PG’s Roth 401k. Is it right for you?

Roth 401k Savings Option

In July 2018, P&G added a Roth 401k option to their employee 401k retirement savings plan. The Savings Plan is a defined contribution plan that enables employees to defer a portion of their salary into a company sponsored retirement plan investment account.

2021 IRS Contribution Limits

The 2021 IRS elective 401k salary deferral contribution limits are $19,500 under age 50 and a “catch-up” provision for contributions up to $26,000 over age 50.

Elective contributions by employees into The Savings Plan by highly compensated employees with over 12 years of service may be limited to $14,000 annually.

Another Procter & Gamble retirement benefit is their company funded Profit-Sharing plan, the PST Plan. According to the IRS, total contributions to all defined contribution plans is limited to $58,000 in 2021.

Benefits of a 401k Plan

A 401k retirement plan allows employees to save money specifically for retirement. A traditional 401k enables pre-tax salary deferral contributions and tax deferred growth of the savings. The traditional 401k provides both a short-term benefit and a long-term benefit.

The short-term benefit is that salary contributions are usually pre-tax; meaning that your taxable income is reduced $1 for $1 by the amount of your contribution each year. For all pre-tax traditional 401k participants, and especially those in higher tax brackets, 401k contributions can help reduce income taxes.

The long-term benefit is that savings grow taxed deferred. Capital gains, interest and dividends accumulate inside the plan and are not subject to tax until a withdrawal is made.

Eligible, penalty free withdrawals by individuals over the age of 55 (if separated from service in or after age 55) from a traditional 401k or over age 59 1/2 from a rollover IRA are taxed as ordinary income. Withdrawals made prior to age 59 1/2 are subject to a 10% early withdrawal penalty unless they qualify for certain hardship exceptions (see IRS details here).

Pre-Tax Contributions Explained

For example, for tax year 2021, an employee earning $250,000 and deferring $14,000 might save as much as $3,360 in income taxes (this simplified example assumes $14,000 x 24% tax bracket in 2021, married filing jointly, not including any other income, deductions, or exemptions).

Sounds great right?  Yes, but there is a catch. Since the money is saved pre-tax, and grows tax deferred, it becomes taxable as ordinary income when it is distributed out of the 401k (or subsequent IRA if balances are rolled over after retirement). In other words, if you expect to have a high income during retirement, you may be taxed at higher tax rates on your distributions.

Post-Tax Contribution Plans

Is there another way to save for retirement? Yes. The Roth IRA or Roth 401k. Unlike a traditional 401k or traditional IRA, contributions into a Roth IRA or Roth 401k are always after-tax, and savings grows tax free. A Roth IRA can be opened by working age individuals with earned income. In 2021, annual contributions can be made up to $6,000 ($7,000 over age 50) or up to earned income whichever is lower (see more here).

Roth IRA Eligibility Limits

However, eligibility to make contributions is gradually reduced (phased out) for married couples filing jointly, beginning at $198,000 adjusted gross income (AGI) and eliminated for couples with AGI above $208,000 (these are all 2021 figures, see IRS for more details here). That’s fine if your AGI is below the phase-out threshold, but with AGI above the upper limit, you are not eligible to contribute at all.

What is a Roth 401k?

Enter the Roth 401k. A Roth 401k is a retirement benefit employers may offer employees.  Like the Roth IRA, contributions are always after-tax, and savings grows tax free. The biggest differences between the Roth IRA and the Roth 401k are the contribution eligibility thresholds and the maximum contribution limits.

In 2021, eligibility was not limited by income, and the maximum contribution worked the same as in a traditional 401k. Thus, Roth 401k participants give up the current year tax benefits of pre-tax contributions but gain the benefit of no tax liabilities on eligible distributions.

The Roth 401k may be an attractive retirement savings vehicle for higher income individuals that expect to have relatively high income during their retirement.

 

 

Disclaimer
This material is provided by Schmitt Wealth Advisers for informational purposes only.  It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product.  Opinions expressed by Schmitt Wealth Advisers are based on economic or market conditions at the time this material was written.  Economies and markets fluctuate.  Actual economic or market events may turn out differently than anticipated.  Facts presented have been obtained from publicly available sources (unless otherwise noted) and are believed to be reliable.  Schmitt Wealth Advisers, however, cannot guarantee the accuracy or completeness of such information.  Past performance may not be indicative of future results.

 

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