Principles in Practice: Be Diversified
Why should you use the Roth 401k, even if you are a highly compensated employee?
As we continue our discussion of the Tax Planning PentagonTM, one of the most powerful tools that you might have at your workplace is the Roth 401k. This is an account that falls under the “Tax Deferred with Tax Freedom” category. Although you don’t get an immediate tax deduction when you make an “after-tax” payroll contribution, your investment will grow tax-deferred and allow for tax-free distributions during your retirement years.
Over time, this desirable tax treatment will help to balance out your “pre-tax” contributions to your regular 401k, which will be fully taxable distributions to you throughout retirement. The best part is, there is NO income restriction on your ability to fund the Roth 401k.
So, regardless of your income level, folks under 50 years old can contribute up to $17,500 into the Roth 401k for 2013, while those over 50 can contribute up to $23,000, if they elect the “catch-up contribution”. Then, you can even fund a Roth IRA in the same year, as long as you meet the income eligibility requirements, which would add another $5,500/person (under 50) to $6,500/person (over 50) to the “Tax Freedom” corner of your pentagon!
Here are 5 things to investigate/understand before using a Roth 401k:
- Does your company’s 401k plan provide this opportunity? If not, ask them to get it added to your plan as soon as possible.
- Did you get a tax refund last year after funding your pre-tax 401k? If so, think about blending in a portion of your contribution into the after-tax Roth 401k in order to possibly “soak up” some of that refund in the current year.
- Are you in one of the lower tax brackets and itemizing your deductions? Think about solely using the Roth 401k, since the benefit of the “pre-tax” 401k contribution is minimal, but having tax-free distributions to you and your heirs would be priceless.
- Are you in the higher tax brackets and aren’t eligible to contribute to a Roth IRA, but you donate generously to charities? Think about blending in a portion of your 401k contributions into the “after-tax” Roth side, since your charitable deductions can be the primary reducer of your taxable income along the way. In fact, the generous physicians and executives we serve love this approach, because it is one of the few ways to build up tax-free resources within their company benefits.
- Keep in mind that only your contributions/gains in the Roth 401k will become tax free down the road. Your company’s matching and/or profit sharing contributions will still be fully taxable when you begin the distribution process. So, make sure that the 401k plan is using a good recordkeeper to clearly delineate between the Roth and Pre-tax portions of your 401k account. Once you have separated from service, your Roth contributions, plus their gains, would be rolled into a Roth IRA for you at your favorite custodian.
How are you building your Tax Planning PentagonTM? If it doesn’t include “Roth Resources”, then we can discuss how to beef up that portion of your plan.< Back to Updates