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401(k)s

Traditional Vs. Roth, Two Ways To Save

April 14, 2008
By Jennifer Campion

 
 

If your company offers a retirement plan, you know that once a year you have important decisions to make. You need to decide how much to defer from your pay and which investment options best suit you. You need to review your beneficiary information, too. Some of us may also need to choose between the traditional 401(k) or the new Roth 401(k). Many employers are already offering it or will soon. Also, employers that offer the Roth may still offer employees the traditional 401(k). Each retirement plan has advantages and you can take part in both. Let’s look at the two and see how they differ.

The 401(k) plans have many similarities. In both your money grows tax-deferred. You do not pay taxes on capital gains or distributions. There are no income restrictions; all employees, regardless of compensation, may participate in either plan. The contribution limits are the same. The money is accessible at death, disability, separation of employment or on reaching the age of 59½.

The plans are also different. To start with, the traditional plan allows your contributions to be invested before taxes are taken out. This allows every dollar you contribute to go directly into your account, which reduces your taxable income. Taxes are due when you withdraw the money. With the Roth 401(k), contributions are taxed before investment. (If your employer offers a match, it will be treated the same for both plans. The contribution will be pretax for both 401(k)s. With the Roth 401(k), the matching funds will be taxed upon withdrawal.)

Rollovers in both plans are allowed. Traditional 401(k)s may roll over into a traditional IRA and a Roth 401(k) may roll into a Roth IRA.

So what are the perks for Roth 401(k) participants? Hint: They come later in the game. With traditional 401(k)s and IRAs, the government requires minimum distributions for people over the age of 70½. However, if you roll your Roth 401(k) into a Roth IRA, minimum distributions do not apply. Your money may continue to grow undisturbed and tax deferred.

Consult your tax adviser when evaluating your choices. He or she will be able to help you make the choice: get a tax break by contributing to a traditional 401(k), which reduces your taxable income, or contribute to a Roth 401(k) that doesn’t give immediate tax breaks but does provide tax-free income upon withdrawal.

If both plans appeal to you, you will be happy to know that you may contribute to both. The contribution limit is per person, not per plan. As long as your total contributions add up to no more than $15,500 per year, you can contribute to both plans.

You should be aware that the Roth 401(k) is part of legislation that must be extended by Congress at the end of 2010. If Congress does not extend the plan, no additional funds could be put into a Roth 401(k) after January 2011. Money already in the plan would be allowed to stay there.

Whether you choose the traditional 401(k), the Roth 401(k) or a combination of the two, the 401(k) is a wonderful way to save for retirement. The money is taken directly from your paycheck, making it a convenient way to save. Both plans are portable: If you leave a job you can take the money with you to your new employer or roll it over into an IRA. Traditional or Roth — don’t delay! Take full advantage of your 401(k) today!

JENNIFER CAMPION is a financial planning specialist with Smith Barney in Baltimore. This article was written by Jennifer Campion and does not reflect the views of Smith Barney or its affiliates. Visit Jennifer’s website at www.fc.smithbarney.com/jennifercampion.

 
 
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