Are You Taking Advantage of This Lesser-Known 401(k) Feature?
You’ll need income outside of Social Security if you want to enjoy a comfortable retirement. And if you have access to a 401(k) plan through work, you have a prime opportunity to build yourself a nice nest egg.
The great thing about 401(k) plans is that they come with higher annual contribution limits than IRAs. Plus, many of the companies that offer 401(k)s also match worker contributions to some degree. So you might, for example, snag a free $3,000 toward retirement simply by having that much money allocated from your own paychecks.
Another benefit of saving in a 401(k) is getting to shield some of your income from the IRS. Traditional 401(k) contributions go in tax-free, and many savers enjoy that tax break immensely.
But while your 401(k) plan might give you a near-term tax break, you shouldn’t necessarily go after one. Instead, you may want to look at a lesser-known 401(k) feature that won’t save you money on taxes immediately, but could come in extremely handy during retirement.
Look at a Roth 401(k)
In recent years, a growing number of 401(k) plans have adopted a Roth savings option. And if your plan offers a Roth, it could pay to take advantage.
A Roth 401(k) won’t give you a tax break on your contributions. Rather, you’ll fund your retirement plan with after-tax dollars. But come retirement, your withdrawals will be yours to enjoy tax-free. And that’s a big deal.
You might end up on a tighter budget in retirement than today. And so wouldn’t it help to not have to fork over a chunk of your income to the IRS?
Also, if you save well for retirement, you might end up in a higher tax bracket as a senior than you’re in today. In that case, you can benefit by not having to pay taxes on the Roth 401(k) portion of your income.
Furthermore, when you save for retirement in a 401(k) plan, you’re eventually forced to start taking required minimum distributions, or RMDs, from your account. With a traditional 401(k), those RMDs will create an automatic tax liability for you. But if you keep your savings in a Roth 401(k), you won’t have to worry about taxes on the money you’re required to remove from your savings.
Explore all of your savings options
Many people are familiar with the Roth version of an IRA. But some don’t realize that their 401(k) plans even offer a Roth savings component. If you’re not sure whether yours has one, ask.
A Roth 401(k) could give you a lot more financial flexibility later in life. And so it pays to see if that option exists in your employer’s retirement plan.
Another thing you should know is that while Roth IRAs have income limits that bar higher earners from making direct contributions, Roth 401(k)s don’t have those restrictions. So you could be in a solid position to save for retirement in a Roth 401(k) and enjoy a steady stream of tax-free income later in life.
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