When it comes to saving for retirement, many investors will do so in their company 401k plan. A benefit of doing so if you are investing before-tax dollars which simply means the taxes you would have paid on the income and all the earnings from your investments will be deferred until you begin to withdraw money from your retirement account. My experience is that many investors are in a more favorable tax position post-retirement.
Along with a traditional 401k plan, many plan sponsors offer a Roth version of their 401k. This tool along with its cousin the Roth IRA seemed initially to be most beneficial to high earners, but as time has gone by the Roth 401k and IRA have become very popular with a wide spectrum of retirement savers, not just the high earners–and for good reason, I think.
The Roth 401k and IRAs, of course, are different from traditional 401k and IRA accounts in that the money you invest is with after-tax dollars. Like traditional 401k and IRA accounts, however, the earnings in the plan grow tax-deferred. One major difference is the tax treatment once you hit 59-1/2 when the growth of the Roth versions are generally tax-free as long as you have held the Roth account assets for at least five years.
Another benefit of the Roth versions is that you won’t be required to begin Required Minimum Distributions at age 70-1/2. Not only that, currently you can convert a traditional IRA to a Roth regardless of income or tax filing status.
Naturally, the Treasury will want its share of taxes under a conversion. Keep in mind that should you convert to a Roth, you need to hold the assets in the account for a minimum of five years after conversion or you will face taxes and penalties.
Ultimately much of the outcome of whether a traditional 401k / IRA contribution or the Roth version will come down to your future tax bracket. If your future tax bracket actually rises, you will be glad you used the Roth. If it goes down, however, you will be glad you did not. In reality, we can’t predict the future tax laws or where we might land under future tax laws.
Whether to Roth or not to Roth
This decision is not what I call a needle mover. That is, your ultimate success will not be determined by which you choose. More important is getting your asset allocation and deferral amount correct. Those issues are needle movers. That is, the quality of your retirement can be hugely impacted by your asset allocation and “how much” you ultimately save.
The good news is we don’t have to make a choice of one over another. We are allowed to do both (or at least most will). I view this as just another diversification issue, one that ultimately is not going to move the needle…so don’t over stress on this.
How about both?