How A Roth 401(k) Can Trick You Into Having More Saved For Retirement

New research challenges the retirement rules of thumb

New research shows that Roth 401(k)s may help people save more for retirement — by accident.

A recent study from Harvard Business School looked at companies that had added a Roth 401(k) in addition to a traditional 401(k) option to their benefits menus between 2006 and 2010. The upside of a Roth 401(k) is that it allows people to pay taxes upfront, with no taxes owed when you pull the money out at retirement. The downside? You don’t get a tax deduction at the time you make your contribution.

The surprising result? Being taxed today or down the road doesn’t seem to change the amount people are saving. But going with the Roth can mean significantly more money in your pocket over the long term.

John Beshears, a behavioral economist and the study’s lead author, offers an example in The Wall Street Journal: If you were to save $5,000 a year in a 401(k) that earns 5 percent annually for 40 years, you’d retire with over $600,000. If it’s in a Roth, every penny is yours. If it’s in a traditional, you’ll owe taxes on the balance. At a 20 percent tax rate, that balance comes out to $480,000 — a big difference.

(Note: If you don’t have a 401(k) at all but opted for a Roth IRA instead of a traditional one, this research likely means more money in your pocket down the road as well.)

Here’s how you can use the findings to boost your retirement balance.

Challenge Your Current Retirement Plan

If anything, use this research as a reminder to really think through your retirement savings goals and the current plan you have in place to achieve them. “From my experience, most people don’t even understand the basics,” says 401(k) and financial expert Mike Alfred, CEO of Brightscope. “They rely on their colleagues or coworkers or financial advisors.”

Andrew Choi, Yale economist and co-author of the study, agrees. “People will put away 10 percent of their income, but they have no idea what that will translate into [in retirement].” So instead of relying on rules of thumb about how much you should be socking away, he recommends taking a more personalized approach by calculating how much money you think you’ll need in retirement, then working backwards to figure out how much you should save per year. A retirement calculator can get you started.

Is A Roth The Right Option?

As with most personal finance questions, the answer is: It depends. If you expect your income tax rate to be higher in retirement than it is today, then the Roth 401(k) will save you money on taxes down the road. If you expect your tax rate to be lower, a traditional 401(k) is the way to go. If you’re on the fence, consider splitting your contributions between the two accounts. Yes, you can generally do that if both are offered. (This year, you can contribute up to $18,000 to a Roth 401(k), a traditional 401(k) or both. Over 50? Make that $24,000.)

Roth or Regular: Maintenance Required

You need to tend to your 401(k) to get the most out of your investment – and unfortunately many people don’t. This means grabbing any matching dollars on the table, bumping up the amount you’re contributing each year until you’re at a level that will sustain you in retirement (which generally means maxing out), and rebalancing annually to realign your investment mix with your age and risk tolerance. The need for the latter is driven by the fact that if the market goes up (as it has been lately), you could wind up with a greater percentage of your assets in stocks than you intended and, as a result, be taking more risk than you thought. If you don’t want to rebalance (or know from past experience you’re unlikely to), opt for a target-date fund, which will take a riskier stance (more stocks, fewer bonds) when you are younger and become more conservative as you approach retirement.

With Ellie Schroeder

Jean Chatzky

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