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Truth be told, saving for retirement is about as much fun as flossing your teeth; you only do it to make life better in your golden years. Of course, it would be more appealing if there were a way to sweeten the payoff. While the Roth 401(k) option is no longer new (it has been around since 2006), it can add some serious sweetness your retirement savings if used correctly.
This feature of the traditional employer sponsored savings plan expands employees’ options for tax-free retirement income by allowing participants to designate some or all of their deferral contributions as Roth 401(k) deferrals. Traditional 401(k) deferral contributions defer tax liability on the contribution as well as the earnings until they are later withdrawn. With the new Roth 401(k) deferrals, contributions are taxed in the same year they are made, but both the savings and earnings come out tax free when withdrawn, assuming certain requirements are met.
There are additional advantages associated with designating some or all of your deferrals as Roth 401(k) deferrals. By creating a stream of tax-free income at the time of retirement, you are able to diversify your income between taxable and non-taxable thereby allowing you to better control the taxes you pay. In addition, assets held in a Roth 401(k) can be rolled over to a Roth IRA. This is particularly relevant when completing your estate planning. While your prized pair of antique cufflinks will only go to your grandson after your pass away, 401(k)’s, including Roth 401(k)’s, and traditional IRA’s require individuals age 70 ½ and older to take out a minimum amount each year. This is money that must be withdrawn and taxed, whether you need it or not. This is not so with the Roth IRA. Roth 401(k) assets rolled into a Roth IRA can continue to grow tax-free and potentially create a tax-free stream of income for your beneficiaries.