The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: aprilm on October 23, 2017, 01:17:03 PM
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I received an email from my employer that I'm about to reach the $18k threshold in my 401k. Unfortunately, I didn't realize that the contributions I make to the Roth through my employer count towards the $18k contribution limit, so does that mean I've missed out on the tax deferral benefits for contributions I made to the Roth? YTD, I've contributed $14k to the "traditional" 401k and $3500 to the Roth 401k.
Can I contribute a full $5500 to a separate Roth IRA?
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a 401k and a IRA are totally separate accounts. a 401k has an $18k yearly limit and an IRA has a $5500 yearly limit.
A 401k is special because within it you can have a traditional portion and a roth portion, if you so choose. Sounds like you have both these two sections within your 401k "bucket". The $18k limit applies to the entire 401k bucket, so both your $14k and $3.5k apply to the $18k limit. Yes, the portion you allocated as roth will miss out on the tax deferred growth, but roth money is still tax advantaged, you just paid the tax now instead of later.
You can open a separate roth IRA (or traditional IRA if you meet the requirements) and contribute $5500.
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Thanks for the explanation.
After thinking about it, I don't really understand the benefits of a Roth 401k...
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The government benefits from the Roth 401k because it causes people to pay more taxes today. Most folks, especially aspiring early retirees, are better served by maxing their traditional 401k first (normally $18k) then separately maxing their Roth IRA with after tax money (normally $5.5k).
Can you recharacterize your Roth 401k contributions to traditional 401k contributions?
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Thanks for the explanation.
After thinking about it, I don't really understand the benefits of a Roth 401k...
Similar benefits as a Roth IRA...
It might be better to go traditional 401k paired with traditional IRA. It might be better to hedge and do a little of both. You might swing heavily to Roth 401k + Roth IRA. It all depends on your income and retirement plans.
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The advantage of a Roth 401k is that you can fund it up to 18K, while a Roth IRA is limited to 5.5K. Funding both as Roth means you can sock away up to 23.5K/year that will never be taxed in the future, since you pay the tax today. If your income will be rising substantially in the future, you may be prohibited from investing in a Roth IRA but you will still be able to contribute to a Roth 401k. Any employer match will be put into a t401K account, tax deferred.
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Roth = pay tax today, no tax on withdrawal
traditional = pay no tax today, pay ordinary income tax on withdrawal
If your marginal tax rate will be higher when withdrawing than it is today, it is better to go Roth. If your marginal tax rate will be lower when you're withdrawing than it is today, it is better to go Traditional.
Since this is an early retirement / frugality forum, most folks will be spending far less in retirement than they earn while working - that means we'd usually expect the marginal tax rate paid in retirement to be lower than the marginal tax rate while working - that means the standard advice is usually to go traditional. But there is some nuance to this decision - do you have a pension coming? When / how much will your social security be? Already have a large traditional balance? Age at retirement? So you've got to decide given your specific situation and plans for the future.
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OP, just wanted to offer solidarity. I made this same mistake last year. I spaced out thinking the new option for a "Roth" portion of the 401k was the equivalent of a Roth IRA, so I went along for 3/4ers of the year thinking I was going to max the 401K PLUS put another 6500 'in the Roth'.
I only figured it out when my automatic deductions stopped with several months (and several thousand in matching funds) to go.
401K ≠ IRA
:head:desk: