My employer offers some amazing benefits. If you have a child, they’ll send you a rocking chair. If you buy a bicycle, they’ll reimburse $100 of the purchase. If you buy a fuel efficient vehicle, they’ll give you $500. And, I recently discovered that they also offer the Roth 401(k) as an investment option, which could be huge for someone’s financial future.
The Roth 401(k) has been around since 2006 and is finally starting to gain traction in the investment community. The Roth 401(k) acts exactly like a Roth IRA in the sense that investors put in after-tax money and can withdraw the funds at a later date tax-free. In my opinion, investing in a Roth 401k is a better option than the traditional 401k.
5 Reasons Why I’m Investing in a Roth 401k Instead of the Traditional 401k
When I first started working at my place of employment, I almost immediately began setting aside 6% of my earnings toward the traditional 401k that they had available. In addition to my 6%, they agreed to match 3% and also contribute an additional 4% whether I was investing in their 401k or not (like I said before, they have amazing benefits). I’m definitely glad that I started investing early, but now that I’ve dug into the numbers and ran the calculations, I wish that I would have started investing in a Roth 401k instead.
1) I Can Afford the Tax Hit Today
At this moment, I live on approximately 25% of my after-tax income. Paying the tax on my investments really isn’t that big of an issue, so why not start investing in a Roth 401k and just take care of it now? I don’t have a crystal ball for the future, and even though I am investing responsibly for my retirement years, there’s still that chance that I won’t have that much money when it comes time for me to retire (since as you know, there’s no guarantee that the market will continue to rise as it has in years passed).
If this becomes my reality, then it would be extremely nice to avoid the tax man with my investment withdrawals. If I avoid the tax now (by investing in a traditional 401k), then my hunk of money at the end of life would be worth far less than the face value since I’ll be taxed on each withdrawal. If I truly needed the money, this certainly would not be cool.
2) I Don’t Have to Worry About Large Earnings in the Future
Liz and I were chatting the other night and I mentioned that it sure would be nice to have a tax free withdrawal if we have millions of dollars in the future and want to live large. She looked at me with a smirk, “Millions, huh?” – almost like it was impossible. Naturally, I had to prove it to her (and myself) that since we started investing early, millions of dollars is certainly not out of the question.
If I were to invest $750 a month from this point on and earned an average of 8% each year, my nest egg would grow to $3.5 million by my 69th birthday. It sure would be nice to live large and withdraw $200,000 a year without worrying about the government taking 40% of it. By investing in a Roth 401k, that’s entirely possible.
3) Taxes Will Likely Be Higher in 30 Years
Some people think that taxes will go unchanged for the next 30 years. Others think that tax rates will actually decrease. I, on the other hand, think that income tax rates will almost certainly rise in the future. The main reason for my belief is the national debt. Not only does it continue to rise by the second, but our government is doing nothing to counter this issue.
This year alone our nation is running a $493 billion deficit, meaning that we’re consciously spending $493 billion more than we’re budgeted to earn. The debts are larger than our yearly GDP, and the income isn’t even close to enough to pay it down. The only way I see this getting under control is with an increase to the income tax percentages in the future. If I’m right, then it would make a ton of sense to be investing in a Roth 401k now when tax rates are low.
4) Amazing for Estate Planning Purposes
The average investor won’t ever have to worry about this, but if you’re an avid investor and started when you were young, then you’ll likely retire with millions of dollars and possibly some additional income sources as well, which means there really may not be any reason for you to withdraw money from your 401k. Instead, perhaps you’d like to will the money to your children, grandchildren, or to a worthwhile charity after you pass. But, before you get too far ahead of yourself on this one, understand that with a traditional IRA or 401k, you’ll be required to make a minimum distribution out of your investment account at age 70 1/2.
As you can see in the IRS form below, at age 70 1/2 you must take that first distribution, which equates to approximately 3.6% of your retirement fund. In the next year, you’ll have to remove another 3.8%, and then 3.9% the year after. By age 90, you’ll be removing 8.8% per year, whether you need the income or not.
This forced withdrawal may not seem like a big deal to many of you, but if you want to leave an inheritance for your children or grandchildren, then it’s a huge deal! First of all, once you finally pass on, your inheritance may be much smaller than you wanted it to be. Second, your beneficiaries will have to pay some hefty tax on your gift to them, often up to 40% for a large inheritance.
What if I told you that investing in a Roth 401k or Roth IRA would save you from making a minimum distribution requirement AND that it wouldn’t be taxed when willed to someone else (up to $5,000,000)? It’s absolutely true. According to IRA guru, Ed Slott, a $5,000,000 Roth asset passed onto a grandchild would be worth $400,000,000 by the time they turned 81 years old. Talk about one heck of a nice gift! I’d call that a legacy!
5) The Match Keeps Me Diversified
As I stated earlier, my employer matches my contributions, but the contributions are not matched within the Roth 401k, they are matched within a traditional 401k. This is how almost every company operates as well, which should make your decision to move your contributions quite simple.
By investing in a Roth 401k with your contributions and your company contributing in the traditional 401k, you are covered in all scenarios. If the taxes go up in the future, then awesome, you benefited because you already paid taxes on your Roth 401k fund. If the taxes go down, that’s cool too, because you can then withdraw from your company’s contributions in your traditional 401k and come out ahead. The match in the traditional 401k still keeps me diversified with each passing month that I contribute.
Will these benefits push you to start investing in a Roth 401k? Why or why not?
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.