We’re in Our Mid-50s and Have $2 Million in Our 401(k)s. Should We Pivot to Roth Contributions?

We’re a dual-income couple in our mid-50s with over $2 million in our 401(ok)s. Ought to we “sacrifice” the pre-tax profit and change to Roth contributions at work?

-Wendy

Like most tax-related questions, the reply is “it relies upon.” Primarily based in your scenario, switching contributions to a Roth 401(k) may make sense for a couple of key causes, together with tax range and tax-free development. Nonetheless, there could also be extra components that make sticking with a standard 401(ok) and opening a Roth IRA on the facet extra fascinating. You’ll additionally wish to take into account the pay now vs. pay later tax influence of your alternative. Numerous components and assumptions (like future tax charges) go into these calculations, but it surely’s price attempting to determine which path will prevent probably the most in taxes over your lifetime.

There’s no easy one-size-fits-all reply for this, so it makes probably the most sense to debate this with a financial advisor or tax professional. They’ll have superior modeling packages that may assist you see the totally different tax implications of sticking with a standard 401(ok) or switching to a Roth account. (And if you happen to’re serious about working with a monetary advisor, this tool can help you match with one.)

What Is a Roth 401(ok)?

Extra employers than ever are providing Roth 401(ok) plans as a part of their advantages packages. These hybrid accounts mix options of traditional 401(k) plans and Roth IRAs, providing you with a office retirement choice with particular tax-free development options. Nonetheless, these plans haven’t fairly caught on but. A lot of the cash in worker retirement accounts sits in conventional 401(ok)s, largely as a result of folks usually desire the “pay much less tax proper now” mannequin.

In contrast to a daily 401(ok), contributions to a Roth 401(ok) gained’t decrease your present tax invoice. These contributions are made with after-tax {dollars}, so that you pay taxes upfront in trade for an enormous profit down the highway. The trade-off is tax-free development, which means if you happen to observe all the principles you gained’t should pay any tax on the earnings contained in the account once you withdraw them.

Transferring all or a portion of your contributions to a Roth 401(ok) offers you larger tax range. For those who go for a hybrid strategy, a few of your cash will likely be taxable once you withdraw it (conventional), whereas some will likely be tax-free (Roth). That offers you extra flexibility with future tax planning, one other key profit. (A financial advisor might help you establish whether or not a Roth 401(ok) is best for you.)

Execs and Cons of a Roth 401(ok)

Roth 401(ok)s include advantages and disadvantages, similar to another sort of retirement account. For most individuals, the professionals outnumber the cons. However probably the most important downside – an even bigger tax invoice at the moment – may outweigh these advantages.

First, let’s take a look at the advantages of Roth 401(ok) plans:

• Tax-free earnings development (usually)

• No required minimum distributions (RMDs) from Roth 401(ok)s for folks turning 73 after Dec. 31, 2023, due to the SECURE 2.0 Act

• No earnings restrictions for contributing to a Roth 401(ok)

• Tax-free distributions on the cash you withdraw correctly out of your Roth 401(ok)

• Decrease adjusted gross income (AGI) sooner or later, which may improve your eligibility for issues like tax-free Social Safety advantages

Now for the drawbacks:

Right here’s one tough function that might go both method: Matching contributions for Roth 401(ok)s have traditionally been made on a pre-tax foundation. In that case, you don’t pay any present earnings taxes on the match, however you’d be taxed on that cash and any earnings once you withdraw it sooner or later. Nonetheless, SECURE 2.0 Act offers employers a brand new choice to put these matching contributions into the Roth 401(ok) account, simplifying funds for his or her workers. Test together with your employer to see how they deal with Roth 401(ok) matches. (And if you happen to need assistance planning for retirement, this instrument might help you match with a financial advisor.)

Roth 401(ok) vs. Conventional 401(ok)

Now that you just perceive the professionals and cons of Roth 401(ok)s, let’s take a look at how they evaluate to conventional 401(ok) accounts.

The primary distinction between the 2 is tax timing. With a standard 401(ok) plan, you contribute pre-tax {dollars} so the cash you set in doesn’t depend as taxable earnings now. You’ll pay earnings taxes once you take the cash out. With a Roth 401(ok), you contribute post-tax {dollars} and the cash you set in counts as present taxable earnings. Whenever you withdraw these contributions and their associated earnings, they gained’t be included in your earnings and also you gained’t pay tax on them (if the cash is withdrawn correctly).

Early withdrawals are additionally handled in a different way. With a standard 401(ok), distributions taken earlier than age 59 ½ might set off 10% early withdrawal penalties on the complete quantity. With a Roth 401(ok), withdrawals are pro-rated to incorporate contributions and earnings, and that 10% penalty will get utilized solely to the earnings portion.

One other necessary distinction: RMDs. Each sorts require RMDs proper now, however that’s about to vary. You will need to take RMDs from conventional 401(ok) accounts when you attain age 73. However beginning in 2024, folks turning 73 after Dec. 31, 2023, won’t should take RMDs from Roth 401(ok)s. (And if you happen to need assistance planning for RMDs, consider working with a financial advisor.)

Roth 401(ok) vs. Roth IRA

Whereas they share some necessary similarities, Roth IRAs and Roth 401(ok)s have some equally necessary variations.

Roth IRAs have strict earnings limits, which stop many individuals from contributing. For 2023, people who earn greater than $153,000 or {couples} incomes greater than $228,000 can’t contribute to Roth IRAs. Anybody can contribute to a Roth 401(ok) no matter earnings.

Roth IRAs even have considerably decrease contribution limits. The maximum contribution for 2023 is simply $6,500 or $7,500 if you happen to’re 50 or older. The maximum contribution for a Roth 401(k) is $22,500 or $30,000 if you happen to’re 50 or older. Plus, Roth 401(ok)s have the potential for employer matches which aren’t accessible for Roth IRAs. (And if you happen to need assistance choosing between retirement accounts, consider speaking with a financial advisor.)

Subsequent Steps

There’s rather a lot to contemplate when selecting between conventional and Roth 401(ok) accounts. To make the absolute best resolution primarily based in your distinctive monetary scenario, discuss to your monetary advisor or tax skilled.

Suggestions for Discovering a Monetary Advisor

• When you have questions particular to your gifting and tax scenario, a monetary advisor might help. Discovering a financial advisor doesn’t should be exhausting. SmartAsset’s free tool matches you with as much as three vetted monetary advisors who serve your space, and you may interview your advisor matches for free of charge to resolve which one is best for you. For those who’re prepared to search out an advisor who might help you obtain your monetary targets, get started now.

• Think about a couple of advisors earlier than deciding on one. It’s necessary to ensure you discover somebody you belief to handle your cash. As you take into account your choices, these are the questions you should ask an advisor to make sure you make the best alternative.

Michele Cagan, CPA, is a SmartAsset monetary planning columnist and solutions reader questions on private finance and tax subjects. Acquired a query you’d like answered? E-mail [email protected] and your query could also be answered in a future column.

Please notice that Michele isn’t a participant within the SmartAdvisor Match platform, and he or she has been compensated for this text.

Photograph credit score: ©iStock.com/courtneyk, ©iStock.com/designer491

The put up Ask an Advisor: We’re in Our Mid-50s and Have $2 Million in Our 401(k)s. Should We Pivot to Roth Contributions? appeared first on SmartAsset Blog.