If your retirement plan offers it, you should consider taking advantage.
You’ll need money outside of Social Security to pay your living costs in retirement. Those benefits will only replace about 40% of your pre-retirement earnings if you bring home an average wage, so you’ll want to supplement that income to help ensure that you don’t wind up cash-strapped throughout your senior years. And that’s where your personal savings come in.
If your company offers access to a 401(k) plan, it often pays to sign up. Not only are 401(k) plans pretty seamless to fund given contributions are taken automatically as payroll deductions every pay period, but many employers also match worker 401(k) contributions to some degree. The result? Free money for your retirement.
Meanwhile, Vanguard reports that in 2022, 94% of larger 401(k) plans offered a Roth savings option. And last year, 80% of all Vanguard 401(k)s allowed savers to choose a Roth.
But surprisingly, only 17% of 401(k) savers from Vanguard’s pool opt for the Roth savings feature. And that means many savers could be missing out big time.
The upside of funding a Roth 401(k)
Taxes can be a huge burden in retirement because many seniors end up finding that money is tight. One major benefit of saving in a Roth 401(k) is getting access to not just tax-free investment gains in that account, but tax-free withdrawals when the time comes to tap retirement savings. That could make it a lot easier to manage your expenses on what could be a lower income than what you enjoyed during your working years.
Also, starting in 2024, Roth 401(k) plans will not force savers to take required minimum distributions (RMDs). As of now, Roth IRAs are the only tax-advantaged retirement plan to not impose RMDs. But come next year, Roth 401(k)s are joining their ranks.
Not having to take RMDs gives you a lot more flexibility with your money. Many people need to tap their nest eggs regularly in retirement to cover their living costs. But if you end up in a position where you have other income sources and don’t need to take retirement plan withdrawals, with a Roth 401(k), you won’t be forced to. And that means that if you so choose, it will be easier to leave more of that money behind to your heirs.
It pays to crunch the numbers
A big reason a lot of savers favor traditional 401(k)s over Roth 401(k)s is that they want an up-front tax break on the money they’re contributing to their long-term savings. But if you can swing your contributions without that immediate tax benefit, then it could pay to shift over to a Roth 401(k) so you can enjoy tax-free gains and withdrawals and get out of taking RMDs in retirement.
Remember, too, that you don’t have to commit to a traditional 401(k) versus a Roth. There’s nothing wrong with splitting your money across both accounts so you get some immediate tax savings, but you also get access to tax-free income once you’re retired and want fewer expenses (like an IRS bill) to worry about.
