in contributing towards a 401k plan, which method would you choose? pre-tax or after-tax? it says here http://www.research401k.com/roth-401k-faqs.html In a traditional 401k plan, annual contributions are made with pre-tax dollars (meaning BEFORE taxes have been paid). On the other hand, a Roth 401k plan requires annual contributions to be made with AFTER-tax dollars (after taxes have been paid). For example, if you earn $50,00 a year: which one results in paying lower taxes and having more current income? although no one would want to pay lower taxes now and face a huge tax bill upon retirement either !
I think you've answered your own question--using a traditional 401(k) you pay lower taxes because you're only taxed on your aftertax income; therefore, if you contribute the exact same amount in a Roth IRA, you end up with less take-home pay because your gross income has been taxed at a higher rate. The younger you are, the more sense a Roth makes...your retirement money has a longer time to grow. Figure out how much you'll pay in taxes on your investments in, say 40 years. That's where the difference really is. The question becomes, do you want to tighten your belt a little while you're working so that you'll have a much better income when you're retired? One caveat--if your employer offers to match your contributions, you'd be crazy not to take them up on it. Before you do anything else towards retirement, make sure you are contributing up to the maximum matching level.
Well after-tax doesn't work the same way as a Roth. A Roth 401k came out in calendar year 2006 but very few companies have taken it up for a number of reasons, mainly the lack of clarity in the legislation. Pre-tax is your average normal 401k plan After-tax does use after tax money (ie debited from your take home and not the gross) but the earnings can be taxable. This is a major difference between a roth and an after tax 401k. If you leave the job a huge mistake a lot of people make with after tax 401k contributions is they can withdraw it (wrong) or roll it into a roth ira (wrong). Once out of the 401k you will need to track a "cost basis" and keep it going. It gets a lot more fun if you have both pre and post tax. Most people have all pretax. Almost everyone with post tax money also has pretax too. Lets fast forward to you are 59.5 yrs old and can draw from it penalty free. Lets say you have 50 percent pre and 50 percent post tax. Generally it will be easier to keep track of what is what in two different accounts. But if you pull out 1000 dollars, the IRS will say 50 percent is pre tax and 50 percent is post tax. It is a proportional system. You cannot elect to pull the 1000 dollars fully out of the pre or post tax account. If you do go with a post tax account. KEEP RECORDS of everything. Otherwise you are almost guarenteed to make an error and pay double tax. Remember it is YOUR responsibility to track this, no big brokerage firm will track cost basis on a IRA account and the IRS will say to you "its not our job to figure out what is pre and what is post tax" you tell us and if you get audited the balance of evidence is on YOU and not them. Unless you decide to work for one company until you retire and put all your contributions in post tax until age 65, you will need to keep volumes of evidence as proof. Good luck, preparing a 401k is one of the most important things you can do. You are on the right track with asking questions.
How so? The only way to be sure is to have a crystal ball to know what your tax rate at retirement will be. The best thing is to do a little of both if you're able to. The industry has been telling people for the past 25 yrs. to take advantage of pre-tax deferrals because you get the tax break now and the odds of you being in a higher bracket at retirement age are slim.
Your age is also a key factor. IMO, as a general rule someone just starting their career would best served putting their retirement money into a Roth 401k.
Why is that? I would think that if you are just starting that you wouldn't have the ability to set aside as much post tax as you could pre tax.
There's the rub. 20-somethings don't generally put much into their 401(k)s, especially if they can't get a tax break now. And the percentage of people maxing out to $15,000 is low. Probably under 10% and the overwhelming majority of those people are well-off and/or older. There's going to be a HUGE amount of people in 20 to 30 yrs. that are going to have next to nothing saved in their 401(k) plans. I don't think politicians even have this on their radar.
Is there a rollover procedure from a standard 401k to a roth 401k? Do you just pay the ordinary tax rate and if so, is in on the contributed amount or the total? Are there penalties?
