Think You Can’t Contribute to a Roth? Think again: Advantages of a 401(k) Roth Option

Dollarphotoclub_76953749Key Takeaways

  • The Roth option in 401(k) retirement plans eliminate IRS income limits applied to Roth IRAs.
  • Participants in plans offering the Roth 401(k) option can split their contributions between both traditional and Roth accounts–thus, building two buckets of money to fund their nest egg.
  • There are no income limits for Roth 401(k) accounts, and potential ways to avoid Required Minimum Distributions!

Does your current employer’s sponsored 401(k) retirement plan offer a Roth option?  Sounds like a simple question, but many plan participants don’t know the answer. Regular readers of this blog know we have touched on the differences between Traditional and Roth contributions.  We will explain three advantages that the Roth 401(k) option offers plan participants: Eliminating income limits, creating multiple buckets of retirement funds and easing your tax burden in retirement.

1. Eliminating income limits    

Many savers, investors and retirees are unclear about the difference between Roth IRAs and a Roth 401(k) option.  As many of you know, the IRS sets income limits above which you cannot contribute to Roth IRAs – for tax year 2016 the upper limit for a single tax filer starts at $117,000 and ends at $133,000.  For married filers, the phase out starts at $184,000 and ends at $194,000. Remember, these income limits apply to Roth IRAs NOT to Roth 401(k) accounts. The Roth option in a 401(k) plan is eligible to all participants regardless of income level.

2. Creating two buckets of retirement funds 

The debate between traditional and Roth contributions centers on one’s prediction of their future tax rates. Simply put, there is no right or wrong answer. The argument for traditional contributions hinges on your belief that your tax rate will be lower in retirement than it is now during your working years.  However, no one knows for sure where tax rates will be in the future.

A way to hedge this unknown is to contribute to both the traditional and Roth options in your retirement plan. The maximum allowable contribution to a 401(k) for 2016 is a total of $18,000 (with an additional “catch-up” contribution of $6,000 allowed for those for age 50 and older). Splitting your contributions between traditional and Roth accounts creates a tax savings opportunity now, along with tax free withdrawals in retirement. Finally, if you leave your current 401(k) plan, your Roth 401(k) account can be rolled over into a personal Roth IRA regardless of your current income level.

3. Easing one’s retirement tax burden

The advantages of a Roth continue into retirement. Let’s make a reasonable assumption that a retiree rolls over his or her Roth 401(k) into a personal Roth IRA. Not only are withdrawals from Roth IRA accounts tax-free, they are NOT subject to IRS RMD rules starting at age 70 ½.  This advantage can ease a retiree’s tax burden throughout their retirement.

Conclusion

Not all 401(k) plans offer a Roth option.  However, if your current employer’s plan offers the Roth option, taking advantage of it can be beneficial when saving for retirement. Please contact us if you have questions about your Roth accounts, or to determine if the strategies laid out in this post make sense for your situation.

About the Author

Patrick D. Melvin Jr., is a Wealth Manager at Independence Advisors, LLC.  Pat models client’s financial plans and works with the firm’s clients on financial planning areas such as retirement planning, investment planning and estate planning.  CLICK HERE TO ASK PAT.

 

About Patrick Melvin Jr.

Patrick D. Melvin Jr., is a Wealth Manager at Independence Advisors, LLC. Pat models client’s financial plans and works with the firm’s clients on financial planning areas such as retirement planning, investment planning and estate planning. CLICK HERE TO ASK PAT.

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