Financial adviser shares advice for getting the most out of a 401(k)
COLUMBIA, Mo. (KMIZ)
Many employers offer a traditional 401(k) and a Roth 401(k) option, but how does someone know which one to choose?
WR Tax Planners Wealth and Tax Adviser Paden Squires said no blanket advice works for every person, but there are some things people can consider.
"A lot of it really comes down to your personal situation of which is the best path to take," Squires said.
The difference between the pre-tax and Roth 401(k) options shows up when employees pay taxes on the money they put into the account. Money in both accounts will still sit and grow, tax-free.
In a pre-tax 401(k), the employee will not pay taxes on the money now but will pay taxes when the money is taken out.
In a Roth 401(k), the employee will pay taxes on the money now but will not pay taxes when the money is taken out.
Squires said it's also important to note the pre-tax option has a minimum distribution age, which changes, that will require the contributer to start taking money out once they hit a certain age. However, a Roth does not.
Squires said people should consider their current tax situation. Generally, if someone is making less money now than they expect to down the road, it makes sense to contribute to a Roth 401(k) and pay taxes now while they're in a lower tax bracket.
At the same time, if someone is in a high tax bracket now and thinks they'll be in a lower tax bracket later after they quit their job, it generally makes sense to contribute to a pre-tax 401(k).
"You're trying to make a judgment on what your future situation is going to be like, what future tax rates are going to be like, so it's a bit of a guessing game, to a degree, but it's just making sure you manage that," Squires said.
When in doubt, he said people can contribute to both.
"That's advice I give to people from time to time where it's like, 'Hey, we don't necessarily know what the future is going to be like, what tax rates are going to be like and maybe we put money in a little bit of both buckets so we have some flexibility later on down the road,'" Squires said.
There's no penalty for changing any preferences, either.
Squires also said people need to take advantage of their company match. Most employers match up to a certain percentage of what employees put into their 401(k).
For example, he said an employer might match up to 3% as long as the employee puts 3% in their account. So, he would advise people to put in the 3% because it is a 100% return on their money.
"We're definitely advising clients to take advantage of that match in most situations because it's just like an automatic doubling of your savings that doesn't cost you anything," Squires said.
This match only goes into a pre-tax account no matter if an employee contributes to a pre-tax or Roth 401(k).
To figure out what retirement options are available and what company match is offered, Squires said people will need to consult with their human resources department.
"It should be a matter of just adjusting the percentages you want withheld into which type of accounts," Squires said. "Every employer is going to have probably a little different options."
He said if an employer doesn't have good investments, it might make sense for an employee to only contribute what their company will match and then put their money somewhere else like an Individual Retirement Account, or IRA.
When it comes to changing jobs, he said an employer might be forced to take the money out of their 401(k) or roll it into an IRA.
He said taking money out of a 401(k) is usually not a good idea because it all becomes income, meaning a large tax bill for the employee. It also likely includes a penalty for pulling the money out before retirement age.
Rolling the money into an IRA, however, would not be taxable as the employee would be going from one pre-tax account to another. He said an IRA is the same thing as a 401(k) but it is now just in that individual's account instead of the employer, also giving that person more access to other investments.
