When it comes to retirement planning, no amount of care can be called too much. And, speaking of “much,” most of us have a number of options on the retirement plans we have available as vehicles for saving.

If your employer offers this, one of these options may be a Roth 401(k). Roth 401(k)s were enacted effective January 1, 2006, and they are becoming more widespread and popular. In 2023, fully 93% of 401(k) plans in the United States offer a Roth option.

But is a Roth 401(k the best fit for you? That’s a discussion you should have with your virtual CFO or your trusted financial advisor, but here are some general notes:

Traditional 401(k) Plans

Initially created as part of The Revenue Act of 1978, signed into law by President Jimmy Carter, and governed by regulations initiated in 1981 and to date, 401(k) accounts held some $8.9 trillion at the close of the third quarter of 2024.

These plans were created as a measure to offer lower-tier employees a retirement savings option – a number of employers had allowed such perquisites only to executives.

Traditional 401(k) plans are funded by employee contributions of effectively deferred earnings since the contributions are made in pre-tax dollars, with tax liabilities imposed upon withdrawal.

Additionally, employers may contribute to their employees’ 401(k)s—in 2024, some 98% of employers offered “matching” contributions, though usually lower than the employees’ own contributions.

In 2023, the average employee contribution to a 401(k) represented 8% of their annual compensation. The average employer matching contribution ranges between 4 and 6 percent.

Participants in 401(k) plans must take required minimum distributions at some point following retirement – but no later than April 1 of the year following the year you turn 73, unless you are still working. In that case, you can defer your withdrawals from the 401(k) plan you have with your current employer.

Withdrawals can be made from a traditional 401(k) plan’s vested balance at any time, but if the participant has not reached age 59½, not only is the withdrawal subject to income tax liabilities but also to a penalty equal to 10% of the withdrawal. This penalty can be abated if the withdrawal is for an allowable purpose—e.g., a first-time home purchase, unreimbursed medical expenses, or the birth or adoption of a child.

Saving via a traditional 401(k) is at least in part predicated on the idea that following retirement, your income tax bracket will fall, meaning (greatly simplified) that you will pay less in taxes upon withdrawal of your assets than you would have during your working life.

But, as noted, that is, if anything, oversimplified. Tax rates and brackets change over time under new administrations and new Congresses.

You may be in a high tax bracket now and an even higher one later – if tax rates go up, if you expect a significant inheritance after your retirement, a business sale, or another kind of windfall.

In that case, you might consider choosing a Roth 401(k).

Roth 401(k) Plans

As noted, Roth 401(k)s are a relatively new option, compared with traditional 401(k) plans.

Like Roth IRAs, Roth 401(k)s are funded via after-tax contributions. The participant pays taxes on these contributions when earned, not, as with traditional 401(k) plans, when they are withdrawn.

In addition, Roth 401(k) disbursements are not taxable, provided the account has been open for at least 5 years and the participant has reached 59½.

Another benefit of Roth 401(k) plans is that, under the SECURE 2,0 Act of 2022, participants do not need to take RMDs at all. Account holders can pass their accounts to their beneficiaries intact, with withdrawals tax–free.

Before the SECURE 2,0 Act became law, Roth 401(k) participants were subject to the same RMDs that traditional 401(k) plans and IRAs mandate – but no longer.

However, under the provisions of the first SECURE Act, signed into law in December 2019, certain beneficiaries of an inherited Roth 401(k) must take RMDs over a period of 10 years.

Those beneficiaries of an inherited 401(k), whether traditional or Roth, who need not take RMDs are:

• The deceased account owner’s spouse.
• A disabled beneficiary.
• A chronically ill beneficiary.
• A beneficiary not over 10 years younger than the deceased account owner.
• A minor beneficiary who is the child of the deceased account owner (the 10-year distribution rule will only become effective when the beneficiary reaches the age of majority).

If your employer’s 401(k) allows it, you can convert a traditional 401(k) to a Roth 401(k), subject to tax liabilities on the amount converted, as with converting a traditional IRA to a Roth IRA. Figure this carefully if you choose conversion – we do not recommend paying the taxes owed on the assets you convert out of your retirement funds. Use another source – such as your non-retirement investments.

So, Which is Right for You?

There is no simple answer to whether a traditional or a Roth 401(k) is your best option.

It depends on too many factors:

• Whether you feel it’s wiser to pay taxes on your retirement savings now or after you retire.
• Whether you want to leave your retirement savings to a beneficiary free of taxes.
• Your current financial picture.
• Your family situation.
• How you see things changing as the years go by.
• What you want out of retirement.

We strongly suggest you consult with your virtual CFO or other trusted financial advisor (and at RFG, we’ve been advising our clients on retirement and other financial planning concerns for decades) to determine the best options.

For you. For your family. For your legacy.

If you have any questions about traditional or Roth 401(k)s, IRAs, or other retirement plans available to you, please click here to email us directly. We are here to answer your questions and help you plan your retirement so you can enjoy the assets your efforts have brought you—however you choose to do so.

Until next time –

Peace,

Eric