For retirees, the allure of “tax-free” income is undeniably appealing. However, traditional 401(k) accounts, often the primary retirement savings vehicle, come with the burden of income taxes when you start withdrawing.
The good news is that you can create a reservoir of tax-free retirement income, even while you’re still working, thanks to the Roth 401(k). This article sheds light on maximizing your tax-free savings potential, especially if you’re a high-income earner.
Embrace the Roth 401(k):
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- Roth 401(k) plans offer a unique advantage: you pay taxes upfront on your contributions, enjoy tax-free growth, and make tax-free withdrawals in retirement, given certain conditions are met.
- In 2018, nearly 85 percent of surveyed employers offered Roth 401(k) accounts, making them increasingly accessible.
Contribution Limits and No Income Ceiling:
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- Roth 401(k) plans are a boon for high-income earners because they don’t impose income restrictions like Roth IRAs.
- You can contribute more annually to a Roth 401(k) compared to a Roth IRA, with total contributions of $19,000 in 2019 (plus $6,000 catch-up contributions for those aged 50 and over).
Consider an In-Plan Conversion:
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- If your workplace offers a Roth 401(k), consider transferring some of your traditional 401(k) savings to the Roth through an in-plan Roth conversion.
- Keep in mind that amounts converted from pre-tax to after-tax are included in your income and subject to taxes.
- Consult with a financial advisor or accountant to strategize this conversion and prevent a sudden tax spike.
Know Your Plan’s Rules:
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- Even if you’ve left your employer, you may have funds in both traditional and Roth 401(k) accounts.
- Some retirement plans permit an in-plan conversion of your existing savings, allowing you to reap the benefits of a Roth account.
- Ensure that your retirement plan document allows for this conversion.
- Note that you can’t make after-tax contributions from an external bank account directly; plans typically do not facilitate such one-off contributions.
Roth 401(k) plans are a powerful tool to create tax-free retirement income, particularly for high-income earners. By contributing after-tax dollars, you can enjoy tax-free compounding over time and a more flexible retirement income strategy. To make the most of your Roth 401(k), consider in-plan conversions and be mindful of your plan’s rules. With careful planning and expert guidance, you can secure a brighter financial future and relish the prospect of tax-free income in retirement.
