Retire Well

Using the 'new kid on the block' to save for retirement

Using ‘the new kid on the block’ to save for retirement
Using ‘the new kid on the block’ to save for retirement

Does your company offer a Roth 401(k)?

These tax-advantaged retirement savings accounts combine many of the benefits of a traditional 401(k) plan and a Roth individual retirement account — with a few major differences, too.

While Roth 401(k) plans have been around since 2006, many companies only recently are starting to offer them as an option for employees. A 2015 analysis by benefits consulting firm Aon Hewitt found 58 percent of employers included Roth 401(k) plans in their offerings, up from just 11 percent in 2007. It also showed workers are increasingly using these accounts, and contributing to them at an average rate of 10.5 percent, three percentage points higher than contributions to traditional 401(k) counterparts.

Roth 401(k)s are still the new kid on the block. Unfortunately, not a lot of people out there understand the differences or how to use them.
René Nourse
founder of Urban Wealth Management

Despite the trend, financial advisors say there is a lot of confusion and a lack of awareness about this important retirement savings tool. (For a link to an Internal Revenue Service chart comparing 401(k) plans, Roth 401(k) plans and Roth IRAs, click here.)

"Roth 401(k)s are still the new kid on the block," said René Nourse, a certified financial planner and founder of Urban Wealth Management. "Unfortunately, not a lot of people out there understand the differences or how to use them."

Unlike a traditional 401(k), which is funded with pretax money, contributions to a Roth 401(k) are made with after-tax dollars.

Paying taxes on the money up front makes it similar to a Roth IRA, as does the fact that money in a Roth 401(k) grows tax-free and can be withdrawn for expenses in retirement tax-free, as well.

Roth 401(k) plans and traditional 401(k) plans have the same maximum contribution limit of $18,000, or $24,000 for those over the age of 50, for 2016. If your company offers both, you can split up to that amount between the two however you wish; just be sure, advised Nourse, to contribute at least enough to get your employer's match.

"You get a little more leverage from funding a Roth 401(k)," she said. "Having a tax-free bucket of money takes a lot of the unknown out of it" when it comes to your retirement income.

Whether a Roth 401(k) or traditional 401(k) is right for you really depends on your current tax situation — and the one you'll be in when you're retired.

Talk to a benefits advisor and a financial advisor. Whatever option you choose, make sure to maximize your employer contribution. Also, be disciplined about your savings, financial advisors say, increasing your contributions every year if you can.