Rethinking Retirement Savings: The Downsides of a Roth 401(k)

One of the most important things you can do for your retirement is save consistently for it. You should expect to need money on top of what Social Security pays you. And the larger a nest egg you bring into your senior years, the less financial stress you might have.

Now you have choices for finding a home for your retirement savings. Anyone with earned income can contribute to a traditional IRA. And based on how much you earn, a Roth IRA may be an option, too.

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If your employer offers a 401(k) plan, you may decide to sign up for the ease and convenience it offers, not to mention a workplace match. And if that 401(k) has a Roth option, that's something you may be interested in as well.

Roth 401(k)s offer a number of benefits, including tax-free gains and withdrawals. But before you get your mind set on a Roth 401(k), consider these pitfalls.

1. There's no immediate tax break

When it comes to retirement plans, the IRS won't give you the best of all worlds. You either have to pay taxes on the money you contribute or pay taxes on the money you withdraw.

With a Roth 401(k), you get the benefit of tax-free withdrawals at a time in life when money may feel tight. That's a good thing.

On the other hand, with a Roth 401(k), you're giving up your immediate tax break. And that could cause you a world of strain.

Let's say you're aiming to contribute $12,000 a year toward retirement. Without the up-front tax break, you might have to cut back on other bills or scramble to make a contribution that size work. With a traditional 401(k), you may find that meeting your goal is easier because you're getting a tax break right away.

2. You may be looking at limited investment choices

One general disadvantage of 401(k)s is that they typically don't let you hold individual stocks in your portfolio like IRAs do. That ultimately leaves you with less control over the assets you're putting your money into.

Plus, some 401(k)s truly offer limited investment choices. If the funds that are available through your employer's 401(k) charge high fees, those costs could eat away at your returns. An IRA could help solve for this if you're a hands-on investor who wants more options.

3. You may not get the full benefit, depending on your retirement tax bracket

The nice thing about a Roth 401(k) is that your money is yours to enjoy tax-free later in life. But if your tax bracket ends up being lower in retirement than during your working years, you may not get the full benefit from a Roth 401(k).

Sure, you'll still get to withdraw your money without having to pay the IRS a portion. But if you expect your tax bracket to be higher in your working years than in retirement, a traditional retirement account could make more financial sense.

All told, a Roth 401(k) could be a valuable retirement savings tool worth using. Just make sure you understand the drawbacks before choosing it as the place to put your money.

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