Introduction to Roth 401k
By 401k on Aug 16, 2008 in Information | 2 Comments
What is a Roth 401k
Roth 401k is a retirement savings plan and it is one of the newest options for employee retirement plan benefits. This type of retirement plan combines the flexibility of Roth IRAs and 401k plans and is offered by an employer.
An employer can offer this type of 401k plan to employees as an option. If the employee chooses to contribute to a Roth 401k, the employee will pay for the contributions through after tax dollars. Keep in mind that you can contribute to both a traditional 401k plan and also a Roth 401k plan. However, the combined contribute (as of writing in 2008) limit per tax year is $15,500 if the participant is under 50 and $20,500 for those over 50.
As with other types of 401k, your employer may provide an employer’s match, and the percentage may be different for a Roth 401k and a Traditional 401k. Also keep in mind that the employer’s match is not included in the annual contribution limits. One thing of note is that employer’s matching funds is made on a pre-tax basis. This means that the matching part of the account will be taxed when you withdraw funds.
History of the Roth 401k
Started in 2006, employers can start allowing employees to choose the Roth 401k as one of the options.
Employers have been very slow in adopting this option because it is a hassle and increase their administrative cost. So far, most of the offerings are only available in larger firms but with time, smaller firms will start adopting this relatively new retirement savings option.
Traditional 401k and Roth 401k
The major difference between a Roth 401k and the traditional 401k is that Roth is made with after tax dollars while the traditional 401k’s contribution is made with pre-tax dollars. This means the funds within a Roth 401k (whether it’s your contribution or the gains from your investments) can be withdrawn tax free, as long as it is made at least 5 years after the first contribution and that you are 59 and a half years old. This is the major attraction of this type of retirement savings. The other subtle advantage of Roth 401k is that you can better gauge your financial health because the withdrawals are all made tax-free.
On the other hand, a traditional 401k is made with pre-tax dollars. That’s why cash strap employees can make more contributions to the traditional 401k.
Keep in mind that the contribution limit for Roth 401k and traditional 401k are both the same. If you think about the pre-tax versus after-tax difference, this means that if you can contribute to the maximum limit, you are in essence contributing more money into a Roth 401k than a traditional 401k because there’s more money in there that’s already taxed.
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