Is a rollover to Roth 401k a good idea? I have some strong opinions about it, but first let’s take a look at what a Roth 401k is.
Basically, it is similar to a Roth IRA in that you get no deduction for your contributions, but the growth and eventual withdrawals can be tax-free. As a result, you get tax-free retirement income. Another huge plus is that you might make your Roth IRA beneficiary very happy.
The government recently enacted laws to make these plans available. 40% of existing plans out there carry a provision to allow this change, so your employer might offer this to you soon. The question is, should you go for it? And if you own your shop, is this the best 401k for small business owners?
Generally speaking, the older you are, the less attractive the 401k Roth plan is. That’s because the real benefit of tax-free growth requires…well…eh…growth. The longer you keep your money in the plan, the longer the growth has an opportunity to….eh…grow.
You need that growth to make up for the big tax hit you take when you first roll over your money to the Roth 401k. That’s right. If you “take advantage” of the Roth 401k, you’ll have to pay income tax on all the money you take out of your 401k and roll into your Roth 401k.
Can you guess why the government is so anxious to make these plans available? That’s right…the boys and girls in D.C. want to get their hands on those tax dollars. But I digress. Let’s get back to you.
Another reason you might want to pass on this plan is if you will be in a lower tax bracket by the time you start making withdrawals. If that describes you, you’re probably better off to take the tax deduction now while you’re in a high bracket and take (taxable) withdrawals when you retire in a lower bracket. In short, stick to your old 401k.
And as you might have guessed, that’s the scenario most of us considered when we first started contributing to the retirement plans anyway. Put the money in while we work and are in a higher tax bracket. Take the money out when we retire and are in a lower bracket. Simple.
So who is the Roth 401k a good fit for?
The younger you are, the better it is. Also, the higher the tax bracket you’ll be in when you retire, the more attractive the plan is.
But there are a few other considerations — not the least of which is that if you put your money into the Roth 401k, it’s easier to spend. That’s because when you make qualified withdrawals, they won’t trigger income taxes. Believe it or not, that’s my biggest beef with this plan.
My experience tells me that people tend to accumulate assets when it’s difficult or painful to access that money. Most people I meet have most of their money in retirement accounts for exactly those reasons. The Roth 401k doesn’t have those obstacles, and that worries me.
You might tap that cookie jar sooner rather than later if you have a Roth 401k. If so, that will be the greatest cost of using the Roth 401k.
What say you? Do you have the discipline to take advantage of the Roth 401k and not tap it? Would you roll your 401k over the Roth 401k?