Roth 401k contributions are significant for ensuring your financial security in retirement. However, when deciding how much to contribute to each type of retirement investment vehicle you use, you need to understand Roth 401k limits.
Roth 401k limits depend on your age, but despite investment limits it is a great investment tool. You are able to contribute much more each year than with a traditional IRA. Your nest egg will have more purchasing power, because the withdrawal of your contributions will not be taxed. The benefits for self-employed individuals is even greater. Find out what other benefits a Roth 401k provides and why you should start investing in one today.
What Is a Roth 401k?
A Roth 401k is similar to a traditional 401k. However, contributions are not tax deductible. If you invest in a traditional 401k, your money’s growth is tax-deferred. You pay taxes on both earnings and contributions when the savings are withdrawn. There are no penalties associated with this if it occurs after age 59-and-a-half
Solo Roth 401k
An incredible 57 million United States workers are part of the gig economy. This means they are self-employed in one way or another. If you are a W-2 employee with a company that only provides you with the option for a traditional 401k, and you are also self-employed, set yourself up with a Solo or Individual Roth 401k. It will help you diversify when your taxes come out, and individual plans have much better investment opportunities than employer-provided plans.
Experts say you should invest 15% of your income annually into retirement vehicles such as the Roth 401k. If your employer matches your contributions up to five percent of your salary, you would need to invest 10% of your salary yourself to hit the 15% goal. If some of your retirement contributions are being made in IRAs, make sure you are allowed to invest in mutual funds and not just CDEs. You will enjoy a much higher rate of return, which will make living in retirement much less stressful.
Reasons to Invest
There are several reasons to invest in a Roth 401k. One is you believe you will be taxed at a higher rate in retirement, but there are many reasons besides this. Let’s discuss the benefits.
Roth IRAs have income limitations which prevent some investors from contributing. Additionally, annual contributions are capped at $5,500 per year for individuals. Roth 401ks are not limited by such restrictions.
Despite Roth 401k limits, contributing protects you from future taxes. The United States is currently in $21.4 trillion of debt, including $5.7 trillion of intra-governmental debt. This is likely to increase in the future. To mitigate this, politicians may implement tax rate increases. Some of us are not concerned by potential future tax rates because we believe we will have more income in retirement than we do now.
Let’s say you currently make between $0 and $38,700 per year now. If you are single or file your taxes as married filed separately, your federal tax rate is between 10 and 12%. If you plan on withdrawing $40,000 per year from investments in retirement, Roth 401k contributions will protect your purchasing power because their withdrawals are tax-free.
The Roth 401k is a great investing tool because it comes out of your paycheck automatically. This means you will never see it, so you cannot miss it. It is easy to say you will put $106 per week into an IRA. However, when that money is in your checking account, you may spend it on dinner and a movie with a friend or anything else that is not your IRA. This may be okay, as you have 16.5 months to make your IRA contribution for the tax year, but a Roth 401k protects you from yourself and any bad spending habits you have.
If you have trouble saving money, look for an employer with an opt-out program for 401k investments. This means a percentage of your salary is automatically put into a 401k for you unless you go through the trouble of paperwork to reduce or stop the automatic contributions. If you have never seen this money in your paycheck, chances are you will adjust your lifestyle to match your income and never miss it.
A major benefit to the Roth IRA is that when you die, your 401k investments can be transferred to your beneficiary, even when the rest of the estate is in probate for 18 months. Roth 401k limits include the inability of the beneficiary to slow down distributions after the account holder dies. On the flip side, they can speed up the withdrawals if they need money for funeral costs, lawyers, tax accountants and other professionals to help with the process of handling the estate. Another benefit is if you change jobs and you were investing in your employer’s Roth 401k, you can easily roll it into a Roth IRA with minimal paperwork or headache.
Many financial planners advise you to diversify your investments to mitigate the risk of marginal tax rates changing in either direction. To do this, save money in a Roth 401k and traditional 401k, or a Roth 401k and traditional IRA. While your employer’s human resources department is great for setting up your Roth 401k account, feel free to walk into your bank or credit union or call any mutual fund group for further investing advice. Their job is to help you. With free advice from these professionals, if you want to pay for a meeting with a financial advisor, you will be better informed and able to ask more meaningful questions.
Roth 401k Limits
Roth 401k limits change from year to year based on factors such as inflation. As of 2018, the contribution limit is set to $18,500 for people under the age of 50. However, If you are 50 years old or older, the Roth 401k limits $24,500. Individual or solo Roth 401k limits are different. If you are self employed, you are entitled to Solo Roth 401k contributions. In 2018, the limit of these contributions was 25% of your annual income or $55,000 until age 50, at which point these 401k limits are $61,000 or 25% of your income, whichever is less.
You can contribute up to 20% of your net self-employment income as an employer. This number is calculated by subtracting half of your self-employment income from your business income. This “employer contribution” can be made with pre-tax dollars to reduce your tax liability.
If you have Roth 401k investments, you are required to withdraw annually beginning in the year you turn 70-and-a-half years old. However, this is not much of a negative, because you were saving for retirement to be able to take it out eventually. Another limitation to Roth 401k investing is the 401k contribution cap applies to both traditional and Roth 401ks. This means you are limited to either $18,500 or $24,500 annually, depending on your age across all plans. If you wish to save more than this for retirement, invest more of your money into an IRA.
A Roth 401k is an excellent investing tool to ensure your financial security in retirement. Roth 401k limits are much less restrictive than Roth or traditional IRAs. It protects your purchasing power in the future because the withdrawal of your contributions is not taxed. Roth 401k limits allow you to contribute up to $18,500 per year if you are under 50, and $24,500 annually if you are 50 or older as of 2018. If you are self-employed, you can avoid these restrictions by setting up an individual Roth 401k. Contribution limits are the lower of $55,000 or 25% of your income.
You can make a tax-deductible employer contribution to your own retirement account through your business of up to 20% of your net business income. You have a much greater range of investment opportunities if you set up your own 401k or IRA. There is little paperwork, and it is really simple if you have a professional do all the paperwork for you. They can even advise you on what to invest in based on your risk tolerance and stock options, which have the lowest fees.
Talk to a financial planner if you are unsure how much to save to be financially secure in retirement. The general rule of thumb is 15% of your gross income including alimony payments, rental income, and more. Included in this 15% is any IRA or 401k contributions you make and any matching contributions made on your behalf by your employer. Do not worry too much about general rules here, though. Every dollar you save today will be worth $1,632 in 40 years, if you calculate a rate compounded monthly, with an average rate of return of 7%. The important thing is you do not live beyond your means now to ensure the security of your future.