My company offers a 401(k) and a Roth 401(k), and I currently contribute to both; should I put all of my contribution money toward the Roth 401(k)?
My company offers a 401(k) and a Roth 401(k). Currently I contribute 6 percent to my 401(k) and 8 percent to my Roth 401(k). Is this a good long-term strategy? I want to contribute all to my Roth 401(k) starting in 2019. Is that a better strategy? Also, can I take out my principal if needed from my Roth 401(k) since it’s after-tax dollars?
When determining whether to contribute to a pre-tax or Roth 401(k) you should consider your current tax bracket. Currently, we're in a historically low tax environment starting this year. If you're in one of the lower 3-4 tax brackets it can be advantageous to contribute more to the Roth side of the 401(k). You're essentially "guessing" that you'd pay fewer taxes today than you would in the future. It's especially beneficial for younger individuals who are at the beginning of their earning years and will likely only move up in tax brackets as their careers progress.
However, having buckets of pre-tax and after-tax funds to withdrawal from in retirement is also advantageous because you can control your taxes better then. Therefore, contributing to both is a great strategy. If you take out the principal of your Roth 401(k) you'll still be taxed on the earnings portion, relative to the amount of earnings in the account. Your retirement accounts are meant for the long-term and if you need funds prior to then, it's important to set aside investments or cash for that purpose. Withdrawing early from retirement accounts is almost never a good idea.
My company offers a 401(k) and a Roth 401(k). Currently I contribute 6 percent to my 401(k) and 8 percent to my Roth 401(k). Is this a good long-term strategy? I want to contribute all to my Roth 401(k) starting in 2019. Is that a better strategy? Also, can I take out my principal if needed from my Roth 401(k) since its after-tax dollars?
The benefit of contributing to a 401(k) is that the money goes in pretax. This lowers your taxable income today. When you take qualified distributions in the future, the amount will be taxed as ordinary income. Contributions to a Roth 401(k) comes from after-tax money, which will cost you more up front. However, qualified distributions will be tax free. So, the debate really comes down to comparing your current tax rate with your future tax rate at retirement. If you expect your tax rate will be higher at retirement and prefer to pay taxes at a lower rate now, then a Roth 401(k) is the better option. If you believe your tax rate at retirement is going to be lower than they are today, then contributing to a 401(k) today will save you more on taxes. For most people, the answer is not so clear cut. By having both accounts, it gives you the flexibility to manage your gross income in the future to ascertain a certain income threshold.
Besides taxes, you need to also know that a 401(k) requires the account owner to take required minimum distributions at age 70 ½. This is still true even if you rollover your 401(k) to a traditional IRA. If you rollover your Roth 401(k) to a Roth IRA, you can avoid required distributions. Some use this strategy to pass on to their heirs.
If you plan document allows you to take money out of your Roth 401(k), the amount will be prorated between your original contribution and the earnings. Assuming you don’t meet the requirements for a qualified distribution, age 59 ½ or disabled, the earnings part of the distribution will be taxed and is subject to a 10% penalty. Unqualified withdrawals are meant to be punitive.
Having a balanced approach to this is usually my answer to most clients. However if you are looking for the biggest tax break today I would lean a bit toward the Traditional. I really like the ROTH because my clients today don't have hefty ROTH balances and whenever they are looking for funds they always have to withhold taxes. This is not a happy moment for them. So a balance approach or a lean to tradition if you need a tax break today. The principal balance on the ROTH is penalty free. However that should not be a reason for using the ROTH. Retirement dollars should be for retirement.
The purpose of the retirement savings is not to take them out until retirement. With Roth 401k you will not be able to take the tax deduction, but you can with regular 401k. The big advantage with Roth 401k is its tax exemption status. All the growth will be tax-free when it's time to withdraw.
Note: If you are going to be in the same tax bracket after retirement both Regular and Roth 401k results in the same return. If you are going to be in lot lower tax bracket at the retirement you would be better off going with Traditional IRA. If your tax bracket will be higher than the present tax rate or if you need flexibility in withdrawing funds or escaping the mandatory withdrawals after 70and half years you should look into Roth 401k.
I have many clients who use this strategy. Depending on your age, contributing to both a Traditional 401k and a Roth 401k is a good strategy. This way you get both a Pre-tax (Trad) benefit to help lower your taxable income currently and you get a benefit of tax free income when you take distributions in retirement from your Roth.
Keep in mind if your company offers a match, 100% of that match will be a Pre-tax benefit (since it hasn't been taxed previously).
As far as if it’s a "better" strategy doing 100% Roth, it’s really a preference as many other factors need to be considered (age, Income, AGI/Taxes, other retirement/investment accounts, are you maxing out your contributions, etc...).
Normally, you will NOT be able to take out your principal in a Roth 401k. It really depends on what it says in your Plan Document. Many plans Do Not allow for distributions unless there is a Separation of Service (Termination). IF your plan does allow it, you also have the 5 Year Rule regarding Roth Contributions (can't take tax-free until after 5 years).