Tax Relief by Using the Roth 401(k)

Numerous investors have a new retirement savings option: the Roth 401(k). And it could possibly be a large advantage to all those people who're getting close to retirement and wish to save more and take advantage of tax relief.

First off, the Roth 401(k) isn't for everyone. If you're in retirement, it is not accessible to you, because just like the standard 401(k), the Roth 401(k) is offered by employers (note that if you are self-employed, you qualify!). However for individuals who're still working, the Roth 401(k) may be considered a practical investment option.

Just like it sounds, the Roth 401(k) combines functions of the Roth Individual Retirement Arrangement (Roth IRA) and the conventional 401(k). As with a Roth IRA, you receive tax relief:

• contributions to a Roth 401(k) are made on an after-tax basis (i.e. no tax relief at time of contribution);
• the account grows tax-free;
• distributions are not subject to income tax (provided you have held the account for 5 years or even more, and also the distribution is made once you attain age 59½, in the event you end up being disabled, or in the event you die).

However as with a 401(k), you might contribute to a Roth 401(k) no matter your income, and its contribution limitations are the same as the conventional 401(k), which in 2012 is $17,000 (or $22,500 for all those fifty or older using the catch-up provision).

If you are trying to stash as much as possible into your retirement accounts, the Roth 401(k) may possibly become a great chance for tax relief, according to your other financial conditions.

Before you decide to contact your employer, though, you might want to be aware of two things. Firstly, the contribution limit is applicable to contributions to both kinds of 401(k) plans, so you can only save a total of $17,000 in your conventional 401(k) and Roth 401(k) put together. Nevertheless, you may utilize both plans, contributing, for example, $8500 to each (although this author recommends placing your total contribution in the Roth 401k). Additionally, your employer might not yet offer the Roth 401k so as to enjoy the tax relief described.

So who might select the Roth 401(k) over the traditional 401(k)? That is an individual choice which you should talk about with somebody knowledgable of your person financial circumstances and goals, like your financial advisor or tax consultant. However, if you expect your income tax rates to become the same or greater in retirement than it's now, you need to select a Roth 401(k). This author expects tax rates to be higher in the future so any mechanism that will perm it you to get tax-free income later (even if you forego tax deductions now) will be to your benefit. Or, if you believe your tax bracket will be reduced in retirement than it is now, you would choose a traditional 401(k).