This article was originally published on Kiplinger – https://www.kiplinger.com/
The Roth 401(k) contribution limit increased by $500 to $18,500 for 2018. Workers age 50 and older can save an extra $6,000 for retirement.
More employers are adding a Roth 401(k) option to their retirement plan, which should appeal to workers who anticipate being in a higher tax bracket in retirement.
Roth 401(k) Contribution Limits for 2018
The maximum amount workers can contribute to a Roth 401(k) for 2018 is $18,500 if they’re younger than age 50. That’s $500 higher than the 2017 Roth 401(k) contribution limit. Workers age 50 and older can add an extra $6,000 per year in “catch-up” contributions, bringing their total to $24,500. Contributions generally need to me made by the end of the calendar year.
The Roth 401(k) was created about a dozen years ago. Today, two-thirds of companies offer it to employees, according to a recent survey by the Plan Sponsor Council of America. The Roth 401(k), as the name implies, combines features of the tax-friendly Roth IRA and the traditional 401(k).
How Is a Roth 401(k) Different from a Traditional 401(k) or Roth IRA?
As with a Roth IRA, you make after-tax contributions to a Roth 401(k). This won’t lower your tax bill now, but it will provide you with income in retirement that is free from taxes. You can make withdrawals from a Roth 401(k) tax-free, and without incurring a 10% early-withdrawal penalty, once you’ve turned age 59½ and have had the account open for at least five years. (If you retire after holding a Roth 401(k) for only two years, for example, the money must sit for three more years to be fully tax-free, even if you own an older Roth 401(k) account from a previous employer that meets the five-year test.)
And as with a traditional 401(k), there are no income limitations with the Roth 401(k), making it an attractive option for high-earners whose salaries might disqualify them from contributing to an IRA. You can also sock away thousands of dollars more each year with a Roth 401(k) and traditional 401(k)s than you can with Roth IRAs. The annual contribution limit for a Roth IRA is $5,500, or $6,500 if you’re age 50 or older. You’ll be obligated to take required minimum distributions from a traditional 401(k) and Roth 401(k) once you reach age 70½.
How Much Should You Save in a Roth 401(k)?
Many employers match employees’ contributions up to a certain percentage of salary. Note that any employer contributions to a Roth 401(k) will be made pretax and will grow tax-deferred alongside your own Roth contributions. When you withdraw money, you will owe income tax on the employer match.
Melissa Brennan, a certified financial planner in Dallas, recommends that people save at least 15% of their income for retirement, including any employer match. If your employer contributes, say, 2%, then you would need to save an additional 13%.
“Every year, add another percentage point until the employee deferrals and the employer contributions reach a total of 15% of gross income,” Brennan says. So if you’re saving 3% now, bump that up to 4% next year, 5% the year after and so on.
The Roth 401(k) can help you build a sizable nest egg. For example, a 25-year-old who contributes $5,500 a year to a Roth 401(k) and has an annual return of 6% will accrue a nest egg of $902,262 at age 65. If instead he or she is in the 22% tax bracket and saves the same amount in a taxable account, assuming the same return, the balance would amount to $643,500 after 40 years.
Is a Roth 401(k) Right for You?
Stuart Ritter, a certified financial planner with T. Rowe Price, says Roth 401(k) plans are most beneficial for workers who don’t anticipate that their tax bracket will decrease in retirement. This “usually includes younger people who expect their income to increase as they get older,” Ritter says.
Brennan also recommends a Roth 401(k) for younger workers. If and when income increases substantially and their tax bracket is higher than it will likely be in retirement, it might make sense at that point to switch to pretax deferrals in a regular 401(k), she says.
(Note: If you invest in both a Roth 401(k) and a traditional 401(k), the total amount of money you can contribute to both plans can’t exceed the annual maximum for your age, either $18,500 or $24,500 for 2018. If you do exceed it, the IRS might hit you with a 6% excessive-contribution penalty.)
Roth 401(k) Retirement Savings Tips
Advice for maximizing your Roth 401(k) account:
- Max out your contributions. For each year that you’re able, aim to hit the $18,500 limit.
- Once you turn 50, add another $6,000 to that limit annually while you continue to work.
- If your employer offers to match your contributions up to a certain amount, be sure to invest at least that much in your Roth 401(k) each month. It’s free money, after all.