If your goal is to put as much money as possible into your 401k then you best bet is to fully fund your Roth 401k. The IRS set the contribution limit for your 401k in 2009 to $16,500 and a $5,500 catch-up contribution if you are over age 50. The funny thing is that the IRS doesn’t differentiate between Traditional and Roth contributions. They are not equal.
With a Traditional 401k contributions are pre-tax which means that you don’t pay taxes today. So if you were to max out your Traditional 401k then you could contribute $16,500 or $22,000 if you are over age 50. Simple enough right?
Now is the fun part. If you were to contribute to a Roth 401k the limits are the same. Remember though, that this is post-tax contributions which means you pay taxes today before the money goes in. So if you were to contribute the maximum of $16,500 you would really be putting aside even more income depending on your tax bracket. Let’s say you are in a 25% federal tax bracket. That would mean you would essentially be putting aside $22,000 of your income for retirement. If you were over age 55 that number would be about $29,333. My point is that it’s not apples to apples so make sure you are realizing how much you are contributing.
To take this one step further. You max out your 401k. Either way $16,500 goes into the account correct? It grows at about 7% for 30 years. Using the Rule of 72 we know that it will double every 10 years. So it doubles once to $33,000, twice to $66,000 and a third time to $132,000. Are you with me so far? Good. Here’s the key. If you have $132,000 in a Traditional 401k you still owe taxes on it, at 25% worst case scenario you really only have $99,000. Where as if you have $132,000 in a Roth 401k you really have $132,000.
If you goal is to put away as much money as possible for retirement then you should be taking advantage of the Roth 401k. If it’s not an option for you go to your HR or the owner of your company and ask them to make it an option. In most cases it can be added at no cost. If there are any questions please direct them to me.
One more side not, whether you contribute to the Traditional or Roth portion of your 401k, any employer match will be pre-tax so it will show up in the Traditional portion.
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Ever since I first started hearing about this new Roth 401k deal I haven’t liked it, and here’s why. If you pay taxes on the back end (regular 401k) vs. at the front end (Roth 401k), while your principle may be larger simply by default, the amount of money paid in taxes would be greater than had you simply deferred the taxes. Part of this is because you are in a higher tax bracket working. In retirement when you begin withdrawing the funds your income will be less, making your tax bracket lower.
So why do you think you will in a lower tax bracket in retirement? Are you just going to be living off of less money? Is that your goal?
I think today people live off of less money, not because they want to but because they have to. When I retire I want to be able to golf or travel or just randomly buy the grandkids something or give money to the kids. I want the flexibility and options to be able to do this. So for me it is important to me to balance out or diversify the tax treatments of my retirement monies. The Roth 401k is a huge benefit in helping me do this
I also believe that taxes are only going up and I don’t like the way a Traditional 401k is passed on when I die.
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