Is a Roth 401(k) Right for You?

Like a Roth IRA, a Roth 401(k) has tax-free withdrawals. However, contributions are taxed. Roth 401(k)s benefit those who will be in the same tax bracket or a higher tax bracket by the time they retire. Roths can be great for high earners or young people starting to save for retirement.

At retirement, if your tax rate will…
Drop: Do you expect Social Security to finance a large part retirement? This could cause your tax rate to drop. Moving to a low-tax state like Florida (a popular destination for retirees) from a high-tax state could cause your tax rate to drop. The Roth might not be the right call, but look at the other factors to see if it could still benefit you.

Rise (or stay the same): then you may be better off with a Roth 401(k). Taking money out of an IRA can raise your tax rate. Losing mortgage deductions (or other deductions) can also raise the tax rate.

However, there are still other factors to consider.

AGI: Another factor to consider is that Roth 401(k) contributions do not lower your adjusted gross income (AGI). Many tax credits and deductible expenses are based on your AGI. For example, medical expenses are only deductible in excess of 7.5% of your AGI.

Minimum distributions: Rolling the Roth 401(k) account into a Roth IRA will eliminate required minimum distributions starting at 70 1/2.

Inheriting a Roth 401(k): Like those who inherit a Roth IRA, those who inherit a Roth 401(k) can spread distributions out over their lifetime. Spouses who inherit a Roth 401(k) have the option to postpone distribution by rolling the 401(k) into their IRA.

Earning more than $173,000: The Roth 401(k) is a great alternative to Roth IRAs for married couples filing jointly earning more than $173,000, since that is the amount at which couples are prevented from fully funding a Roth IRA.

For more retirement planning tips, check out Retirement Saving Tips.

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