Roth 401k

[Yobz]

I never heard of a Roth 401k but my company offers it, so I have to ask here: should I invest in the regular 401, or the Roth 401k? I'm 22 years old (turned 22 2 weeks ago) and single. Company matches 50% up to 3% (I contribute 6%, they put in 3% yearly).

Any advice?

[MisterW]

Actually, your company will match 50% of your contribution up to 3% of your salary. In other words, if you contribute 6% of your salary, your company will only match 50% of the first 3% of your salary, which equates to 1.5%. If you're contributing 6% or 3%, your company is still only matching 1.5% of your salary.

A Roth 401k provides the best of both worlds (Roth IRA with 401k). A traditional 401k uses pre-tax money that you invest and it grows tax-free. Once you reach age 59.5, you can take the money out, but it is taxed at the income bracket you fall into at the time (usually a higher income tax bracket than what you were in at the time of your initial investments).

A Roth IRA is funded with after-tax money, and it grows without tax. When you take the money out at 59.5, the money is not taxed. Since you are putting money in at a lower tax bracket than you would likely be in when you take the money out, the Roth IRA is a better (tax-wise) investment than a 401k. However, since your company matches some of your contribution on a 401k, the 401k is also a good investment, and you should put in enough money to get the maximum employer contribution possible. The recommended line of thinking is to fund your traditional 401k until you get the maximum amount of employer contribution, then fund a Roth IRA.

The Roth 401k combines the best of both of these into one fund. You contribute after-tax money and get a company match. Your money grows without being taxed, and when you take it out, it is tax-free. You gain the tax advantages of a Roth IRA over a 401k but get the company match advantage of the 401k. Also, there is a higher limit to what you can contribute to your Roth 401k (I think $14,000 anually?) whereas a Roth IRA currently limits you to a $4000 investment anually. Also, you cannot contribute to a Roth IRA if you make more than a certain amount of money (I think in the neighborhood of $90,000 per year).

I'm not an expert on this, but from what I've read, if you have a company that offers a Roth 401k, then this is the best retirement plan you can fund. It's better than a traditional 401k and it's better than a Roth IRA. Congrats on working for a company that offers it!

[Yobz]

My company says that if I invest 3% they will match 1.5%, if I put in 6% they will match 3% and if I put in 10%, the will only match 3%

Edit: thanks for the run down, looks like I should choose the Roth 401k option, but I'm not sure (since I'm in one of the highest, if not the highest tax bracket now)

['Chair]

I'm no finance whiz, but went through the same learning process you are going through a couple of month's ago. Here's the conclusion I came to with the help from people on this board and some morning star help.

Before you decide roth401k or traditional, you need to address/assess some other factors such as the choices(stocks/bonds) you have to invest in through your company. if they aren't that good, consider just investing 6% to max the company's match...then taking the rest and maxing a rothIRA (not through your company...getting better selections). People here seem to prefer the Vanguard or Fidelity funds for their investments.

ex. I decided I am gonna save about 15% of my salary for retirement. And my company's 401k program isn't great, so I'm putting in enough for the match, then maxing a rothIRA and then the rest is going back into the company 401k. I could probably do better by taking that little extra going back into the 401k and putting it in something else and I probably will, but for now its fine.


do some more searching and find the other factors such as time horizon etc etc...

[Yobz]

I think this is also a non-issue. They allow me to manage my 401k myself and put it into whatever I want. It also instantly matures, there is no 5-year waiting period or any of that crap. Don't know if that makes a difference.

[danny31415]

I've looked into this recently as well. A few things that you should note. If you do choose the roth 401k then the matching contribution (the 3% from your employer) is still put into the regular 401k, which makes sense, that money is not after tax dollars. The decision mostly comes down to what you think the odds are of you being in a higher or lower tax bracket at retirement than you are now. If higher choose roth, if lower choose regular. Since you said you are in the highest tax bracket I would imagine that you should probably stick to the regular 401k (see exception below).

If you pay the exact same rate at retirement, then there will be no difference between the roth and the regular 401k with one exception. The exception is this, if you are putting the maximum amount into the regular 401k (15k a year I believe) then the roth 401k will allow you to effectively put away more. You can put away 15k post tax dollars into the roth, which if you are in the 33% bracket is the same as 22.5k pretax. So this allows more money to grow without the taxes slowing down the compounding.

I'm no expert, this is just information I have found googling around so take it for what its worth.

[Misfire]

If you think your income tax rate will be higher when you retire than it is now (hint: it will be), do the Roth.

Contribute 6% like you're doing (to take advantage of the free money), then switch to a Roth IRA up to the max (because you get more investment choices), then, if you still have money to invest, go back and max out the Roth 401k.

[Misfire]

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I think this is also a non-issue. They allow me to manage my 401k myself and put it into whatever I want. It also instantly matures, there is no 5-year waiting period or any of that crap. Don't know if that makes a difference.

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It may when you leave your job and have to roll it to an IRA.

[danny31415]

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If you think your income tax rate will be higher when you retire than it is now (hint: it will be), do the Roth.


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Why do you think his rate will be higher when he retires? He said in one of his posts that he is in the highest tax bracket. It might still be the case that he is in a higher bracket when he retires, but that would require the government to raise taxes.


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Contribute 6% like you're doing (to take advantage of the free money), then switch to a Roth IRA up to the max (because you get more investment choices), then, if you still have money to invest, go back and max out the Roth 401k.

[/ QUOTE ]

I'm not positive on this, but I thought the maximums were for combined roth 401k and regular 401k, so if I contibute 10k to my roth and 5k to my regular, then I have reached the 15k maximum.

And also for my company at least, the matching is for either type of contribution, but the matched funds go into the regular 401k not roth. So I put 6% in my roth and they will match 3% into my regular.

[kyleb]

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If you think your income tax rate will be higher when you retire than it is now (hint: it will be), do the Roth.


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Why do you think his rate will be higher when he retires? He said in one of his posts that he is in the highest tax bracket. It might still be the case that he is in a higher bracket when he retires, but that would require the government to raise taxes.

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And for some reason you foresee taxes going down....?