Saving for retirement independently is an important thing. Without savings of your own, you might struggle financially once your career wraps up.
This especially holds true in light of Social Security cuts, which may be a possibility in a little over a decade. But if you bring a healthy nest egg with you into retirement, you’ll be in a strong position to manage in the wake of reduced benefits.
Meanwhile, if you have the option to participate in a 401(k) plan, it pays to go that route. Not only do 401(k)s come with higher annual contribution limits than IRAs, but many also come with free money in the form of employer matching dollars.
If you’re going to save in a 401(k) plan, you may want to consider a Roth 401(k) over a traditional one. A growing number of 401(k)s are adopting this feature, and you could benefit from it during retirement.
Why it pays to save in a Roth 401(k)
As of the end of 2021, a good 77% of 401(k) plans had adopted a Roth savings option, according to Vanguard’s 2022 How America Saves report. Yet as of late last year, only 15% of participants had elected a Roth savings option.
The reality, though, is that there’s much to be gained by saving in a Roth 401(k). Though you’ll forgo the initial tax savings you get with a traditional 401(k), the money you invest in a Roth 401(k) will grow tax-free. Then, once you start taking withdrawals, those will be yours to enjoy tax-free, as well.
That’s important because money may end up being tighter during retirement than it is today. If you’re able to avoid having to give the IRS a portion of your retirement-plan withdrawals, you’ll end up in a more secure position.
If you’re a higher earner, you might assume that you can’t fund a Roth 401(k). But that’s not the case. While Roth IRAs are subject to income limits, they don’t apply to Roth 401(k)s.
Is a Roth 401(k) right for you?
When you save in a Roth 401(k), you set yourself up to worry less about taxes down the line. Remember, we know what tax rates look like at present but have no idea what they’ll look like in the future. If tax rates go up, that won’t impact you as much if you keep your retirement savings in a Roth 401(k).
Plus, whether you put your money into a traditional 401(k) or a Roth, you’ll eventually be forced to take required minimum distributions from your account. With a traditional 401(k), those will create an automatic tax liability. But with a Roth 401(k), you won’t have to pay any taxes on those distributions.
As such, it makes sense to consider the upside of putting your savings into a Roth 401(k) if your plan offers that option. And if yours doesn’t, talk to your employer or plan administrator about incorporating a Roth feature so you can enjoy the many benefits involved.
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