Contributing to a Roth 401(k) or Roth IRA is a sound investment option. Roth accounts allow for retirement savings that provide significant, long-term tax advantages. Before committing to a retirement option, weigh the pros and cons and consider what is right for your particular financial goals.
The main difference between a Roth and traditional retirement plan lies in when you pay taxes on the income contributed to your account. With a traditional 401(k)/IRA, you contribute pre-tax dollars now and pay taxes when you withdraw the income later. A Roth plan allows you to do the opposite. Your current contributions are made with after-tax dollars. Then there are no tax implications when you make withdrawals during retirement.
Benefits of Roth Plans vs. Taxable Accounts
When you choose a Roth plan instead of a standard taxable 401(k)/IRA, the real value is in looking at how the plan is used. You will get the same investment options with a Roth or standard plan, but a Roth 401(k)/IRA typically provides liability protection. While taxable accounts are not exempt from bankruptcy protection and lawsuits, Roth 401(k)/IRA accounts are generally protected.
There is also no need for tax reporting, since Roth plans do not require annual reporting. With other taxable accounts, you need to pay income tax annually. A Roth plan is handled differently. Both accumulated income and qualified distributions are tax free.
Benefits of Roth Plans vs. Tax-Deferred Retirement Accounts
With a Roth 401(k)/IRA, you experience greater tax savings than you would with a tax-deferred retirement account. The long-term level of tax-free growth makes these plans particularly popular, since paying taxes on their proceeds in the future is not required. If they have strong growth, it will basically set you up to receive tax-free money in retirement.
There is also no age limit to make Roth contributions, as long as you are still earning income. Also, you will not have to take required minimum distributions. Roth plans can continue to grow if the owner of the plan does not want to withdraw money.
Benefits of Roth Plans for Estate Planning
For estate planning, the Roth 401(k)/IRA has some notable benefits. With tax-free distributions, there is no income tax incurred on a Roth plan's distributions. Additionally, the Roth 401(k)/IRA offers an opportunity for tax-free growth for beneficiaries, who only have to take minimum required distributions. They can leave the lump sum to grow, if they wish. Bypassing probate is also a valuable benefit, as most Roth plans simply pass to the beneficiary.
Backdoor Roth IRA Option
If your annual income is above the IRS Roth cap, you can plan for retirement using a “backdoor” Roth IRA. This unofficial, IRS-approved approach can be complicated but well worth the effort. There are a few ways to contribute to a backdoor Roth IRA, including:
- Contributing to an established IRA and rolling the funds to a Roth IRA account. Or, passing existing money from a traditional IRA to a Roth account.
- Converting your entire traditional IRA account into a Roth IRA account.
- Making after-tax contributions to a traditional 401(k). Then rolling it over to a Roth IRA.
Going with one of those methods doesn’t mean you’re exempt from paying taxes—you will still owe taxes on the entire amount transferred to your Roth IRA.
Choosing a Roth 401(k)/IRA option makes sense, especially in the long term. With a Roth account, you can maximize your savings and capitalize on a retirement strategy that gives you a strong financial future.
Insogna CPA is experienced and well-equipped to deliver a seamless retirement planning experience to its clients. For more information on building wealth and creating a comfortable future for yourself, contact our team of licensed CPAs.