To Roth 401k or Not to Roth 401k


As the labor market has been gutted by COVID (early retirements and twenty-somethings who got used to the government sending them paychecks for 18 months and are not willing to work), employers are having to pay significantly higher wages and offer new and exciting benefits to coax people back into the workforce. One of these benefits is an employer-sponsored 401k. This plan is a tax- efficient way for employees to save for retirement through employee payroll deferral. One of the main benefits to having a 401k is the ability to defer your current income until a time in the future, typically during retirement, when your income is lower. Your deferred payroll deposits are not included in your current taxable income and are allowed to be invested in different markets and grow tax-deferred, until you withdraw those funds when you retire. Another added benefit to a 401k plan is that often, employers will match the contribution you make. Then, this type of savings plan is even more beneficial for the employee and becomes a very valuable part of their employment package. Some employers, in an effort to try to retain and recruit good employees, have instituted match policies of up to 10% of the salary percentage that employees put away on their own. That is essentially a 10% increase in pay if you stay with the employer for a specific period of time, as laid out in the plan’s vesting schedule.

A newer component that employers have added to these deferred compensation plans is the ability to contribute into a Roth 401k, which is on an after-tax basis. The money contributed into the Roth portion of the 401k could be able to grow completely tax-free for retirement if certain plan criteria and IRS rules are met. Although the employee is allowed to put money into the Roth portion of their 401k, the employer contribution (or the “match”) can only be put into the tax-deferred side. Many of our friends and clients are often asking, “Should I be putting money into the Roth portion of my 401k instead of the traditional side?” You might think there would be a simple answer to this question, but I can assure you there is not.

The decision to contribute to the Roth portion of your 401k as compared to the traditional portion takes into account many different variables that are very much based on the individual’s own circumstances. So there is no “rule of thumb” or cookie-cutter answer. These decisions are always best made with the guidance of a qualified financial planner and/or investment advisor. Here are a few questions you can think through which will help guide you in this decision-making process.

Are you at the lower end or beginning of your earnings career or toward the top?

What is your current tax bracket and what tax bracket would you project to be in during retirement?

What are your overall thoughts regarding the U.S. current debt and tax structure? Do you think it will be higher during your retirement than it currently is?

Considering your overall investment/retirement scenario, how many pools of money do you have to draw from?

Having answers to these questions will be very helpful for you and your financial advisor when deciding IF and how much of your contributions should be going into the Roth portion of your 401k. Before you spend time laboring over these questions, your first point of order may be to contact your employer’s HR department and ask whether your 401k even allows for a Roth portion.

Hope you’re enjoying an amazing start to your summer here in Michigan. Gotta love the seasons our great state provides us!




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