Whether it makes more sense to pay taxes now or at retirement is a question many workers will be pondering if their employers offer them a new Roth 401(k) investment option.
Starting next year, the Internal Revenue Service will allow employers to offer a Roth 401(k), which has been described as a cross between the Roth IRA and a traditional 401(k). More than a third of employers say they “are very or somewhat likely” to add the new option, the Dallas Morning News reported, citing a study by Hewitt Associates, an employee benefits consulting firm.
One of the hallmarks of the Roth 401(k) is that there are no income limits, as there are with a Roth IRA. To be eligible to make the full contribution to a Roth IRA, individuals must have an adjusted gross income of less than $95,000; or less than $150,000 for married couples filing jointly.
Some of the guidelines are still being worked out for the Roth 401(k), but as is true for the Roth IRA, the contributions are taxed up front, so no taxes need to be paid when the money is withdrawn if certain conditions are met. This is unlike a regular 401(k) in which taxes are deferred until the money is taken out.
"If you feel tax rates will be higher in the future, you may want to consider doing a Roth 401(k) to take the tax hit now," Richard O'Donnell, pensions editor at RIA in New York, told the newspaper. He added, though, "You've got to be able to afford to front-load the taxes.”
One employee benefits expert says he would rather pay the taxes now, so he will invest in a Roth 401(k).
"I am absolutely personally convinced that income tax rates are going to go through the ceiling over the next 10 to 20 years," said Dallas Salisbury, chief executive of the Employee Benefit Research Institute in Washington.
Like a regular 401(k), employers can match workers' contributions in a Roth 401(k), but the worker will have to pay taxes on the employer's contribution upon withdrawal since the employer's match would be made on a pretax basis.
Next year, the limit for contributing to 401(k) plans is $15,000, which includes both options. Anyone who wants to maximize their contribution to their 401(k) will have to divvy up their $15,000 limit between Roth and regular 401(k) plans.