Roth 401(k) Plans
In 2006, an innovative retirement account was introduced. This new cutting-edge plan is a derivative of the traditional 401(k) plan we all know so well. There is one major difference that sets this new Roth 401(k) account apart from the traditional 401(k). With a Roth 401(k), the entire funding of the plan will be done with money after taxes have been paid. This does make it very similar to a Roth IRA, however, the Roth 401(k) will have contribution limits. There are no income limits placed on contributions to the account. All funds that are placed into a Roth 401(k) will continue to mature in the account without any taxes and the funds are later distributed to the account holder with no taxes. The contribution limit of the account
as of 2007 was $15,500 is $16,500 annually and $25,500 $22,000 for anyone over the age of 50.
Roth 401(k) return of investment
The Roth 401(k) plan may not be the best financial decision for all people, however, if you will be retiring and remaining in the same, or moving to a higher tax bracket, or you will be entering retirement with a margin of 10% of your current tax bracket, the Roth 401(k) plan might be the right choice for your situation.
Illustrating an example to determine when a Roth 401(k) would be beneficial. Mr. Gruber is in currently in the 40% bracket. When he retires, he will be in the 30% bracket, a reduction of 10%. In this case, the use of a Roth 401(k) would be a financially sound decision. In this illustration, Mr. Gruber is a 40 year old who is funding $16,000 into a Roth 401(k) plan. He will fund for a period of 25 years and when he enters retirement, he can take tax-free distributions when he is between the ages of 66 and 85. Since the funding that is being made is not deductible to the plan, the individual will have to pay taxes based on the funding since the funds are paid after taxes. The taxes to be paid are as follows:
- 40% bracket will require $6,400 in taxes
- 30% bracket will require $4,800 in taxes
- 15% bracket will require $2,400 in taxes
In this instance, we will presume that there is an average 7% rate of return for the course of the Roth 401(k) plan.
Traditional 401(k) Plan vs Roth 401(k) Plan
To create a matching illustration with investments to a traditional 401(k) plan, the individual will have to invest a certain amount of money that will equal the taxes that would have been saved if they were using a traditional 401(k) plan (as opposed to the investments of the Roth 401(k) plan). The money that would have been saved is as follows:
- $6,400 in tax savings in the 40% bracket
- $4,800 in tax savings in the 30% bracket
- $2,400 in tax savings in the 15% bracket
In reality, we need to consider the investment in an after-tax stock market with actual numbers. These numbers should always include the tax on capital gains as well as dividends and after the taxes are paid from the broker account. The numbers below are based on the taxes that are due on the annual growth in the account.
- 25% if in the individual is in the 40% bracket
- 20% if in the individual is in the 30% bracket
- 15% if in the individual is in the 15% bracket
What is the amount that can be received in retirement from the Roth 401(k) plan?
The return of investment of the Roth 401(k)
Between the ages of 66 to 85, the individual would receive $65,364 from the plan annually. This income received would be tax free.
In comparison, what is the amount if the individual used a traditional, taxable (upon withdrawal) 401(k)?
The return of investment of the Traditional 401(k)
- if the individual were in the 40% tax bracket, the amount would be $41,325
- if the individual were in the 30% tax bracket, the amount would be $46,348
- if in the individual were in the 15% tax bracket, the amount would be $55,045
These numbers that are provided above will have to be in addition to the extra side account. This extra account would be contributed with the extra money that would be in possession after funding a traditional 401(k) plan that is deductible. Recall the traditional 401(k) plan is made with contributions before taxes. In other words, the contributions that were made were tax deductible. From this account, the individual would then receive the following amounts when they enter retirement:
- $17,759 in the 40% bracket
- $15,591 in the 30% bracket
- $10,861 in the 15% bracket
So we now add the last two sets of numbers, based on the fact that the individual has a regular 401(k) and an extra side account:
- $59,084 if the individual is in a tax bracket of 40%
- $61,939 if the individual is in a tax bracket of 30%
- $65,906 if the individual is in a tax bracket of 15%
These numbers clearly show that the Roth 401(k) will provide more retirement income that the traditional 401(k), no matter what the tax bracket is.
If the tax brackets change in retirement for the Roth 401(k) plan
Let'ís take a look at the situation if the individual begins in a 40% bracket and then reduces to a 30% tax bracket when he retires. In this case, the client would be able to remove $66,322 annually. If the numbers dropped from 30% to 15%, the client would get $69,123. If the tax bracket went from 30% to 40%, the result would be $54,119 and if the tax bracket was 40% and went to 15%, the amount would equal $76,550.
The Roth 401(k) plan is a good choice for almost any individual as you can observe by the returns. Businesses should consider the Roth 401(k) for their employees.
Contact Estate Street Partners to discuss how we can help you in your Roth 401(k) planning. Estate Street Partners offers advanced asset protection strategies utilizing our premium Ultra Trust® irrevocable trust for transferring your assets to your beneficiaries.
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- Part 1 - Estate Street Partners
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- Part 3 - What is a Trust?
- Part 4 - Asset Protection Plan
- Part 5 - Asset Protection Eligible Assets
- Part 7 - What is Probate?
- Part 8 - What is Estate Tax?
- Part 9 - Medicaid Spend Down Rules
- Part 10 - What is the Ultra Trust®?
- Part 11 - Irrevocable Trust Benefits
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