Tuesday, January 23, 2018

My Roth 401k

I wanted to briefly describe my Roth 401k and why I chose Roth. My employer matches up to 4% of my contribution to my Roth 401k and for me that was a no brainer. Would I like to invest that additional money on my own in dividend growth stocks? Yes, but the employee match is too good to pass on. This is basically free money and I would encourage you to take the employee match.
My 401k is through Principal Financial Group and there are limited investment options. I've chosen the S&P 500 Large Cap Index Fund because I like investing in the top companies in the world. However, there are not a lot of other choices and no options for dividends or dividend reinvestment.

Now, I will never increase it past the 4% unless they increase how much they are going to match. Why? Because there are too many limitations on a 401k to begin with. 

I understand why they exist. They were created to encourage people to save for retirement and they make it hard for people to touch that money. I believe for the most part this is a good thing. However, there should be some flexibility for the rest of us. If I want to take that money out before I'm 60 then I should be able to do that without penalty. Life is unpredictable and it is a shame we have to work and save up money that we can't even touch until we are 60.

This is basically why I chose a Roth 401k instead of a regular 401k. 

Here are some key differences between a Roth 401k and a regular 401k:

Roth 401k:
1. Contributions are from post tax money (earnings grow tax free)
2. I can withdraw my contributions early without tax or penalty
3. I can withdraw my gains early with a 10% penalty fee
4. Good if you think your income in retirement will be higher than your current amount

401k:
1. Contributions are from pre tax money (allows you to deduct contributions now, but you pay tax later when you start withdrawing)
2. If you withdraw any amount early you will pay a 10% penalty and income tax depending on your bracket
3. Good if you think your income in retirement will be lower than your current tax bracket

It may be very hard for you to choose which one you want. There are a lot of unknowns in the future such as tax rates and your income. However, right now a Roth provides me with more flexibility. If I retired tomorrow I could start withdrawing my contributions from my Roth account without penalty or tax. This allows me flexibility in an early retirement. 

Although I'm not sure about my income levels in retirement at this point. I believe my income may be higher now than in retirement, but that is hard to predict. If I were to continue to invest until I'm 65 then its very possible my dividend income and any other amounts (social security, stock selling, etc.) may easily exceed my current income. Again, because of this I'm happy using a Roth which will allow me more flexibility.

Let me know what you guys think! Do you have any questions about your 401k? Which 401k did you choose and why?

2 comments:

  1. Isn’t a roth401k better anyways since the principal will be a lot less than the end of the portfolio compared to the amount of profit made regardless of your income?

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  2. Hey Justin thanks for stopping by!

    While I agree a roth 401k is better it will definitely depend on a few things.
    Your interest/profit will eventually be greater than your contributions, but that will depend on how long you have a 401k, how the market is doing, and how much you are contributing to it each year.

    Roth 401k withdrawals are never taxed if you wait until 59.5 years. That includes principal and interest/profit. Regular 401k withdrawals are taxed on principal and interest/profit.

    Again, it really comes down to how much you are making in retirement versus how much you are making now. I'm really not sure at this point, but I know that a roth 401k provides more flexibility. I may look into withdrawing early from my roth to reinvest in dividend stocks. I can do this without tax or penalty if its from the principal.

    Does that help?


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