Think of your pre-tax account and your Roth 401(k) account as 2 buckets of money within your 401(k) plan. When you leave your job, you can rollover the pre-tax amount to a Traditional IRA or your next 401(k) plan or just leave it where it is. The same thing applies to your Roth 401(k) money - roll it to a Roth IRA, to another 401(k) plan that has the Roth option (not many companies have it yet) or leave it where it is. You can't roll Roth IRA money into your Roth 401(k) however. After 5 yrs and a triggering event (generally age 59.5, death or disability), you can take out the Roth money tax-free. If you don't meet the requirements you will be taxed on the earnings, not the basis that you already paid tax on. An interesting thing about Roths is that there are no required minimum distributions. Here's an example I've seen about estate planning. Say you roll your Roth 401(k) to a Roth IRA and then let the money just grow. Then you live a long life and are lucky enough to not need your Roth IRA money. You don't have to take RMDs at 70.5 and then the money can be passed on to your beneficiary - spouse, child or grandchild or whoever.
Because of "the miracle of compounding". Here's the $64,000 question: Would you rather pay tax on $1,000 today or tax $64,000 in retirement?
Well they did change the law so that companies now automatically enroll employees into their retirement plans... a big step in the right direction.
Right, but you'd be putting 30% less in to compound, so I think that would reduce your final balance by 30%. (Assuming 25% Fed, 5% state rates) I think it's a wash. If I'm wrong here, let me know. I'm putting "leftovers" in the ROTH, while putting a lot in my 401k-style plan due to the VERY low fees involved.
That's what I was thinking as well. 401K A 29.5 year old contributing $500/mo pretax assuming 8% compounded anually gives you $734,075.21 at 59.5. 70% of that is $513,852.65 Roth 401K A 29.5 year old contributing $500/mo pretax would actually be contributing $350 after taxes. Assuming 8% compounded anually gives you $513,852.65 at 59.5. All you are betting on is tax rates and a hotter market earlier in your life.
So it becomes the $45,000 question. Every financial advisor I've ever heard thinks the ROTH IRA is a great deal for young investors and I don't see why a ROTH 401k would be any different. I'm not young and I don't have access to a ROTH 401k but here's the strategy would recommend to any young person: 1. Marry into money. If step one fails go to plan B: 1. Invest in company 401k up to the company match. 2. Invest in ROTH IRA up to the $4,000 limit 3. Invest in company 401k up to the $15,000 limit 4. Invest post tax dollars in stocks/real estate I'm like you, I think it's important to invest in both pre and post tax plans, but the ROTH is so much more flexible.
Just enrolled in my 401(k) at work, 23 years old and putting away the max. FWIW most of my educated friends know it is important to enroll in a 401(k) as soon as possible. However other friends of mine have no idea what a 401(k) is.
That's great. The big challenge is when many people leave their jobs and have to decide to (a) roll it over or (b) buy that new car or take the fancy vacation. Too many people unwisely cash out because it's so tempting.
That's impressive. I started slowly, but I'm up to 15% as of the 1st of the year, and getting a 5% match on top of that. (Fully vested) Everything I've seen basically says that it's extremely important to build a healthy nest egg before age 35.
My wife has a Roth 401(k) option, but we chose not to go with it for one reason. Confusion at retirement. My wife's contributions are post-tax, however the company match is pre-tax. So the 50 cents on the dollar up to 6% that she gets as a match is treated differently at distribution time. Until more Roth 401(k)s come to market, we felt it was better to wait and see how it all shakes out.
hey, when I started working, I maxed out my 401(k), too. i put about a grand a month away in my IRA and mutual funds. one must love capital growth, compounding interest and dividends!! i'll be well set. and it sounds like you should be in a good position, too.
If you can afford a 401(k) and a Roth IRA, that would be your best course of action. Wealth is not having a fancy car or big home. It is the ability to live your life the way you see fit. Right now I am pretty fortunate. I am able to max out my 401(k) and Roth IRA. At some point, I probably will not be able to do both. The bottom line you want to avoid the taxman. He is unrelenting.
Personally I've found that maxing out the match on my company's 401(k), which is a total of 14% of my pre-tax income, and maxing out my Roth IRA contributions will leave me with a healthy liquid nest egg at 65 in addition to some real estate holdings. For younger investors, the roth 401(k) is a good option to add to the QRP's out there.