You have probably heard many things about 401 K's and maybe even Roth IRA's. The chances are good that you are not so familiar with the Roth 401k retirement investment vehicle. There are a number of important differences between Roth 401k's and traditional 401k's, as well some differences between between Roth 401k's and Roth IRA's. This newer version of retirement savings and planning is something that everyone should understand and consider taking advantage of for themselves. Let's take a closer look at the Roth 401k and the 2012 Roth 401k limits.
What is a Roth 401k?
A Roth 401K is much like its name implies. It is a combination of the more standard 401(k) with the Roth IRA. This means that it has characteristics of both types of retirement savings plans. For example, employers offer you the Roth 401k as they would a typical 401(k) plan. Yet, your contributions and those that an employer matches are made using dollars that have already been taxed upfront. This means that while you do not have the advantage of tax deduction now, your account will actually gain in value tax free for the rest of your working career. Besides this, any allowable withdrawals that you take in retirement will not have to be taxed. The only caveats to this tax free withdrawal plan are that you have to be minimally 59 and 1/2 years old and that you must hold this account for at least five years.
Who can use a Roth 401k?
Anyone is allowed to open a Roth 401k, but some individuals gain more advantage from it than others do. If you are a high income person who has not been allowed to make contributions to a Roth IRA, then you gain a substantial advantage from this Roth 401k retirement planning investment vehicle. This is primarily because no income restrictions exist with the Roth 401k.
2012 Roth 401k Limits
With 401(k)'s, you are restricted by annual contribution limits that were $16,500 in 2011 and will be $17,000 for 2012. The same is true with the Roth 401k accounts. Traditional Roth IRA contributions are limited to a more restrictive $5,000 per year for those under fifty, and to $6,000 annually for those fifty and up. So with the Roth 401k account, you are able to put away a significantly more generous annual contribution for your retirement than with Roth IRA's.
Who Would Most Effectively Choose A Roth 401k vs. A Roth IRA?
If you are in the early years of your working career, then the odds are high that your take home pay will rise in the future. With this income increase will come higher taxes both during your working years and likely in retirement. For you who are in this situation, the Roth 401K and Roth IRA's both make more sense, as you are able to save at a lower tax rate penalty now than you will be able to do in the future. The principal advantage that the Roth 401k offers versus the Roth IRA is the substantially higher contribution limit of $17,000 per year versus $5,000 per year.
There is little doubt that Roth 401k's make more sense than plain Roth IRA's. The big question for you is whether the Roth 401k is more viable than the standard 401(k). This comes down to your guess as to whether you will pay a higher tax rate when you are retired or now when you are in your earnings career.
For more information, please see the following article on the 2012 Roth 401k limits.