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When Does It Make Sense to Contribute to a Roth 401(k)?

When Does It Make Sense to Contribute to a Roth 401(k)?

Many people decide to have financial freedom during retirement. It might also be a good idea to take part in the 401(k) plan sponsored by the employer. This is true when you consider the rising concerns about Social Security's Solvency. 

However, there are some critical decisions one needs to make. For instance, what is the value that one will contribute in the 401(k)? Should you consider a traditional 401(k) or a Roth 401(k)?

One, however, needs to understand the differences between both 401(k) and its impact. This article explores how to decide if 401(k) is right for you.

Deciding Whether to Make Roth 401(k) Contribution 

Here are helpful steps that can help you determine if Roth 401(k) will help take care of your financial needs during retirement. 

Know What Your Employer Offer 

The first step is to know the plans your employer offers, whether Roth 401(k) is one of them. Not all firms offer this plan as it started in 2006. 

For people with a Roth 401(k) plan, check if it provides features similar to the traditional 401(k), like automatic enrolment. 

One also needs to understand the matching contribution system of the company if the firm offers such. Some employers will lure you with incentives to enroll in a 401(k) plan via contribution matching. You should contribute as much as essential to get the best of the match. If there is a company's match, the employer can allow a matching contribution if you enroll in Roth 401(k). 

The company match, however, needs to go to the specified Roth 401(k) account. As a result, the investment growth alongside the matching funds will be subjected to the ordinary income tax when you start withdrawing after retirement. 

There is an employer that might have an after-tax 401(k) plan. However, this is not similar to Roth 401(k) and shouldn't be taken as one. 

Consider if you can get tax breaks by reducing your income. 

There are many ways to get tax breaks and credits when you lower your AGI (Adjusted Gross income). For instance, in 2021, if your AGI exceeds 66,000 USD as a married couple going through the joint filing route, you cannot enjoy the Retirement Savings Contribution Credit. 

When you contribute to a traditional 401(k), it brings down your taxable income. It can qualify you for a more significant tax credit if your income does not rise excessively above the threshold. As a result, you are better off paying attention to your AGI, and bringing it down when it makes sense, and can make you qualify for a Roth IRA.

Decide when you need to pay taxes: Now or Later.

The income tax code of the United States is a complex process. It might not make it easy if you are considering it to decide whether you should go for the Roth 401(k) or traditional 401(k) route. However, the overall decision is hinged on whether you intend to make a tax payment now (Roth) or when you withdraw the funds (traditional).

You need to do some planning before deciding which option is right for you. With planning, you can ascertain when the highest tax bracket will be. 

The Roth option is acceptable for people who are still early in their careers and their tax bracket is low. One has the opportunity to lock in the present income tax rate, which could reduce compared to what your future income tax will be when you retire and resort to the savings. 

On the other hand, for people in their peak earning period with a few years to retirement, they are better off taking the tax breaks today using their pre-tax 401(k) contribution, the traditional one. This will reward you with a lower income tax rate when you retire compared to paying tax when you are earning more money.