Unless you have the IQ of Lindsay Lohan (sorry, Linds), you’re probably smart enough to know by now that you should be socking away a good deal of money into one of those handy-dandy retirement accounts. This is especially true for us young’ns who have years upon years for our money to ride out the recession and start compounding earnings like rabbits.
We all thought we knew everything there is to know about 401Ks and Roth IRAs until the new retirement tool waltzed in like he owned the investment-world. Well, hell-ooo there Mr. Roth 401K. You’re looking mighty attractive, aren’t you?
Here’s the deal. Roth investments are amazing for one simple reason:
The earnings you make from a Roth investment are 100% tax-free when distributed to you in retirement.
That means that, even though the money you contribute to your Roth IRA/401K has already been taxed, any – and I mean ANY – earnings you make from your Roth is 100% NOT TAXED. This is why Roth IRAs are such an amazing retirement tool, but also why they come with some limitations that weed out those uber-rich guys.
If you’re new to retirement accounts, I put together a very minimal table showing the basic key points about these three types of retirement tools – the 401K, Roth 401K, and the Roth IRA:
As you can see, there are pros and cons and several differences among each account. Can I tell you whether you should put your money in one over the other? No, I can’t. But I can help show you the benefits of each tool. However, if I had the option of using a Roth 401K, I would be ALL OVER that. 😉
Here are more fun facts about these retirement investments:
- This type of investment is relatively new, so they are pretty rare. They haven’t become outrageoulsy popular just yet mainly because companies aren’t willing to hire more personnel to help manage the Roth 401K. If your employer offers this type of retirement, I would definitely ask your Human Resources office about the details!
- As I mentioned in the bullets above, the max is $16,500 – but only to the extent that you don’t contribute to a traditional 401K. So you can only contribute a max total of $16,500 to either account (for example, you could contribute $8,250 to each account).
- Roth 401Ks are not subject to the income limitations that Roth IRAs are! No matter what you make, you should be able to contribute.
- Employers are allowed to match contributions, but you’ll have to ask your HR department more about that for your particular company.
- Since we can’t predict the future (try as we might), we have no idea how much higher or lower our taxes will be in 30 years; the Roth 401K dodges the risk of high future taxes by having 100% tax-free distributions for you to live off of when you retire.
- To be eligible to contribute to a Roth IRA, you must have had earned income in that year. This means that you can’t use money gifted to you or scholarship money.
- You cannot contribute more than you make (a given if you abide by the first bullet).
- You can invest in many different things – stocks, bonds, mutual funds, etc.
- Did I mention that all the earnings from a Roth IRA are TAX-FREE?!
- The biggest benefit to this retirement tool is the employer matching. Most companies offer some sort of matching deal up to certain amounts that you contribute. For example, your company may match up to 5% – but you’ll have to contribute at least 5% to get the full matching. It’s generally understood that you should contribute at least up to the amount that is matched, otherwise you’re passing up free money.
- You’re employer maintains this plan (similar to a Roth 401K), so it doesn’t require much effort from you, the employee. It’s simple to set up automatic withdrawals that will be deposited right into your 401K account. I recently heard a great quote from Ramit Sethi about this type of automation. He said, “Don’t make retirement about willpower, make it automated.” He couldn’t be more right – once that money is deposited into your 401K, there’s no way you can go out and spend it!
I hope this helps you along in your decision on where to put your retirement money. There are many great tools available to us for retirement that are just too good to pass up! Keep putting that money away every payday and you can rest easy knowing that your beach house and country club memberships will be fully funded whenever you’re ready to retire!