By now, most investors know something about Roth IRAs, and about the option of converting a traditional IRA into a Roth. But there may be another option: investing in a Roth 401(k) at work.
The 401(k) version of the Roth doesn’t get much attention, but can be especially good for people who would like to hedge their bets with two types of retirement accounts.
Roth 401(k)s work like Roth IRAs. You get no tax deduction on contributions, while withdrawals, including investment gains, are tax-free. But there are two key differences.
First, there is no income limit for opening a Roth 401(k). Anyone can have one if your employer offers it. To open a Roth IRA and make the maximum contribution, your modified adjusted gross income must be below $105,000 if you are single, $166,000 if you are married and file a joint return. (There is no income limit for converting a traditional IRA into a Roth.)
Second, you can put much more into a Roth 401(k) — $16,500 a year, or $22,000 if you are 55 or older. For a Roth IRA, the figures are $5,000 and $6,000.
You don’t hear much about Roth 401(k)s because most people prefer traditional 401(k)s. Those offer an income-tax deduction on contributions, while withdrawals are taxed as income. Most people assume their tax bracket will be lower in retirement than in their working years, so the traditional 401(k)’s upfront deduction is more valuable than the Roth 401(k)s tax exemption on withdrawals.
But you can only guess what your income will be in retirement, especially if that’s many years away. And no one knows what tax brackets will be in 10, 20 or 30 years. So one option is to divide your contributions between a traditional 401(k) and the Roth version. That way, you can hedge your bets. After you retire, you can take money out of the Roth in years when your tax bracket is high, then use the traditional 401(k) when it is low.