Are Roth contributions tax deductible?
The Roth 401 (k) was created a few years ago. Since the Roth 401 (k) was originally due to expire before the end of the decade, few companies bothered to establish Roth 401 (k) s for their employees. Fortunately, Congress had already made the Roth 401 (k) permanent in 2006.
When you have a Roth 401 (k) option at work, understanding how and when to use it is important. If you don't have a Roth 401 (k) option at work, it still makes sense to understand what you might be saying to your benefits department that they are missing out.
How a Roth 401 (k) works
Like contributions to a Roth IRA, contributions to a Roth 401 (k) are not tax deductible. Effectively, you are using after-tax dollars to fund your contribution. However, if the money is distributed to you one day during your retirement, the entire account is tax free. (A regular IRA and 401 (k), on the other hand, are tax-privileged, meaning you will have to pay a lot of taxes on your distributions during retirement).
No income restrictions
Contributing to a Roth IRA is only allowed if your income is below certain limits. However, there are no such limits on a Roth 401 (k) plan. This makes the Roth 401 (k) attractive to those who would otherwise not qualify for this retirement option, which enables tax-free growth in investment returns.
Higher contribution restrictions
Roth IRA contributions are capped at $ 5,500 (2016) or $ 6,500 (2016 if 50 or older). But Roth 401 (k) contributions can be as high as $ 18,000 (2016) or $ 24,000 (2016 if 50 or older).
Note, however, that these limits are the total allowable for all 401 (k) contributions. So if you are 45 years old and want to pay out US $ 12,000 on regular 401 (k) contributions in 2016, you can contribute a maximum of US $ 6,000 to a Roth 401 (k). regular 401 (k) and a Roth 401 (k) are allowed as long as your combined contribution does not exceed the annual limit. However, you could also make a Roth IRA contribution if you have reached the annual contribution limit for a 401 (k) plan.
401 (k) contribution limits for 2016
IRA contribution limits for 2016
Employer matching contributions
Your employer will determine whether or not you will receive a suitable contribution from your company. When you receive one, it is done before tax and is kept separate from your Roth 401 (k).
Roth 401 (k) vs. Regular 401 (k)
Choosing which plan to join if your employer gives you both options could be difficult. There are many variables to consider, but the most important one is your projected retirement income tax versus your current income tax rate. The more likely you are to believe your future income tax rate is higher, the more attractive a Roth is. Young people who are in relatively low tax brackets today should seriously consider a Roth 401 (k).
You can run some hypothetical scenarios to compare the differences between regular 401 (k) and Roth 401 (k) using comparison calculators.
Roth 401 (k) is a company decision
Not every company has a 401 (k) plan, and not every company with a 401 (k) plan has chosen a Roth 401 (k) plan. If you don't see the option listed in your benefit book, ask your representative. If your employer gets enough inquiries, the company could just add them.
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