You will need income outside of Social Security if you want to enjoy a comfortable retirement. And if you have access to a 401(k) plan through work, you have a great opportunity to build yourself a nice nest egg.
The advantage of 401(k) plans is that they come with higher annual contribution limits than IRAs. Additionally, many companies that offer 401(k)s also match worker contributions to some degree. So you could, for example, get $3,000 free for retirement just by having that amount of money allocated from your own paychecks.
Another benefit of saving in a 401(k) is to protect some of your income from the IRS. Traditional 401(k) contributions are tax-exempt, and many savers benefit enormously from this tax break.
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But while your 401(k) plan may give you short-term tax relief, you shouldn’t necessarily be looking for one. Instead, you might want to look into a lesser-known 401(k) feature that won’t save you money on taxes right away, but could prove extremely useful during retirement.
Look at a Roth 401(k)
In recent years, an increasing number of 401(k) plans have adopted a Roth savings option. And if your plan offers a Roth, it might be worth taking advantage of it.
A Roth 401(k) will not give you tax relief on your contributions. Instead, you will fund your retirement plan with after-tax dollars. But when you retire, your withdrawals will belong to you tax-free. And that’s a big problem.
You could find yourself with a tighter budget in retirement than today. And wouldn’t it be helpful to not have to pay part of your income to the IRS?
Also, if you save well for retirement, you could find yourself in a higher tax bracket as a senior than you are in today. In this case, you may benefit from not having to pay taxes on the Roth 401(k) portion of your income.
Additionally, when you’re saving for retirement in a 401(k) plan, you’re eventually required to start taking the required minimum distributions, or RMDs, out of your account. With a traditional 401(k), these RMDs will create an automatic tax liability for you. But if you keep your savings in a Roth 401(k), you won’t have to worry about taxes on the money you need to withdraw from your savings.
Explore all your savings options
Many people are familiar with the Roth version of an IRA. But some don’t realize that their 401(k) plans even offer a Roth savings component. If you’re not sure if yours has one, ask.
A Roth 401(k) could give you a lot more financial flexibility later in life. It is therefore beneficial to see if this option exists in your employer’s pension plan.
Another thing you should know is that while Roth IRAs have income limits that prevent high earners from making direct contributions, Roth 401(k)s do not have these restrictions. So you could be in a strong position to save for retirement in a Roth 401(k) and enjoy a steady stream of tax-free income later in life.
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