Making the most of your employee benefits is essential in this tough economy. With more employers than ever adding a new Roth 401(k) option to their retirement plan offerings, should you make the switch or stick with your existing retirement strategy?
A survey from Aon Hewitt found that employers plan to take advantage of a brand-new law allowing workers to make transfers from their existing regular 401(k) accounts to Roth 401(k)s. Although half of the major employers surveyed don't offer a Roth 401(k) option yet, nearly one third of them expect to add a Roth in the next 12 months.
When Would You Like to Pay Taxes?
For decades, regular 401(k)s have let you arrange to have money taken out of your paycheck on a pre-tax basis and put into a retirement account. By contrast, Roth 401(k)s give you the option of contributing after-tax money toward retirement.
Whenever you can use pre-tax money to invest, or to pay for any expenses, it's usually a smart idea. But with traditional 401(k)s, there's a tradeoff: You have to pay taxes on the money you withdraw when you retire.
With Roth 401(k)s, on the other hand, you put post-taxed money into the account, but any future distributions -- money you withdraw, hopefully, after earning a good return on your investment -- are tax-free. In essence, you're trading a current tax break for a future one when you choose a Roth over a traditional 401(k).
Which One Should You Pick?
If you have access to both, choosing between a Roth or a regular 401(k) requires guessing about your future tax rates.
If you pay taxes at a lower rate now than you expect to after you retire, then a Roth is smart.
If your income puts you in a higher tax bracket now than you're likely to be in during retirement, then the pre-tax traditional 401(k) is a better move.
Workers who are just starting out in their careers should strongly consider a Roth 401(k). With modest entry-level salaries, most new workers don't pay high taxes anyway, making the current tax break of a regular 401(k) worth little. In fact, with the new tax law allowing you to convert existing 401(k) balances to a Roth 401(k), workers in low tax brackets should take a close look at paying some extra tax now in order to avoid higher taxes down the road.
Contact your human resources department to find out if you have a Roth 401(k) available to you. If so, ask for information about your options for both future contributions and your existing retirement account balances. And if your employer doesn't offer a Roth 401(k), you might gently suggest the possibility of adding it to an existing plan.