Whether you work for a private company, a non-profit organization, or a government agency, these days you probably have access to a retirement savings plan. It may be called a 401(k), a 403(b), or a 457(b). It will certainly offer the traditional version of a retirement savings plan, but it may also offer a Roth option.
Whether it offers a Roth option is up to your employer. So is the selection of investments you can choose from. Most of them will be mutual funds, but they may range from highly conservative bond funds to highly speculative stock funds.
- If you have an employer-sponsored plan, it's up to the employer whether a Roth account is an option.
- The Roth option means a bigger hit to your take-home pay during your working years in return for a bigger retirement income down the line.
- You can divide your savings between both types of accounts. You can even change your mind.
Seven in 10 employers who offer a retirement plan include the Roth option as of 2020, although only about 18% of employees chose it, according to one recent survey.
It's worth considering. The Roth can be a little more pain in your working years in return for a lot more gain once you retire.
Roth vs. Traditional
When you invest in a Roth account, you pay with after-tax dollars. But when you withdraw money after you retire, you owe zero taxes on that money. The investment returns over time are tax-free, and you have already paid the income tax on your contribution.
If you invest in a traditional retirement account, you pay with pre-tax dollars. Your taxable income is reduced by the amount you pay in. That softens the impact of the loss in your take-home pay. After you retire, you'll owe income taxes on those pre-tax dollars you put in, and on the investment returns the account generated.
There are a few other differences that won't matter much to you until you retire. Investors in a traditional account must begin taking required minimum distributions (RMD) by age 72. In the past, you had to stop contributing to a traditional IRA at the same age taking RMDs was required. As of 2020, because of the SECURE Act of 2019, you can contribute to a traditional IRA at any age so long as you have income. Neither restriction applies to the Roth account.
Percentage of employees who choose the Roth option over the traditional retirement option.
You Can Choose Both
If your employer offers both traditional and Roth options, you can split your money between the two if you like. You just can't pay in more than the maximum amount allowable for either or both.
For both the 401(k) and the 403(b), that is $19,500 for 2020 ($19,000 for 2019), plus another $6,500 ($6,000 for 2019) if you are aged 50 or older. For the 457(b) plan, the limits are the same except that you can pay in up to $39,000 for 2020 ($38,000 for 2019) if you're three years or less from retirement age.
Your employer may place other limits on the amount you contribute.
You Can Change Your Mind
You can even change your mind any time and roll over a traditional account to a Roth account, or vice versa.
Just remember, if you're converting a traditional account to a Roth account, you'll owe income taxes on the balance in that tax year. If you're converting a Roth to a traditional IRA, the taxes paid will be restored to your account.
More Factors to Consider
If your employer gives you the opportunity to contribute to either, the following are some personal factors that might point to favoring the Roth option:
- You have quite a few working years left to save for retirement.
- You are in a low tax bracket today or you're fairly sure that your tax bracket will be higher when you retire.
- You don't want to ever have to pay taxes on the money your investments earn while they are in your account.
- If something happens to you, you want to be sure your heirs keep as much of their inheritance as possible.
- You can manage the strain of paying in a chunk of your taxable income month after month.
Reasons to stick to the traditional retirement account might include:
- You're on a very tight budget right now. It's easier to squeeze out enough for a traditional pre-tax contribution since some of that money comes back to you immediately as a lower tax on your paycheck.
- You expect to be in a lower tax bracket after you retire. Tax rates are impossible to predict, but many people do have lower incomes after retirement, and therefore owe less in income taxes.
- You're close to retirement age. Those taxable returns have a few more years, not decades, to add up.