If you have been listening to this show for any length of time at all, you have no doubt heard me sing praise of the Roth IRA. The Roth IRA is an amazing planning tool for those individuals who qualify. Not only do you get tax deferred savings for retirement, but all of those earnings actually become tax FREE if certain requirements are met! To make the deal even sweeter, there are no Required Minimum Distributions at age 70 and a half like there are with qualified retirement plans or other types of IRAs. But maybe you are one of those individuals who is no longer eligible to contribute to a Roth IRA due to income limitations. Is there a way for you to get a piece of the tax free pie? Or perhaps you are maxing out your Roth contributions, and you feel that the Roth contribution limit ($5,000 for 2009) isn’t quite enough to provide for the retirement of your dreams. Is there a way for you to sock away more and still receive potentially tax free growth?
The answer is YES! Yes there is! The way to do this through the relatively new Roth 401k option offered by many employers. If your employer doesn’t offer a Roth 401k or 403b option, then take notes as you listen to the show and it may be worth it to schedule a meeting with the decision makers at your firm.
Before I get into all of the benefits available through a Roth 401k, you may be asking why Uncle Sam would be willing to fore go all of that potential tax revenue? The answer is because the federal government has realized that they are in trouble. As you’ve heard in previous shows, Social Security has some very serious problems right now, and it’s only going to get worse going forward. This, coupled with the near extinction of defined benefit retirement plans, has allowed the government to realize that the burden of providing income for retirees has shifted from government funded programs and employers to the employees themselves. Therefore, to encourage individuals to get excited about saving, Uncle needed to provide an enticing incentive to defer gratification into future time periods. Not having to pay taxes seems like a pretty big incentive to me!
So what’s so great about a Roth 401k? Well, let me start by telling you the one caveat: you do not get a current tax deduction (actually a decrease in taxable income) like you would through a traditional salary deferral into a regular 401k. Therefore, for individuals in the highest tax brackets and depending on retirement assumptions, there is an argument that a traditional 401k may make more sense than a Roth 401k.
Now to the exciting part. As I mentioned above, for 2009 the most you can put into a Roth IRA is $5,000 ($6,000 if you are over 50) if your Adjusted Gross Income is below $166k MFJ ($105k Single). However, if your employer offers a Roth 401k option, you can put away $16,500 ($22,000 over 50) with NO income limits! Contributions are made with after-tax dollars and the assets in the plan aren’t taxed at retirement if they are held in the plan for at least 5 years and not withdrawn before age 59 and a half. At retirement or separation of employment, the funds can be rolled into a Roth IRA for further tax free growth (also an amazing estate planning tool!) and are not subject to Required Minimum Distributions. This plan is still ERISA protected and follows the same guidelines as a traditional 401k.
Considering the current state of the economy, our budget deficit now, and projected future government spending, I feel it is safe to assume that taxes are going to go up. If we feel strongly enough that taxes will be higher in the future than they are now, it is nearly a no-brainer to pay tax now on Roth 401k contributions and then reap the tax free benefits at retirement.
Also as you listen to the show I talk about the new Visa Black Card. I’ve been getting many questions from individuals receiving this ‘exclusive offer’ for this new luxury card. I wanted to make clear that this is NOT the American Express Centurion Black Card made famous by the super wealthy, celebrities, and James Bond.
I also share some amazing listener comments from last weeks show. It never ceases to amaze me how intelligent and insightful listeners to this show are. Keep the comments coming!
