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Should I Contribute to a Roth 401K for Railroad Retirement Thumbnail

Should I Contribute to a Roth 401K for Railroad Retirement

Video Retirement Financial Planning


Should I put money into a 401k or a Roth 401k?

Welcome, everyone, to another edition of the Highball Advisors Railroad Retirement Whiteboard. My name's John McNamara of Highball Advisors. And today, we're going to talk about retirement planning, specifically 401ks. Two types of 401ks, most companies offer, traditional 401ks and then Roth 401ks. So, let's walk through them all, and then we'll think about how we should be thinking about which one should we put our money in.

So a traditional 401k is tax-deferred so that money doesn't get taxed. There's no income tax until you withdraw that money, most likely in retirement. And then you have the Roth 401k. Now, what that does is you pay right away with your after-tax money, but then that's it. You're done. So right now, it's basically you can either pay now or pay later is the way to think about it. So if you pay now and do a Roth 401k, it's just going to cost you more upfront.

If you have $10,000 and you're a 20% tax bracket, let's just say, just trying to keep this real simple, you got to pay your $2,000 in taxes. You invest your $8,000. And however that grows, that's it. That's it for the taxes. Now, if you're a traditional and you had $10,000, you can invest the $10,000. But when you want to take that money out for retirement, you've got to pay the ordinary income tax on it, so that's something to think about. All right, and then, obviously in retirement, tax-free income, really, really valuable stuff.

So now you have to say, okay. Well, now I'm completely confused. Should I do the 401k or the Roth 401k? Well, here we go. So if your tax rate is low right now, if you're in a low tax rate, do the Roth 401k. And especially if you say, hey, I'm just starting my career. I'm on that trajectory, on a higher up tax bracket, really great time to do that. It's kind of tough. Especially you're just starting out. You barely have any money in life. And they're like, okay, now I got to take an after-tax hit. But if you can do it, if you can discipline yourself, and it's available to do, it's great, will really pay off dividends later in the future.

Now, when not to do it is if you're in a high tax rate right now. Why pay that high tax rate, especially if you're going to be in a lower tax rate in retirement? Because that's the whole thing about it, is I'll take the tax deduction at a high rate. And then when I get into a lower rate in retirement, because I'm not earning that much. I'm playing golf four times a week or whatever you're doing in retirement. You're just not earning enough money. Then I will pay my taxes at that lower rate. So that's a no on that. So figure out what situation you are in, and then work off of that.

Now, some withdrawal rules to keep in mind with the Roth 401k. You have to hold the money for at least five years. Otherwise, there's penalties involved. I think it's a 10% penalty. And then also, which is interesting with the Roth 401k versus a normal Roth IRA is the government makes you take, if you're holding onto that Roth 401k, there's RMDs starting at 72, where they force you to take that money out of the Roth 401k. So what you can do is just at retirement, take your Roth 401k, and just roll into a Roth IRA. And then you don't have to worry about it. That's a good thing to do right away.

And then finally, when you do your planning on withdrawals. Use your Roths, especially a Roth IRA, a Roth 401k, as your last accounts that you want to withdraw from. You want to withdraw from taxable and tax-deferred, then the Roth, because that's tax-free income and that's growing, so you don't want to touch that one. So let that one grow and grow and grow tax-free. Because let's say if you need money for a vacation house, an RV, or even healthcare, you can take that money out tax-free, and won't really affect you or move you up into a higher income bracket, so that's really nice about the Roths.

So I hope you found this very useful. Reach out to me in the description section. I have a Boarding for Railroad Retirement Assessment. You can sign up for it there, especially if you're nearing retirement, understanding all these tax-free income situations very, very important to the successful railroad retirement. Subscribe to my YouTube channel, click on the notification bell to get the latest whiteboard video. And until next time, everyone, please stay safe, stay on track, and take care. So long, everybody. Bye.

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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. Highball Advisors encourages you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Highball Advisors, and all rights are reserved from Highball Advisors, and all rights are reserved.