Traditional vs. Roth: HALP!
These days, it’s becoming more common for employers to not only offer 401(k) options, but also offer two “buckets” so to speak, in which your money can grow. The traditional (or pretax) bucket, and the Roth bucket. Put simply, the traditional/pretax bucket receives tax-free contributions, which see tax-free growth until the day you take your money out. At that time, it’s taxed at the current tax rate.
With a Roth account, you make contributions that have already been taxed, but then as the money grows and compounds, none of the gains are taxed. (The catch: the first contribution to the Roth has to be at least five years old to be truly tax free.) So on the day you’re ready to withdraw, it’s all yours for the taking. No taxes. (Woohoo!)
So, why wouldn’t you put contributions toward the Roth? That’s a good question. Most people might find that the Roth provides greater benefits for them in the long run. However, depending on your personal situation, both buckets can provide advantages. This may be worth discussing with an retirement account representative for personal navigation. It’s also important to note that your employer’s contributions will always go into the traditional or pretax bucket, per IRS regulations.
So how much should be going into these accounts? (Asking for a friend….)
As you probably know, a good place to start is to understand how much your employer is willing to match, and if you can, contribute at least that percentage. For example, if your employer matches up to 3 percent, you should strive to contribute at least 3 percent. Some employers might match 50 percent of, say 6 Percent. So, for every whole percentage you give, your employer will match half of that up to 6 Percent (which mathematically really is 3% once you contribute 6% of your salary). If you’re not sure, ask your account representative, or HR.
Now again, if you’re like me, you might be comfortably sitting at the same percent, with your employer matching, and not thinking about it any further. But as I started to consider the balance in my 401(k), I couldn’t help but wonder … “What will my balance look like in 30-40 years? Will it be enough to retire or should I be contributing even more? How do I even know?!”
So here is where it gets real. As you get comfortable with your take-home pay, challenge yourself to increase your 401(k) contributions by 1 percent each year – it may seem small,but with all the time ahead of you until retirement, small and gradual increases will start to compound (think: snowball), and overtime, you’ll see great effects. If it’s not too scary, you might even consider putting away 10 percent and see just how impactful that could be! (But DISCLAIMER: this is where you’ll want to seek the counsel of your retirement plan account representative to determine what is best for your personal situation.)
My own account representative advised me to consider this: Use your current annual salary as a measuring tool. By the time you turn 30, do you have your current annual salary in your 401(k) account? By the time you turn 40, do you have three times your current (40-year-old) salary in your account? How about this … by the time you turn 67, do you think you could have 10 times your (then) salary in your 401(k) account?
This got me thinking (and, quite honestly, made me feel a little embarrassed.) But not to worry – if you are behind, that’s certainly no reason to brush it off or feel defeated. Remember, time is on your side! It’s simply a reference point or a goal to work toward. Even if you can get closer to where you want to be, you won’t be losing out.
I know, it might seem like retirement planning isn’t even on your radar. You’re just trying to manage your grocery bills and house payments or rent, right? But there are a lot of tools and retirement calculators out there that are easy to use, like this one. Start using them, and you might just find that you actually enjoy planning for your own retirement. Too far? OK.
And lastly, a little disclaimer (because we like those). I am not a financial advisor, so please make sure to consult with one of those amazing, qualified professionals to determine your own unique retirement plan.
Article Contributed By: Heidi Lengacher
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