To Roth or not to Roth? That should be your first question.

Whenever somebody asks me “so what should I do with my 401(k)?” I always have one answer for them. ROTH. No investment advice, no market-timing, just ROTH. For many people, they have never heard of the term, so let’s start with the basics. A traditional employer sponsored 401(k) Plan (or IRA) is contributed to using “pre-tax” dollars. Meaning, once your employer calculates your gross pay, the amount contributed to your 401(k) is removed before taking out any taxes.

However, with a ROTH 401(k) election (which you will have to make affirmatively), the taxes are calculated and withheld BEFORE calculating the amount to contribute to the 401(k) Plan. Let’s look at a basic example:

Let’s say I made $100 this week before taxes. I elect to have 10% withheld into my 401(k). In a traditional model, there would be $10 withheld from my check (10% x $100 = $10).

Now, let say I make an election to have 10% withheld, but instead on a ROTH basis. For my $100 check, let’s assume that 20% will be withheld in taxes. So, my employer withholds 20%, leaving me with $80.00. I’m left with $80.00…withholding 10% of the $80.00 leaves a ROTH 401(k) contribution of $8.00.

You may be saying…well wait a minute Jake…that’s $2.00 less per contribution…won’t I end up with less money?

Well…probably not. Conventional wisdom says that you will increase your savings rate as you progress in your career, and make up the vast majority of the difference (again remember, not giving official financial advice here). But here’s the real reason to suggest ROTH contributions…THEY ARE ALREADY TAXED.

Let’s move from your $100 a week paycheck to the end of your career. You’ve made a substantial amount of money, and amassed a 401(k) portfolio of $500,000.00. In a traditional setup, that entire nest egg is 100% taxable when you withdraw it. If you’ve retired and need to withdraw funds from your 401(k), you could be hit with a heavy tax burden. Without diving too deep into the weeds, at a certain point the IRS will mandate that you withdraw from your 401(k) account, and if you have been contributing on a ROTH basis the whole time, those funds will be 100% TAX FREE!!! I repeat, 100% TAX FREE. Even the earnings on those contributions will be tax free, assuming a few other regulatory conditions are met, feel free to reach out to me on what those are. Happy to share but a bit beyond the scope of the basics presented here.

One last thing to note: an employer is not required to offer the ROTH option, though most do these days. You will want to check with your HR department or 401(k) Plan Administrator to confirm the option is available.

I think the ROTH approach is great for anyone, but especially younger people. In ever-changing socio-political and economic times, we may not know where tax rates will be in the next 10-20 years. Taking care of that burden now and not having to worry about how much you will owe the government later can be a big help and provide peace of mind for those beginning on their journey to retirement savings.