Retiring on social security alone is a pretty big mistake. The average monthly benefit today is $ 1,657 (this represents the 5.9% cost-of-living adjustment for 2022). All in all, it’s just under $ 20,000 a year.
Even if you’re willing to live sparingly as a senior, you might need a lot more money than that to get the most out of your retirement. You will therefore need to systematically finance a savings plan to ensure you have additional cash to use in addition to social security.
When it comes to saving for retirement, it often pays to participate in a 401 (k) plan if one exists for you. This is because the 401 (k) comes with generous annual contribution limits. And many of the employers who sponsor these plans offer corresponding incentives to get started. For you, that means free retirement money.
But while many workers choose to put their savings into a traditional 401 (k), there is another option you might want to consider – a Roth 401 (k). While not all 401 (k) come with a Roth, the percentage of 401 (k) offering one has risen to 86% in 2020, from 75% in 2019 according to the Plan Sponsor Council of America. And the fact that more 401 (k) are offering a Roth is definitely a good thing.
The advantages of a Roth 401 (k)
With a traditional 401 (k), the money you pay goes in before tax, so you get immediate tax relief. From there, your money grows tax-deferred, and withdrawals during retirement are taxable.
Roth 401 (k) work in reverse. You don’t get immediate tax relief on your contributions when you fund a Roth 401 (k). But the gains from investing in your Roth 401 (k) are tax-free, and withdrawals are tax-free during retirement.
It is the latter that could really come in handy. Once you switch to a fixed income, money could get tight. And so not having to pay part of your income to the IRS could really make retirement less stressful from a financial perspective.
Once you turn 72, you will also need to withdraw the Minimum Required Distributions, or RMD, from your savings. The only way to get out of RMD is to open a Roth IRA. And while Roth IRAs are a great savings tool, they come with lower annual contribution limits and have no option to match with the employer.
RMDs require you to withdraw some of your savings each year, which means you can’t keep that money invested in a tax-efficient way. But if you have your savings in a Roth 401 (k), your RMD, like all withdrawals, will be tax free. And so, while these distributions may be forced, at least they won’t result in tax debt for you.
Explore your options
If you’re not sure whether your 401 (k) has a Roth savings feature, it’s worth digging into. And if your plan doesn’t, talk to your employer about introducing this option. Putting money in a Roth 401 (k) could give you a lot more financial flexibility during retirement – and get rid of stress later in life.