Getting the Most out of Your 401(k): Consider Diversifying with a Roth Account

Here is tip #6 of our seven-part-series to help participants get the most of their 401(k) plans.

Roth 401(k) contributions are made after-tax, while both the contributions and the earnings on those contributions can be withdrawn tax-free. This differs from the traditional 401(k) in which taxes are on both contributions and earnings are deferred until withdrawal. If you’re beginning your career, you’re probably in a lower tax bracket then you will be at retirement. This might mean that it makes sense to take the tax hit now, freeing you from headaches later on.

However, if you think your income may decline at retirement age, a regular 401(k) may make sense.

Do Employers Offer Roth Accounts?

Many employers offer a Roth 401(k) option within their plans. The Roth option allows employees to save on an after-tax basis and make qualifying distributions in retirement that are tax-free. In general, younger and lower-income workers who expect to be in a higher tax bracket later in their careers receive the biggest benefit of a Roth 401(k). However, many individuals find the tax-diversification benefits of having some of their savings in a Roth account attractive.

The more likely a participant is to achieve a high replacement income in retirement, the more attractive Roth contributions may become. Providing employees with the flexibility to manage the distribution of tax risk is an important advantage of the Roth 401(k) option.

Ready for the final tip? Click here to read tip number 7!