In today’s tax environment – namely, a relatively low tax rate today with the perhaps-inevitable prospect of higher tax rates in the future – many people are looking to the Roth IRA as a way to hedge their tax bets. With the Roth IRA, you pay your tax upfront on contributions to the account, and withdraw them tax-free during retirement.
You may want to investigate another lesser-known option available in many 401(k) plans called the Roth 401(k). Stuart Robertson of Forbes describes the Roth 401(k) as a Big Brother to the Roth IRA, saying the 401(k) version of the Roth is bigger and stronger in many ways than the IRA version. You can choose to put some, none or all of your contributions after-tax into your Roth 401(k) savings up to $16,500 a year in 2011, or $22,000 if you are 50 years of age or older. The Roth IRA maximum amounts are much lower: $5,000 and $6,000 if 50 or over respectively.
Additionally, the Roth 401(k) has no income limits. Unlike the Roth IRA, anyone can have a Roth 401(k), if their employer offers it. To invest in a Roth IRA and make the maximum contribution, your modified adjusted gross income must be below $107,000 if you are single, $169,000 if you are married filing jointly.
If your company does not offer a Roth option in your 401(k) plan, Robertson says you should request it. Typically, this requires an amendment to the plan, and only a minor cost to the business owner.
It’s anyone’s guess what tax rates will look like in the future, but if you believe they are only headed upward, then a Roth 401(k) may be a good way to hedge your tax bet.