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December 16, 2009

The ROTH 401 (K)

Filed under: Personal Finance, Retirement, Uncategorized — Tags: , , , — thebalancedspreadsheet @ 11:20 am

Last Friday, my employer gave me an early Christmas gift.  They sent out word that starting in 2010 they would be offering a ROTH 401(K) option along with the traditional 401(K) plan! This was very good news as I already contribute to a ROTH IRA and as I have discussed before in comparing traditional and ROTH IRA’s, the tax free growth you get with a ROTH almost always is better then the deferred growth you get with a traditional retirement plan. The differences between a traditional 401(K) and a ROTH 401(K) are very similar to the differences between a traditional and ROTH IRA.

The big difference is still the tax treatment.  Contributions to Traditional 401(K)’s are tax deferred while ROTH 401(K) contributions are made after taxes and have tax free growth.  That means that ROTH 401(K) contributions will result in a higher tax bill in the year you make the contribution compared to a traditional 401(K).  However, under both plans, if the company matches any of the proceeds that amount and its growth is tax deferred.

The one big advantage of the ROTH 401(K) versus the ROTH IRA is the contribution limits.  You can contribute up to $16,500 combined in 401(K)’s in 2009 compared to just $5,000 for IRA’s.  That means you can get up for $11,500 more in tax free growth a year!  There is also no income limit to participate in a ROTH 401(K) while with a ROTH IRA the limit is $105,000 for single filers and $166,000 for married filing jointly.

After crunching the numbers it looks like I will be making the switch from Traditional 401(K) to ROTH 401(K) in 2010.  I will put 9% of my paycheck into the ROTH 401(K).  My employer matches 6%, so that means I will be getting 15% of my net pay into 401(K).  I will stop contributing to my ROTH IRA in 2010.  This will increase my tax bill for 2010 but down the road I will more then make up for it.  The one thing I was worried about in contributing to a ROTH 401(K) was whether or not the tax free contributions would bump me up into the 25% tax bracket in 2010.  However it looks like I will still be in the 15% tax bracket. 

Has anybody else had experiences with a ROTH 401(K)?  Did you like it?  Hate it? Or were you indifferent?  Any feedback is appreciated.

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