Ask your employer to consider a Roth 401K

Many people are familiar with the concept of a Roth IRA. For those that are not I will give a quick summary of the difference between Conventional and Roth IRAs and why I believe that a Roth is ALWAYS better for new contributions. Both offer significant tax advantages but one provides more advantages today while the other provides more advantages tomorrow. Given they are retirement investing vehicles clearly we should think more about the impact when we are 65 then when we are 30, 40, etc. Here is the basics of each…

• Conventional IRA - You put money in up to a set maximum per year. You then deduct your contributions from your income for that tax year. So if you owe taxes on 50,000 dollars for a tax year, contribute 10,000 to your conventional IRA you will then pay taxes only on 40,000. However, the tax is not avoided only differed until the time of withdrawal. When you then withdraw this money in retirement you pay taxes on 100% of the money you withdraw as 100% earned income. Oh and should social security survive till your retirement since a Conventional IRAs distributions are considered “income” it will effect what portion of your Social Security is taxed.

• Roth IRA - With a Roth we change the time of the tax advantage to the future vs. the present. So this year you owe taxes on 50,000 dollars and put 10,000 into your Roth IRA and you still pay taxes on the full 50K. However you will now never pay tax on that 10K you contributed or the interest earned on it EVER AGAIN. So if you are 30 in that year you will earn interest for 30 years or more tax free and you will NEVER pay a thin dime of tax on the earned interest. Also when you do withdraw the money it is already your money, it will never be considered “income”, you won’t pay any tax EVER.

Now some advisers point out that if you will have lower tax bracket in retirement and believe in “fuzzy math” that a conventional can win out. However, we should live in the world of practice vs. theory. What I have seen actually happen is that be it Roth or conventional people always contribute the same amount. What this means is while you will pay taxes on a Roth contribution today you will end up with the same amount of money at age 60, 65 or whenever you start to take the money out. In other words your tomorrow will be better with a Roth.

Now what many people do not even know is that a 401K which an employer provides can also now be set up with a Roth Option. With a 401K your employer takes a percentage of your check and deposits it for you. While 401’s have some restrictions that IRAs don’t they work quite similar in how they defer or eliminate taxes. The beauty is when you quit working you can roll your 401K into an equivalent IRA and that means if you have a Roth 401k you can roll to a Roth IRA and have money you can take as needed, keep inside the account as long as you like and never pay taxes on it or ever have it count as income.

Again though while the option of a Roth IRA is well known today most people are not aware of a Roth 401K so ask your employer to check into the option for you. To me they are better for all workers but for the youngest workers the advantages are even bigger. There is a good chance that your employer may not even be aware that they can offer a Roth 401k and as we said all the time in the Army “the squeaky wheel gets the grease”.

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