Most of those eligible for a Roth 401(k) don't take advantage of it, because they don't understand it.
The basics A Roth 401 operates much like a Roth IRA. You contribute with after-tax money, but your withdrawals are tax-free. This differs from a traditional 401, in which you contribute with pretax dollars, but your eventual withdrawals are taxed.
One big reason? People don’t understand them. “A lot of people don’t consider themselves to be very well educated about their 401s to begin with,” says Katie Taylor, a retirement expert at Fidelity. Savers already have to work out how much to contribute to their plans, and what asset allocation to choose. Roth plans introduce yet another layer of complexity, she says.Among them: You can effectively contribute more to a Roth 401 than you can to a traditional one.
One caveat: In a Roth 401, your contributions are made with posttax dollars, but that is not the case for any money that your employer contributes as a company match. That money still goes into your retirement plan with pretax dollars, as with a traditional 401. So the money from the company match is not taxed when you receive it. But that money, and any growth, will be taxed as ordinary income when you eventually withdraw it.
That’s especially true when you factor in two things happening at the federal level. The first is the 2017 income tax cuts, which are due to expire after 2026. The second is the looming budget crisis for Social Security and Medicare, which will either lead to retirement benefit cuts or, more likely, tax rises.
For example, you could end up paying lower tax rates in retirement than while working. If that’s the case, you may wish you’d taken the tax break up front, when it was more valuable. Furthermore there is always a risk, if slight, that a future Congress could help meet the looming Social Security and Medicare crisis by taxing some Roth withdrawals, especially for bigger accounts. That would certainly be politically explosive.
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