Pros & Cons of a Roth 401(k)
The Roth 401(k) is a special type of retirement account that can be offered by employers. This type of retirement account provides a way for employees to save money for retirement they will eventually be able to use without paying taxes on it. The Roth 401(k) also offers matching contributions for employees.
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Function
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The Roth 401(k) allows employees to set aside money out of their paycheck. The money set aside with this account is after-tax. This is different from the traditional 401(k) in which you make pre-tax contributions to your account. You can then use the money to invest in various securities such as stocks and bonds. Then, when you reach the age of 59 1/2, you can access the money without paying taxes.
Contribution Limits
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A benefit of this type of retirement account is that it has a high contribution limit. As of 2010, you can set aside as much as $16,500 per year in your Roth 401(k). Once you hit the age of 50, you can then put another $5500 in as well. The Roth 401(k) actually allows you to set aside more effective money than the traditional 401(k). Even though the dollar limits are the same, with the Roth 401(k), you fund it with $16,500 of after-tax money instead of $16,500 of pre-tax money.
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Tax Benefits
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With a Roth 401(k), you can take advantage of certain tax benefits. Once you reach retirement age, you can essentially get a tax-free source of income. If you think that you might be in a higher tax bracket during retirement, this retirement plan makes a lot of sense. If your income stays the same, you may not have as many tax breaks as you are used to during retirement. For example, if you have your house paid off by then, you will not receive a mortgage interest deduction. You will no longer get a deduction for your children either. The Roth 401(k) allows you to receive money that will not affect your annual income.
Investment Options
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A potential drawback of investing in a Roth 401(k) is the lack of investment options. With most 401(k) plans, you have a limited number of funds, stocks and bonds that you can invest in. By comparison, if you chose an IRA or a Roth IRA to invest in, you could potentially invest in many different things including real estate, commodities and precious metals. If you like investment options, you might find that the Roth 401(k) is not your best choice.
Matching Contributions
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With a Roth 401(k), you can receive matching contributions from your employer. For example, if you contribute three percent of your annual income to your Roth 401(k), your employer can put in another 3 percent. A drawback to this situation is that employer contributions are made on a pre-tax basis. The money accumulates in a separate account and then when you retire, you have to pay taxes on the matching money.
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