The Roth 401K
November 21st, 2006 by Endless Aspiration
The Roth IRA has been around for a long time. It allows you to put away up to $4k a year in a government mandated tax free investment account. You can buy stocks, bonds, mutual funds, and maybe even real estate (I’m not sure of the specifics on this but I’m still looking into it), then sell them without out having to pay capital gains taxes. It’s a great opportunity for people who have years of investing ahead of them to avoid paying a ton of taxes. The money put into the account goes in taxed, but comes out tax free.
The 401K is a similar type of gov’t supported investment account. The account is set up by your employer and allows you to put up to $15k into it a year. Instead of the money being taxed before it is put into the account (like the Roth IRA), the money is taxed when it comes out. Normally if you make $35k a year and put $5k into a 401k you will only pay taxes on $30k. This can be a great advantage, especially if it lowers your tax bracket.
Recently the Roth 401k was introduced. It’s a normal 401k in the sense that you can put up to $15k a year into it and it needs to be set up by your employer. To clarify, the IRA can be set up by anybody and does not require an employer to set it up. The Roth 401k puts taxed money into the account and it comes out tax free. This is great as long as you can afford the tax. Let’s run some numbers. If you were to put $10k into a normal 401k and get a 7% return over the next 30 years you would have $76k. At a 30% tax bracket you would have to pay almost $23k in taxes when you took that money out of the account. If you put that same $10k into a Roth 401k account at a 30% tax you would only pay $3k in taxes. This is a pretty simple example and there are some more important factors that you need to consider see Roth vs Normal 401K’s for more info.
Ed Note: Roth IRAs have been available since 1997. The amount you can contribute will increase to $5000 in 2007 and then increase along with inflation.
Individual 401
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