investing

Should I Contribute to a Roth or Traditional 401(k)?

Consider making Roth 401(k) contributions if most of your savings are tax-deferred. Contributing some money to a Roth 401(k) helps diversify your tax situation.

My wife just started a new job that offers a Roth 401(k). Neither of us has worked for a company that offered this option before, and we earn too much to contribute to Roth IRAs. Should she contribute to the Roth 401(k) or stick with the traditional 401(k)?

She should definitely consider making Roth 401(k) contributions if most of your retirement savings is tax-deferred – say, in a 401(k) or traditional IRA. Contributing some money to a Roth 401(k) helps diversify your tax situation. She won’t get a tax break for her contributions now, but she’ll be able to withdraw the money tax-free in retirement (as long as she’s had the account for at least five years and is at least 59½ when she withdraws the money).

You can each contribute up to $18,000 to any kind of 401(k) -- a Roth 401(k), a traditional 401(k) or a combination of the two --in 2015 (or $24,000 if you’re 50 or older this year).

Caveat: If you expect your joint tax rate to drop 10 percentage points or more in retirement, then contributing to the traditional 401(k) could provide more spendable income at that point, says Stuart Ritter, a certified financial planner with T. Rowe Price. “But the diversification and flexibility offered by the Roth might still make it the more compelling choice,” he says. Roth 401(k) and Roth IRA withdrawals are not included in your adjusted gross income, which helps give you more control over your tax bracket in retirement and may also keep you below the income cutoff for the Medicare high-income surcharge or preserve more of your Social Security benefits from taxes.

Unlike money in a Roth IRA, the money in a Roth 401(k) is subject to required minimum distributions starting at age 70½ (unless you are still working in that job), but the withdrawals are generally not taxable. You can avoid having to take RMDs from a Roth 401(k) by rolling the money over to a Roth IRA. See Avoiding Required Minimum Distributions From Roth 401(k)s for more information.

Also see The Basics of Roth 401(k)s and Invest in a Roth 401(k) If You Can.

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