This Roth IRA Benefit Will Soon Apply to Roth 401(k)s

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It’s a really nice perk. 

When it comes to finding a home for your retirement savings, you have choices. You could put your money into a traditional IRA account or 401(k) plan and enjoy an immediate tax break on your contributions. Or, you could put your money into a Roth IRA or 401(k), which won’t give you tax-free contributions, but will give you tax-deferred investment gains and tax-free withdrawals during retirement.

Now, for many years, Roth IRAs held one distinct advantage over all other retirement plans — they were the only tax-advantaged account to not impose required minimum distributions, or RMDs. But starting in 2024, Roth 401(k) plans won’t force savers to take RMDs, either. And that makes the Roth 401(k) a far more appealing option.

What are RMDs?

RMDs are withdrawals you’re required to take from your retirement account on a yearly basis. They’re calculated based on your account balance and life expectancy. (Don’t worry, there are online tools you can use to figure out your RMDs.)

Failure to take an RMD this year results in a 25% penalty. So if you’re liable for a $4,000 RMD and fail to take it, you lose $1,000, just like that.

But RMDs can also be a pain for some people. In a traditional retirement plan where withdrawals are taxed, RMDs create an automatic IRS liability. And even in a Roth plan, taking RMDs could, in some cases, mean losing out on tax-advantaged growth on some of your money. So for many savers, not being forced into taking RMDs is more ideal.

The rules are changing

Currently, Roth 401(k) plans are subject to RMDs. But that’s changing next year. And that gives Roth 401(k) savers a lot more flexibility with their money.

Plus, Roth 401(k)s come with much higher annual contribution limits than Roth IRAs. This year, Roth 401(k)s max out at $22,500 for savers under age 50, and $30,000 for those 50 and over. Roth IRAs, by contrast, max out at $6,500 for savers under 50 and $7,500 for anyone 50 and older.

Granted, many people can’t afford to save more than a few hundred dollars a year in a retirement plan. So for them, those higher Roth 401(k) limits may not make much of a difference. But if you’re someone with the capacity to save a lot of money on an annual basis for retirement, and you don’t want to have to deal with RMDs down the line, then you may want to opt for a Roth 401(k).

Of course, not every employer-sponsored 401(k) offers a Roth savings option. But many of these plans do. So it may be worth seeing if your employer’s plan includes a Roth.

RMDs aside, taxes can be a major burden when you’re retired and potentially on a fixed income. Not having to pay taxes on your retirement plan withdrawals could make your senior years less financially stressful, so it pays to keep your savings in a Roth account — whether it’s an IRA or a 401(k) plan.

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