Now that Gen Z is in the work force, there is no secret they face a unique set of financial challenges and opportunities. One powerful tool at their disposal is the Roth 401(k), a retirement savings account that has the potential to significantly impact their financial future. If you have it, learn about it and act now. Understanding the ins and outs of what you are being offered is crucial to build long-term wealth and secure their retirement.
The Roth 401(k) offers several advantages that make it particularly appealing to workers. From tax benefits and employer matching and other features that can help young savers maximize their financial growth. If you have it, here are the basics of Roth 401(k)s, discuss their tax advantages, explain how to make the most of employer contributions. By grasping these key concepts, you’ll thank The House later for sacrificing a few minutes of your time.
Understanding the Basics of Roth 401(k)
A Roth 401(k) is an employer-sponsored retirement savings account that is funded using after-tax dollars. This means that income tax is paid immediately on the earnings that the employee deducts from each paycheck and deposits into the account. As long as certain conditions are met, such as being at least 59½ and having held the account for at least five years, withdrawals from the account are tax-free upon retirement. Yes, correct, tax free. You already paid the taxes upfront in every paycheck.
Unlike a traditional 401(k) plan, which is funded with pretax money, Roth 401(k) contributions are made with income that’s already been taxed, allowing investments to grow and be withdrawn in retirement without being taxed. Ask yourself this. In a perfect world, will you be in a higher tax bracket now or when you are almost 60? There are no income limits for a Roth 401(k), so these accounts are available to everyone, regardless of how much money someone earns.
Here is the catch:
The key difference between a Roth 401(k) and a traditional 401(k) is how they are taxed. Employee contributions to a Roth 401(k) are made with after-tax dollars, while contributions to a traditional 401(k) are made with pre-tax dollars. Regardless of the account, all employer contributions are made with pre-tax dollars. In 2024, the contribution limit for both 401(k) plans is $23,000. If you are age 50 or older, you can make an additional $7,500 catch-up contribution, for a total maximum contribution of USD $30,500.
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Leverage your employer for:
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- Deep discounts on insurance coverage
- Their 401k match program
- Their Roth 401k
- ESPP discount
Your 9-5 has great tools for building wealth.
Why Post-Tax Matters
Now think about what was said before. The advantage to anyone contributing expects to be in a higher tax bracket in retirement, as they can avoid paying taxes on their withdrawals when their tax rates may be higher. Think about the longer time horizon until retirement, allowing investments to compound. Gains, gains, gains, without the burden of taxes.
The other huge plus is the lack of income restrictions. Unlike Roth IRAs, which have income limits that can prevent high earners from contributing, Roth 401(k)s are available to all employees, regardless of their income level. This makes the Roth 401(k) an attractive option for workers who anticipate higher earnings later in their careers. It’s important for Gen Z workers to consider their current and future tax implications when deciding between a traditional 401(k) and a Roth 401(k). While the Roth 401(k) may require paying taxes upfront, the long-term tax benefits can compound bigly.
Maximizing Employer Match
This is where people get really savvy. Employer matching contributions can significantly boost your Roth 401(k) savings. Many employers match a portion of their employees’ contributions, effectively providing free money for basically showing up. Typically, employer matching contributions are deposited into a separate, traditional 401(k) account. However, the SECURE 2.0 Act, passed in December 2022, now allows employers to make matching contributions directly into employees’ Roth 401(k)s.
Employers may offer dollar-for-dollar matching, where they match 100% of your contributions up to a certain percentage of your salary. For example, if your employer matches dollar-for-dollar up to 5% and you contribute 3%, they will match that 3%. Partial matching is another common approach, where employers match a portion of your contributions.
Strategies to Capture Full Match
To make the most of your employer’s matching contributions:
- Find out your employer’s maximum contribution by reviewing your plan documents or speaking with your HR department.
- Set your contribution percentage to ensure you receive the full match. For instance, if your employer matches 50% up to 6% of your salary, contribute at least 6% to capture the entire match.
- Understand your employer’s vesting schedule. Some companies require you to work for a certain period before you fully own the matched funds.
By contributing enough to receive the maximum employer match, you can significantly increase your retirement savings over time while also maintaining some personal liquidity. For example, an employee earning $60,000 per year who contributes 3% ($1,800) and receives a 3% employer match could see their account grow to approximately $408,826 after 30 years, assuming an 8% annual return.
To truly maximize your Roth 401(k), aim to contribute as much as possible, up to the annual IRS limits. For 2023, you can contribute up to $22,500 if you’re under 50, or $30,000 if you’re 50 or older. If you ask many, it’s more important to maximize the match rather than the IRS. There’s no extra benefit locking up your money until you’re 59.5 if you want to invest elsewhere. The overall importance is knowing the exact portion of your income and capturing your full employer match, to build a robust retirement nest egg.
Take Action Now
Don’t waste your prime not maximizing your earning potential. If you’re lucky enough to have a job, make sure you maximize every way they pay you. Your choices and sacrifices now will only benefit your financial future. It’s those who study those tax advantages, employer matching benefits, and diverse investment options that find their way financially secure. It is to truly do important to grasp these key concepts. In the end, those who start late often regret how much they would have accumulated. Don’t be a sucker. Any free money that is there is for the taking. It is up to you to know your benefits and pave your own way for a secure and comfortable retirement.
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