Clients sometimes mention their employer offers a ROTH arm in the 401(k) plan and ask if they should choose that over the pre-tax option.
The answer to this question depends upon each situation, but, yes, ROTH arms can be attractive. It’s almost like asking, “What’s the best ice cream flavor?” It depends upon your circumstances and preferences.
Here are several considerations that may help you reach a good decision for your own personal circumstances:
- Are you willing to forego the current pre-tax advantages that come with contributing to the more ‘traditional’ arm? Foregoing the pre-tax deduction may result in a significant increase in current taxable income. That impact could be further magnified if your other taxable income is sizeable in a given year.
- Would you contribute to the ROTH arm for several years? Or only one year? Any contribution toward retirement savings is worthwhile. Yet the larger the amount of dollars contributed and the longer the time period, the more powerful the tax deferral of those contributions. And typically the larger those balances can grow on a tax-deferred basis.
- Having diversity across different account types is beneficial. That is, having tax deferred, ROTHs and taxable accounts can provide you with greater flexibility in accessing your monies and also choosing the timing and type of any resulting tax treatment upon taking future withdrawals.
- Will tax rates and your taxable income be higher or lower during your retirement years? It’s easy to automatically think that your income will be lower. Yet given the fact that today’s tax brackets and marginal rates are at historically low levels, it’s quite possible that future rates and brackets will be higher. If that’s the case, then foregoing today’s tax reduction may prove much more valuable during later years – especially if you will also receive future pension benefits or have a sizeable balance in your ‘traditional’ 401(k) or IRA accounts.
Be mindful of the maximum annual contribution amount which applies to 401(k) contributions, regardless of which type contribution you make. IRS rules permit you to contribute 100% to a ROTH arm, 100% to a pre-tax arm or to divide the contribution between the 2 types as long as the total amount contributed does not exceed the maximum contribution ceiling for the year.
For 2017 the maximum 401(k) contribution amount is the lesser of $18,000 or 100% of the employee’s compensation. In addition, individuals who are age 50 or older can contribute an extra $6000 in “catch-up” contributions.
It’s possible that Congress may adopt new legislation in the future which might impact ROTH accounts. It’s unknown what specific impact might fall upon existing ROTH accounts; however, it’s quite possible that existing accounts would be grandfathered from any potential future changes.
The bottom line? Consider your own circumstances and then make a decision that you feel is right for you. Still not sure or need another perspective? Give us a call. We’re here to help!
Image Credit: Valerie Everett