Roth 401(k) great if you can afford cash-flow hit
Q. Recently, my employer added an option to my retirement plan — a Roth 401(k). Can you explain what it is, and whether I should take advantage of it? Thank you. — Jason from Nashua
A. Beginning in 2006, Congress passed rules allowing employers to offer employees who contribute to a 401(k) retirement plan the option of making all or part of their contributions into what are known as ‘ Roth 401(k)’ contributions. The benefit is that they grow — like Roth IRA contributions — tax free, and can be withdrawn, after a certain point, tax free, which is a clear benefit to your retirement savings.
There is, however, one major drawback. Roth 401(k) contributions, unlike regular 401(k) contributions, are not tax deductible. Meaning you have to pay taxes on the income contributed in the year you earn that income, before contributing it to your Roth 401(k).
As a result, the answer to your question is yes but only if you can afford the cashflow hit.
If you can’t afford what is, in essence, a cut in your take home pay, don’t take the option.
As noted, in some cases, employers allow you to do both. You can make part of your contribution to a regular 401k and part to a Roth 401(k), which is a “compromise” you may be able to afford. There are two other points people should keep in mind when it comes to Roth 401(k)s.
First, the legislation that allows for Roth 401(k)s also allows Roth 403(b)s. So, if you work for an employer that allows Roth 403(b) contributions, which is usually a nonprofit, you should consider the same issues I mentioned above before making a decision.
Then there’s employer matches. With Roth 401(k) s (and 403(b)s) employers are still allowed to match a certain percentage of your contributions to the Roth 401k. However, these 401(k) matches are taxed as if they were made to a regular 401(k).
Assuming that you can afford the extra yearly tax hit on the amount you contribute to the Roth 401(k), the fact that the match will be treated and taxed as a regular 401k contribution should not stop you from taking advantage of the Roth 401(k) your company is now offering.
Good luck.