Good retirement planning? No big deal. All it takes is serious option weighing, laser-beam-like consideration, a flexible strategy that lets you change your play at a moment’s notice and a Nostradamus-like ability to see the future.
You’ll often have to predict where the economy, your career, and your money may be decades from now, and how you’ll want to spend (and spend money in) your retirement. Sound like a plan? Actually, though, there is a way to say “I got this” and really mean it.
If your employer gives you individual retirement account (IRA) options, you could be well on your way to nailing down your financial future without excessive hand-wringing. Even better, choosing between a traditional IRA and a Roth 401(k) may not even be a choice you have to make—you could benefit from both. Both investments can serve different purposes and give you different benefits.
A Roth 401(k), for instance, gives you years — possibly even decades, depending on your age — of investment growth, tax free. Ultimately, the difference between a traditional Roth IRA and a Roth 401(k) is when you pay taxes on them.
Traditional 401(k) vs. Roth 401(k)
Here’s the shortcut (and more about this soon). Memorize this and you could be halfway there:
• Traditional 401(k): Pre-tax retirement account. Your contributions are not yet taxed, lowering your taxable income.
• Roth 401(k): Post-tax retirement account. Your contributions will already be taxed before you contribute the money.
Traditional Roth IRA vs Roth 401(k)
It’s easy to confuse the two, but it’s also easy to distinguish between them. Let’s break it down:
Traditional Roth IRA
• No early withdrawal penalty. If you need the money for an emergency, you can withdraw contributions without a penalty from the IRS. However, you may have to pay taxes and penalties on earnings in your Roth IRA if you withdraw money from a Roth IRA you’ve had for less than five years.
• No minimum distributions. Starting in 2020, after age 72, you are not required to withdraw a certain amount of money periodically. (In 2019, the age was 70½). You can let your savings sit in the account and only tap into it when you need it.
• You can continue to contribute to the account. Even after age 72, you can continue to contribute to your Roth IRA. A traditional IRA does not allow contributions after you reach that age.
Related Content: What is an IRA?
• Allows for a company match.
• You won’t be taxed when you withdraw your money (if you’ve held the account for at least five years) because you already paid your taxes on this fund.
• Distribution is required after age 72 unless you’re still working.
Keep in mind, though, not to treat any type of 401(k) like an ATM. The money in an IRA is meant for your retirement, and you might want to fight off any temptation to dip your beak into the fund too early.
How the Roth 401(k) Came to Be
The Roth 401(k) began in 2006 as a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 . It was based on the already-existing Roth IRA, allowing investors to stash their after-tax money in a safe place, for later use.
Contribute to a Roth 401(k) and you won’t be able to claim it as a tax deduction, but you also won’t owe any taxes on any qualified distributions. If you participate in a 403(b) plan, you’re also eligible to participate in a Roth fund.
Roth 401(k) Benefits
Pay today so you don’t have to pay tomorrow. Roth 401(k) contributions are made after you’ve already paid taxes on that money.
When you are able to withdraw your Roth 401(k) money at age 59½, your money is tax free and will remain so going forward, throughout your retirement. The IRS likes this deal too, because they get their taxes now instead of waiting years or even decades.
Roth 401(k) Contribution Limits
The traditional Roth IRA has limits and restrictions on how much income you’re allowed to receive from it. Not so for the Roth 401(k).
However, you’re still limited to how much money you can contribute to your Roth 401(k) each year. In fact, it’s the same for any 401(k) account. Let’s break it down:
• In 2022, if you’re age 50 or younger, you cannot contribute more than $20,500 to your Roth 401(k) account in one year.
• In 2022, if you’re age 50 or older, you cannot contribute more than $27,000 to your Roth 401(k) within one year.
Which Plan Should You Choose: Traditional Roth IRA or Roth 401(k)?
It all depends on your financial situation and ultimate financial goals. A good indicator for choosing the Roth 401(k) is if you expect to be in a higher tax bracket toward your retirement age. It might make sense to pay taxes on the account now, while you are making less money and in a lower tax bracket.
Determining Your Tax Bracket
Note that a tax bracket is the taxpayer group you’re assigned to, according to how much income you generate. Your taxes are calculated based on your group, or bracket. This is usually done by a percentage , to keep it fair (presumably). Your tax bracket is calculated for both state and federal taxes.
The trick (which is perfectly legal) is to consider deductions that could lower your taxable income, thereby lowering your tax bracket.
Of course, any deduction you claim (child support or business expenses, for example) must be approved by the IRS. You could check with your tax expert before claiming any deduction to make sure that the deduction you make is legal and acceptable.
The IRS has a specific calculation for figuring out your tax bracket.
Why a Roth 401(k) May Be a Good Move Now Rather Than Later
You never know what new tax laws may bring in the future—it’s pretty unpredictable. It may be better to pay up now, before a law comes along that is not friendly to your financial plan.
Considerations When Weighing Your Roth Options
Minimum distributions. With a traditional IRA, once you turn age 72, you will be required to take a minimum distribution, whether you want or need it. If you want to avoid this requirement, simply roll over your fund to a traditional Roth IRA.
What If You Change Jobs?
You can leave your Roth 401(k) plan with whomever is sponsoring it, even after you change jobs or retire. This means that even after you go to a new job, you can still contribute to the Roth 401(k) from your old job.
However, you’ll be working with the plan sponsor (and the plan sponsor’s rules) and not your former employer. You could also roll it over to a new employer plan or into an individual Roth IRA. You might even request a cash distribution.
Why a Roth 401(k) Is a Great Retirement Option
It’s all about the taxes, or, more specifically, not having to pay them. When you’re retired, you might want to use your money without having to pay taxes on it.
Also, the more income you have, the higher your tax bracket. This could affect how your Social Security benefits are taxed. The goal is to keep your taxable income low and avoid being placed in a higher tax bracket.
How SoFi Can Help You
Need a little help with the navigation? Don’t fret—most people do. It’s not an easy decision, and sometimes you have to hash it out, out loud, with someone who lives and breathes this stuff. You could talk with a SoFi Financial Planner and get free, no-obligation, personalized advice on how you can maximize your Roth 401(k) benefits.
With a SoFi Invest account, you can easily open an IRA. How easy? It takes about five minutes or less, and you can choose automated or active investing. The choice is yours.
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