Roth 401kPersonal Finance
A Roth 401k program is an employer-sponsored retirement program. This program is self-directed, which means you make the choices as to which investments are made. It is also self-defined, which means you choose to enroll in the Roth and the contributions that are made automatically from your monthly paycheck. You also choose when you begin withdrawing money from the plan, but within a specific financial range. Roth 401k plans are funded with after-tax dollars. All money will grow tax-deferred until you begin withdrawing the money in retirement, and you won’t pay taxes on the withdrawal.
Your employer’s selected Roth 401k provider will give you a range of options that you can choose as investments. Usually, your options consist of a variety of mutual funds. Your plan may allow for commonly traded investments. The money you invest in the account increases at the rate of the investments you select. This means that you directly suffer all the financial risk. If you fail to meet your goals, that is your problem. You will have to fix your failure to retire with the income you desired. This is the risk that comes with a self-directed plan.
You can only contribute to a Roth 401k plan if your employer chooses to create the option for their employees. They also must choose to maintain the plan after establishing it. Some companies allow you to contribute to the plan immediately after you begin working for them. Other companies do not allow you to contribute to a Roth 401k plan until you have been working for a certain length of time. This may be three months, six months, or more.
Roth 401k Contributions & Limitations
Contributions are limited. These limitations are from a combined form of government and the company. The US government limits the highest possible Roth 401k contribution, $17,500 as of 2013. Each year this limit adjusts with inflation, the actual maximum real contribution remains constant. Companies also set their own limit, though it is indirect and according to the government rules. American law states that all Roth 401k users must benefit equally from the Roth 401k program. High-income earners, such as executives and managers, can only contribute their maximum contributions if the lower income employees can as well. If regular workers do not use the program to its full value, the executives cannot use the program to maximum potential.
Company Offers & Matching
Some companies don’t offer plans at all. The plans are not free (or cheap) for employers. They have to pay regular expenses into your Roth 401k every month. This expense mostly derives from company “matching”. A company typically pays 50 cents per dollar of your deposits every month, up to the first six percent of pay. There are other varieties of matching plans as well. Some companies match contributions dollar for dollar up to three percent, then 50 cents per dollar for another two percent. Some offer less, some firms offer more. This system requires additional recordkeeping and payment processing. Additionally, matches to your Roth 401k must be placed in a traditional 401k account than your personal contributions, since your contributions are after taxes and company contributions are untaxed. The government will tax your matches, but it is still “free” money given to you for your retirement.
Company matching helps encourage low-income workers to use their Roth 401k or traditional 401k programs to their full benefit, which allows the executives and managers to use the program to their maximum benefit. However, multiply the costs of Roth or Traditional 401k plans over thousands of employees, and you can see this adding up to a substantial expense. Many firms choose simply not to offer 401k programs to avoid this situation.
If your firm provides a Roth 401k program with a decent matching schedule, you should take advantage of it. Matching up to 5% or 6% results in a large amount of free income. This instantly boosts your return on investment by the amount matched contributions. If the company offers alternative matching, such as company shares or specific investment, try to acquire cash matching instead. If you are forced to take company shares, diversify these by selling them off and buying more other investments. You don’t want a lot of company shares in your Roth 401k. You can only put a limited amount of money in your plan, so it is best that they are diversified.
Roth 401k Plans & Costs
Since you select your investment plan, you also select the investment plans costs. Expenses and fees that are paid to mutual funds are charged, directly or indirectly, against your Roth 401k balance. If the selected mutual funds in your plan have high expenses, your plan will deliver returns at a slower rate. You should always compare the expenses and fees within the program with those outside of your Roth 401k. You may notice that expenses for mutual funds within your Roth 401k are higher than investing in the same vehicles outside of your program. There are also large amounts of hidden fees that can be slipped in a plan under indirect terms. These fees are to be avoided if possible. It may be wiser to use a Roth IRA or invest in alternative methods if this is the case. These expenses sap your returns: investing all the capital, taking all the risk, and receiving 20% or 30% of the return is not a good recipe for success. If these expenses occur within the actively managed funds, look at index funds accessible in your Roth 401k, and compare the cost of investment outside of the program.
Roth 401k Catch-up Contributions
At a certain age, you can also begin contributing more money into your Roth or Traditional 401k. These are known as catch-up contributions, and they occur at ages 50 or over. An employer is not responsible for providing catch-up contributions but may choose to do so. If it provides these contributions it has to extend the opportunity to all people within the company. These offerings are capped as well. As of 2013, the limit is $5,500, increasing with the cost of living.
Your contributions should be kept in line with your personal financial situation. If you have debts, you should pay them down while making reduced deposits. As your debts decrease you can raise your payments. Your debts will grow if you make full contributions instead of paying them off.
Between Ages 59 and a half, and age 70 and a half, you can begin optionally withdrawing money. At age 70 and a half, you will be forced to begin withdrawals or pay a tax penalty. If you are still working at 70 and a half you can delay payments from your 401k, but you will otherwise be charged a tax penalty. This law forces you to withdraw money from your 401k so the IRS can acquire their deferred taxes. The money is taxed as ordinary income.
Job Change & Roth 401k Rollovers
Most workers will leave their firm before they retire. Job changes are frequent, and plans are mobile as well. A Roth 401k plan can be transferred to another firm in a process called a “roll-over”, which occurs tax-free. Some companies let you continue to hold their plans after you have left their firm, but they won’t allow you to add more funds. Any funds that you add they would have to match and they are not likely to match a former employee. The government also allows you to change Roth 401k funds into a Roth IRA fund. If you wish to continue contributing to the fund without rolling it over, this is a solution. You should note that the annual contribution limit for a Roth IRA is substantially less than a Roth 401k. The Roth IRA limit in 2013 is $5,500 a year with catch-up contributions of $1,000. The Roth 401k limit is $17,500 a year with a catch-up contribution of $5,500 if over 50 years of age. There is one benefit of a rollover: Roth 401k owners are required to make withdrawal distributions at 70½ years of age. Roth IRA owners are never required to take distributions while alive.
Death & Beneficiary
You might die before your fund is empty. In this case, your Roth 401k will be inherited by your beneficiary. Note that your beneficiary is not designated by your will. You must entitle your beneficiary in the Roth 401k’s selection forms. No other document will impact who receives your funds in the case of your death. If you want to change who inherits your fund, you must update the beneficiary.
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