Attention, everyone holding a 401(k)! Whether you're on the verge of
retirement, or just starting to contribute to your account, the U.S.
government is recruiting you to join an elite squad of retirement plans...
The Roth 401(k)s!
Here are the terms: No signing bonus, and you have to pay your taxes up
front.
Sound like a deal? Who's ready to sign up?
The truth is, this isn't a good deal for everyone, but for some of you,
it's worth considering.
This deal came out of the fiscal cliff talks, and is expected to generate
$12.2 billion in revenue over the next 10 years. That would come from
investors moving some $48 billion in assets from their 401(k)s to a Roth
account.
Previously, only certain funds and plans were allowed to switch to a Roth
401(k), but now the gates are open to all accounts, putting some $5 trillion
in assets on the table. From Bloomberg:
"This dramatically expands the number of participants who can use
this provision," said Bob Holcomb, executive director of legislative and
regulatory affairs for JPMorgan Chase & Co.'s (JPM) retirement plan
services. "It will allow any amount to be transferred."
That $48 billion seems like an achievable number... but what you need to
consider is if a move is right for you.
First, you pay taxes
on your contributions, not your gains. That really simplifies things for you
in retirement. You know what's in your account, and what's there is yours.
You may pay a higher percentage of taxes up front, especially as your wealth
bumps you into a higher income bracket, but what you take out is tax-free.
The big wrench in that system, however, is the big chunk of change you'll
have to pay out if you're converting a large 401(k) account
to a Roth account. If you have a million-dollar account and you're taxed at
the highest income rate of 39.6%, you will have to pay $396,000 to get that
money into a Roth.
That can really deplete your investments. If you've got the cash outside
of your 401(k), that's one thing, but if you don't, you're putting a big
chunk of your retirement wealth
right into the government's coffers.
(Which is the whole point of opening the gates to Roth accounts for all
funds and plans.)
But for those of you not in the top tax bracket now, but expecting your
tax rate to be higher in retirement, this step could save you a lot of money.
Some tax experts say that if you're in the 15-25% tax brackets, and have a
while before you expect to retire, it might make sense for you to take
advantage of this new legislation.
Outside of the tax situation, however, there aren't many other reasons you
should consider a Roth 401(k) account.
If anything, you should be looking to roll over your traditional 401(k) to
a Roth IRA account. You'd be subject to the same taxation as if you were
getting into a Roth 401(k), but here's where things get really interesting.
Roth IRAs offer a number of different investment avenues not available in
your traditional 401(k)... Things like real estate, private equity, business
startups and other unconventional investments.
These asset classes are off-limits to traditional 401(k) holders. You
could buy land, or condominiums, or even tax lien certificates.
There are differences to how much you're allowed to contribute to your
401(k)s and your IRAs, to the tune of thousands... and your employer won't be
able to match your contributions.
But for some folks looking to take their investment access off of Wall
Street, and into the world of tax-free distributions, a Roth IRA is the way
to go.
Happy Investing,
Sara
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