I am loving connecting with thousands of you via Twitter (come join the fun: click here).
But what I am not loving is my growing sense that a lot of you are getting lousy financial advice. Today I exchanged tweets with someone who has bad info on how Roth 401(k)s work. Roth 401(k)s are a fantastic way to save for retirement, but they do not work exactly the same as a Roth IRA.
Quick Recap of Why I love Roth IRAs.
Anyone who’s been listening to me knows all about the fabulous Roth IRA. With a Roth you forego an initial tax break on the money you contribute; that is you invest with after-tax dollars. So what’s so alluring? The fact that when you go to make withdrawals in retirement you will not owe one penny of income tax assuming you are at least 59 1/2 and have had the IRA for at least five years. That’s a lot different than a traditional IRA; every penny you withdraw in retirement is taxed at your ordinary income tax rate. And as I have told you many times, a Roth IRA can also be a useful emergency fund; the money you contribute (but not the earnings) can be withdrawn at any time without any tax or penalty regardless of your age or how long the money has been in there. That’s because you invested after-tax money. While I want everyone to keep retirement money invested for retirement, the fact that the Roth IRA gives you some flexibility for emergencies is another nice feature.
Enter the Roth 401(k).
While the Roth IRA became available in 1998 it wasn’t until 2006 that the Roth 401(k) arrived on the scene. Not every company offers a Roth, but if your employer does, I think they deserve a serious look-see. Just like a Roth IRA, with a Roth 401(k) you invest after-tax money, so there’s no initial tax break on your contribution. But you get the same eventual payoff: in retirement if you have had the account at least five years and you are at least 59.5 all withdrawals from a Roth 401(k) are 100 percent tax free. Meanwhile, withdrawals you make from a Traditional 401(k) will always be taxed at your ordinary income tax rate. Imagine what that could be given our current deficits.