Starting in 2007 there is a new type of 401k and 403b that will become available. It is a Roth 401k. Similiar to a Roth IRA it will allow individuals to put money into a retirement account and pay tax on it now, but no tax in the future. Instead of taking the tax advantage in the present you take the tax advantage off the increased amount in the future.
For a young person this is a very good strategy because paying 30% of $1000 now is better than paying 30% of $5,000 at retirement. It is also a good choice for people who expect to be in a higher income tax bracket in the future than they are in currently.
I’m not sure how this works for the employer contribution on a 401k. Normally the employer contribution isn’t even reported to the government. You only pay taxes on it when you take the money out. With the Roth 401k, I’m not clear if the employer contribution will be taxed as it is in a traditional 401k or if it will be available at retirement tax free as well.
For most people this isn’t too much of an issue because the employer portion is only a a small percentage of whatever they contribute themselves. However for certian people who own their own business and set the employer contribution percentage themselves, this could be quite a loop hole because it would be a way to put money into a Roth type retirement account without needing to pay taxes on it up front.
As with any investment, make sure you sit down and do the calculations before deciding to invest in a Roth 401k. It may or may not be a benefit to you depending on your specific situation, when you plan to retire, and your expected income until retirement.
Also don’t forget you can get many of the same advantages by using a Roth IRA as well. By putting some money into a traditional 401k and some into a Roth IRA you can give yourself more options for when you retire. When the time comes you can pull money out of which ever account gives you the best tax advantage. For example, if you have a year where you are in a higher tax bracket you may want to pull money out of the Roth account where you won’t be paying taxes at the higher rate. On years where you haven’t had to withdraw as much, you might pull money out of the 401k account to take advantage of your lower tax bracket for that year.
One concern I have about Roth 401k and 403b accounts is how the tax law might change in the future. If the government runs out of money is it possible that they will start taxing withdraws from these types of accounts later on? I don’t know that there is any safeguard to prevent against this. Of course the whole economy could collapse and all your funds could be worth nothing, so I guess there isn’t any way to be completely safe.
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