoiding the required minimum distributions on that money.
Roll over a traditional 401(k) into a Roth IRA—this would be considered a “Roth conversion,” so you’d owe taxes.
Here are the complete IRS Required Minimum Distribution Rules to review.
Statements like the following are common and readily accepted by many people, but can be misleading. Earnings on your IRA or 401k are not taxed as they accrue, but do not accrue tax-free, they accrue tax-deferred. Only earnings on a Roth account are truly tax-free. The valid point however, is that if you are not paying taxes as earnings accrue there are more earnings to compound over time.
Compound interest is your friend — we hear it time and time again, so if you can start saving earlier, your portfolio will have more chance to recover from market shocks and also earn more in interest. If your money is in a retirement account like an IRA or 401(k), those earnings accrue tax-free. In a Roth IRA, the money you put in is taxed upfront, so any earned income accrues tax-free and will also be tax-free when you take distributions after age 59½. Source: CBSNews