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Everything You Need to Know About the Roth 401k and Its Advantages

The Roth 401k is an incredibly powerful retirement vehicle if you have access to it.

And if you don’t understand what it is or how it works, that’s why you have us!

Today we’ll talk about everything you need to know about the Roth 401k.

Some topics we’ll cover in this article include:

  • How the Roth 401k works.

  • Contributing to the Roth 401k.

  • Roth 401k income limits and other Roth 401k rules.

  • Roth 401k or 401k which one is better?

  • How to open a Roth 401k.

After reading this article, you’ll be confident in what steps to take next regarding your Roth 401k. So, buckle up and let’s get started! You may learn something that will change the course of your financial life forever.

Roth 401k - How Exactly Does it Work?

The Roth 401k is similar to a 401k because they are both sponsored by your employer.

But unlike the 401k, the Roth 401k allows employers to make after-tax dollars.

Why might this be better than a 401k which only allows pre-tax dollars?

Well, the idea is that your 401k earnings are subject to taxes when you retire. While your Roth 401k would not be subject to taxes in retirement because you paid your taxes when you made your contributions.

Confused? That’s okay!

To put give you a better understanding, here’s a little breakdown of the difference between the Roth 401k and the regular 401k.

  • Roth 401k: Post-tax contributions and tax-free withdrawals in retirement

  • Traditional 401k: Pre-tax contributions and taxed withdrawals in retirement

Essentially, the Roth 401k allows you to take care of your taxes today so you don't have to worry about it in retirement.

Roth 401k Income Limits, Rules, and Contributions Limits

Roth 401k income limits

Another awesome thing about the 401k is that there are no income requirements.

For example, the Roth IRA does not allow you to make contributions if you make over $140,000 (in 2021). Depending on your situation, this may make the Roth 401k more appealing to you compared to its not-as-cool Roth IRA brother.

An investor is allowed to contribute to a Roth 401k no matter his or her income.

Bonus tip: You can contribute to both a Roth IRA and a Roth 401k if this strategy fits your goals.

Roth 401k contribution limits

But, just like the Roth IRA, there are contribution limits to the Roth 401k.

The contribution limit for a Roth 401k in 2021 is $19,500 for the year. And $20,500 for 2022.

And if you’re over the age of 50, you can contribute an extra $6,500.

If you’re deciding between different retirement vehicles, then the Roth 401k beats the Roth IRA in this battle. The Roth IRA currently allows you to contribute $6,000 per year (and $7,000 if you’re over age 50).

At the end of the day, if you’re choosing between different retirement vehicles, you’re going to choose what’s best for your situation.

A general tip is that you may not know what tax rates and legislation to expect in the future. So it may be wisest to choose a tax vehicle that takes care of taxes today like the Roth 401k or Roth IRA.

Employer match

Just like the 401k, your employer can offer to match your contributions. So if you put in a dollar into your Roth 401k, then your employer may contribute a dollar as well.

It's also important to remember that your employer matches do not have the same tax benefits as your contributions that we’ve been talking about.

Your employer contributions into your Roth 401k are pre-taxed. Which means they will be taxed upon your withdrawal in retirement.

How to Open a Roth 401k

Not all employers offer a Roth 401k. If you’re an employee, you’ll need to ask your HR department what type of retirement plan your employer offers.

You can often either give them a phone call or send an email to find out.

From there, your employer or HR department should be able to guide you on what steps you need to take to begin your contributions.

Then you’ll need to understand what to contribute to and begin your contributions!

And if you’re wondering what you should contribute your Roth 401k in, don’t worry.

We’ll go over that together too.

Contributing to a Roth 401k

Roth 401ks and 401ks typically offer limited investment options for your contributions. So you’ll have to choose something that’s available to you.

Typically only mutual funds and index funds are offered as investment choices by your employer. But this also means you won’t be overwhelmed with investment choices. And these investments are designed specifically for retirement portfolios.

One thing you’ll want to look out for is the different expense ratios on each investment option.

For example, Vanguard index funds have about a 0.04% expense ratio. While you might find other index fund options with expense ratios as high as 0.3%.

Needless to say, these expense fees can eat away at your earnings over time. So you might want to keep an eye out for them.

What Now?

Okay, you understand the Roth 401k. We went over everything you need to know including Roth 401k limits, how to start a Roth 401k, contributing to a Roth 401k, and more.

As an investor, you understand that every dollar has so much potential if used correctly. And the Roth 401k can be a powerful tool for you when you’re deciding where to put your money.

The Roth 401k only came out in 2006 and has become a popular option among employers and employees. There are even reports that the U.S. government prefers the Roth 401k over the traditional 401k since you pay taxes upfront rather than later.

Now that you’ve got a good grip on everything, you can ask your employer if they offer a Roth 401k. In some cases, you may even be able to convince your employer to begin a Roth 401k for you and your fellow employees if they don’t offer one already.

We hope you learned something today and got the information you were looking for.

If you’d like to learn more about other retirement vehicles, please check out our other article, Different Retirement Account IRAs and Pros and Cons.

That’s it for now. Stay tuned for our next article. And sign up for our email list so you can get updated whenever we post educational content!

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