As an employer, you recognize that choosing a retirement plan for your employees is a pivotal step in securing their financial well-being. One of the key decisions they‘ll face on this journey is choosing between a Roth and a traditional pretax 401(k). We understand that making this choice can be challenging, so we’re breaking it down for you to equip your employees to make decisions that impact their unique circumstances.
Helping Employees Understand the Core Difference:
At the heart of the Roth vs. traditional 401(k) decision lies the timing of taxes on contributions and withdrawals. In a traditional 401(k), pre-tax contributions are made, which reduce taxable income today. However, taxes are due when the funds are withdrawn in retirement. On the other hand, a Roth 401(k) involves after-tax contributions, meaning taxes are paid upfront. The benefit here is that withdrawals in retirement, including any investment gains, are typically tax-free. The choice between the two hinges on each individual’s current and future tax situation, as well as their financial goals.
When Roth Contributions Shine: An Explanation for Employees
- Business Income Streams: Roth withdrawals can be advantageous if other income sources during retirement are anticipated. Unlike traditional IRA or 401(k) withdrawals, Roth withdrawals generally don’t affect your Social Security taxation or Medicare premiums.
- Avoiding Mandatory Withdrawals: Some retirees prefer to avoid mandatory withdrawals in retirement, known as Required Minimum Distributions (RMDs). Roth IRAs and Roth 401(K) balances do not mandate RMDs during the original account holder’s lifetime, allowing your investments to continue growing undisturbed.
- Tax Diversification: A desire to diversify your tax exposure in retirement can be a compelling reason to choose a Roth account. Maintaining a mix of tax-deferred (e.g., traditional 401(k)) and tax-free (e.g., Roth) accounts offers flexibility in managing your tax liability during retirement.
- Estate Planning: If you intend to leave a tax-free inheritance for your heirs, Roth accounts can serve as a powerful estate planning tool. They can be passed on to heirs tax-free, providing a valuable financial legacy.
Pro-Tip: If you’re already contributing to Roth deferrals, consider establishing a Roth IRA now to initiate your five-year holding period. When you eventually leave your company, you can transfer your Roth 401(k) account into your Roth IRA account without needing to restart the five-year holding period. Remember, the holding period of the Roth IRA governs when rolling balances from a 401(k) plan.
Create Custom Plan Options for Your Team
Choosing between Roth and traditional retirement accounts necessitates a careful examination of their unique financial situation, tax bracket, and retirement aspirations. Many individuals opt for a combination of both account types to hedge against future tax uncertainties. However, it’s essential to note that your employer contributions are made on a pretax basis and will be taxable when received in retirement.
If you’re still uncertain about explaining retirement benefits to your employees, we encourage you to also talk with your plan’s investment advisor. Our team is committed to collaborating with your investment advisor to assist you with navigating the intricate landscape of retirement planning.
Roth vs. traditional 401(k) decision is a significant one, but it doesn’t have to be intimidating. With careful consideration and the guidance of your experts, you can confidently pave the path to a secure and prosperous retirement plan for your employees.
By Paul McEwan (New Philadelphia Office)