Retiring on Social Security alone is a pretty big mistake. The average monthly benefit these days amounts to $1,657 (that figure accounts for 2022’s 5.9% cost-of-living adjustment). All told, that’s just under $20,000 a year.
Even if you’re willing to live frugally as a senior, you may end up needing a lot more money than that to enjoy retirement to the fullest. And so you’ll need to consistently fund a savings plan to help ensure that you have extra cash to tap on top of Social Security.
When it comes to saving for retirement, it often pays to participate in a 401(k) plan if one is available to you. That’s because 401(k)s come with generous annual contribution limits. And many of the employers that sponsor these plans offer matching incentives to boot. For you, that means free money toward retirement.
But while many workers opt to put their savings into a traditional 401(k), there’s another option you may want to consider — a Roth 401(k). Though not every 401(k) comes with a Roth, the percentage of 401(k)s offering one grew to 86% in 2020, up from 75% in 2019 as per the Plan Sponsor Council of America. And the fact that more 401(k)s are offering a Roth is an unquestionably good thing.
The upside of a Roth 401(k)
With a traditional 401(k), the money you contribute goes in on a pre-tax basis, so you get an immediate tax break. From there, your money grows on a tax-deferred basis and withdrawals during retirement are taxable.
Roth 401(k)s work the opposite way. You don’t get an immediate tax break on your contributions when you fund a Roth 401(k). But investment gains in your Roth 401(k) are tax-free, and withdrawals are tax-free during retirement.
It’s the latter that could really come in handy. Once you move over to a fixed income, money could get tight. And so not having to fork over a portion of your income to the IRS could really make retirement less stressful from a financial standpoint.
Once you turn 72, you’ll also need to take required minimum distributions, or RMDs, from your savings. The only way to get out of RMDs is to open a Roth IRA. And while Roth IRAs are an excellent savings tool, they do come with lower annual contribution limits and no option for an employer match.
RMDs do make it so you have to withdraw a portion of your savings each year, which means you can’t keep that money invested in a tax-advantaged fashion. But if you have your savings in a Roth 401(k), your RMDs, like all withdrawals, will be tax-free. And so while those may be forced distributions, at least they won’t cause a tax liability for you.
Explore your options
If you’re not sure whether your 401(k) comes with a Roth savings feature, it pays to do some digging. And if your plan doesn’t, talk to your employer about introducing that option. Putting money into a Roth 401(k) could give you a lot more financial flexibility during retirement — and take a load of stress off your plate later in life.
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