Brian,
I had to take a few minutes to post a comment about the credit card portion of the show. As a matter of fact, I haven’t even listened to the main topic on ROTH 401Ks yet but I’m sure it will be good. I was just happy to hear someone else out there was as bummed as I was with Chase’s (and maybe others?) new “upgrades!!” and “improvements!!” to their rewards programs. I too am one of your so-called deadbeats and use credit cards for all the free money they’re willing to give me while never carrying a balance and paying off my statement in full. Approximately a month or so ago I received a letter from Chase informing me that I was “in store for exciting new changes to my Chase Freedom Mastercard awards program”. As I began to read the first few paragraphs, these so-called improvements quickly turned into downgrades to anyone with a 3rd grade education. When I finally got to the fine print and finished reading the entire letter, I was not only disappointed that parts of my rewards were getting completely cut out (no more 3% on gas, grocery, and drug stores or an extra $50 when I save up $200 worth which I ALWAYS did) but downright insulted that Chase actually thinks we’re dumb enough not to see right through their failed attempt to put a positive spin on an obvious downgrade. “Are you kidding me?” I believe was my initial reaction. I immediately picked up the phone and dialed Chase’s number. I was greeted by a friendly customer service rep asking what he could do for me. After expressing my displeasurement with my new “upgrades” I asked if there was an opt-out option. I told him quite sarcastically that their gracious new offer was just too much for me and I just couldn’t possibly accept. That did manage to get a chuckle out of him and he indicated that’s how the majority of the phone calls were going for the day. I asked why Chase would be so arrogant as to actually think they could fool the public into believing the changes were beneficial and he had no response. The conversation ended when I told the representative that I would be closing the account as a direct result of these recent “upgrades” and “improvements”. So if the intention of all the VPs and bigwigs at Chase was to lose customers by removing the few incentives to actually use a credit card responsibly, then they’ve succeeded. It’s very irritating and I will stick to my American Express Blue Cash (mentioned in one of your older podcasts) until they too decide to strip me of my rewards…..oops I mean improve my rewards with fascinating new opportunities!!! ~sigh~…..
~Josh
Josh & Brian,
I had the same experience with Chase. My card offers 3% back on whatever 3 categories I spend the most on each month. Not the categories they decide for me ahead of time, but whatever they happen to be that month. I don’t even have to decide. And I get 1% back on all other purchases. And like Josh, I got the extra $50 if I saved up $200 in rewards. All in all it was a pretty good deal. Then I too got the letter with the “exciting changes.” Now the extra rebates are only on gas, groceries and fast food, they are taking away the $50 bonus and want to charge me $30/year for the privilege of getting fewer rewards.
I called and asked the rep if I could stay with my current program instead of the new one. He said No, they were discontinuing the existing program. I pointed out that the new program offered me less and I was definitely NOT going to pay the $30 fee. He said he understood and noted that I was a “good customer” (even though I pay my bill in full every month) and suggested that I try the new program for a while since it was free and if it wasn’t working out , they would find one of their other cards that better met my needs.
When I read the letter from Chase, my first thought was actually, “This is exactly what the Money Guy said was going to happen.” On one hand I guess it’s good that I’m financially responsible enough to be a “bad” customer for the credit card companies and they feel the need to do this. On the other hand, the reduction of benefits and having to be penalized for the excessive risks the credit card companies took stinks.
There is absolutely no way I am going to pay a fee to use a credit card. I have a feeling that in a year things will settle down a bit and it won’t be too hard to get that fee waived. And if they won’t do that, then we can all find a company that does want our business.
QT(the gas station chain) is doing $0.49 32 oz drinks, even better than the $0.99 McDonald’s drinks!
Also, I use the Amex Blue Card for everything and am hoping that is still a good one, but will look forward to a future podcast where BP will do some research for me on some other good credit cars rewards programs
Here’s a macro 401k vs Roth 401K question:
I have always maxed out my 401K and Roth IRA contributions for as long as I have been working. Recently, my employer started offering the Roth 401K and I tried it out w/ a 50/50 split b/t my Traditional 401K & Roth 401K, but the increase in monthly taxes I paid was a little too painful in the near term for me to stomach.
I really do believe the Roth 401k is a better option than the traditional, but here’s my quandry. Today I’m back to contributing the maximum 20%to my traditional 401K. I would like to go back to the 50/50 split b/t Roth & Traditional 401K, but the pay cut I experience due to the raised taxes is still something I don’t want to endure. Would your recommend reducing my contribution from 20% so I could still get the same take home pay, but could contribute more to the Roth 401K? Love to hear some suggestions or things to consider…