Time
As the Rolling Stones said, “Time is on my side.” And so it is with younger investors, time is clearly on their side. The benefit to a Roth IRA or Roth 401(k) plan is that if all of the requirements are met, the distributions are tax-free. To fund a Roth IRA you will need to have earned income. This is the wages you earn as an employee or any self-employed income from a business you may run. The maximum contribution to a Roth IRA in 2013 for someone under age 50 is $5,500. There is a so-called ‘catch-up’ provision of an additional $1,000 for taxpayers over age 50.
The maximum contribution to a 401(k) plan or Roth 401(k) plan in 2013 is $17,500. There is a so-called ‘catch-up’ provision of an additional $5,500 for taxpayers over age 50. Not all employers will offer a Roth 401(k). That’s fine. If your employer offers a 401(k) plan and there is an employer match, sign up for the plan and contribute at least the amount required to get the full employer match. The employer match is an employee benefit you need to be taking advantage of. If your employer offers a 401(k) plan but not a Roth 401(k) plan ask them if they could adopt this plan.
Tax-Bracket
Most younger investors tend to be in the lower income tax brackets. As you grow older and hopefully, become upwardly mobile, your earnings and income tax bracket will increase. Perhaps when you are older, making more money and in a higher income tax bracket a 401(k) plan might make more sense.
Flexibility
A Roth IRA offers more flexibility that an IRA. With an IRA you are allowed an income tax deduction for your contribution. With an IRA any distributions are subject to income tax. Additionally most distributions made before age 59 1/2 are subject to a premature distribution penalty of 10%. This is not the case with a Roth IRA. With the Roth IRA if the account is open more than 5 years and distributions are made after age 59 1/2 then all of the distributions are tax-free. However, a Roth IRA owner can always take out their contributions at any time and they are not taxable. Roth contributions are deemed to come out first.
If you are a young investor are you funding your Roth IRA or Roth 401(k)?
Tom Scanlon has over thirty years experience in public accounting with an extensive background in the areas of financial, tax, and estate planning. He prides himself on providing in-depth and customized solutions to privately held businesses and their owners. He is a Certified Public Accountant and Certified Financial Planner®. Tom is a frequent speaker for area organizations and has recently been quoted on CNBC, Fox 61 News and AARP's blog. Tom also has been a guest columnist for numerous publications including The Wall Street Journal, Barron's, Money Magazine, The Hartford Courant, The Hartford Business Journal, and The New Haven Register. He is a member of the American Institute of Certified Public Accountants, the Connecticut Society of Certified Public Accountants, and the Financial Planning Association. Active in the community, Tom supports a variety of not-for-profit organizations.
As with a safe harbor 401(k) plan, the employer is required to make employer contributions that are fully vested. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding calendar year. Employees who are eligible to participate in a SIMPLE 401(k) plan may not receive any contributions or benefit accruals under any other plans of the employer.
To that end, the answer may be a partial conversion –– when you leave some of your funds in a traditional 401(k) plan to soften the initial tax blow and put some savings in a Roth.
Ezra,
Good point, a partial conversion might be a good solution.
Regards,
Tom
Can roll over to another employer’s Roth 401(k) plan or to a Roth IRA at an independent institution.
Ernesto,
1) To rollover into another employer’s Roth 401(k) Plan the “Plan Document” must allow for this. Follow up with the person that administers the 401(k) Plan.
2) A Roth IRA can be rolled over into another Roth IRA at a different institution.
Regards,
Tom