Do you currently have the option to invest in your company 401k plan? If your company offers 401k investment options, then they might offer a Roth 401k option as well. Much like a Roth IRA, a Roth 401k allows you to invest your after-tax money, which then means that you can withdraw funds tax-free in retirement. When people hear about this option, they get excited and wonder, “Should I max out my Roth 401k?”
Should I Max Out My Roth 401k?
As with most financial questions, the answer to this one is, “It depends”. In the majority of situations however, I would nod my head and respond, “Yes”.
As of this date, the Roth 401(k) maximum contribution is $18,000, while the Roth IRA maximum contribution is set at $5,500. Each year, an investor is allowed to put this maximum amount into their Roth in order to enjoy investment growth and a tax free withdraw in retirement (Note: Some earn too much money to invest in a Roth, but can still perform a backdoor contribution). I have personally asked myself the question, “Should I max out my Roth 401k?” and have just recently increased my contribution to the maximum for these four reasons:
1) Taxes Will Likely Increase
The national debt is now over $18 trillion and is rising fast. There are concerns by many that our nation's debt is far too large to ever repay. Now, whether you believe that or not, I'm sure we can all agree that the debt amount is quite large and might require an income tax hike in the future. If this happens prior to your retirement years, then it would have made more sense to pay your taxes earlier, right? Exactly. Why not pay 25% today to avoid paying a 30% tax in your retirement years?
2) You Can Afford It Now
If you ask any retiree, “Do you wish that you would have paid taxes on your investments back when you were contributing?” many of them would answer with a resounding, “Yes”. The reason for this is simple. In your earning years, you'll likely have more money coming in than in your retirement, which would make it easier for you to pay the tax during those working years. In your retirement, your income will likely be pretty fixed, and ever dollar matters. Why not pay the tax when you can more easily afford it? Your future self might thank you for this.
3) You'll Never Have Too Much Money
Some people have some crazy tactics when it comes to their retirement planning. I have heard of a few people that are trying to give the government as little of their money as possible. To follow through on this, they basically plan to be destitute in retirement. They'll withdraw very little from their 401k (maybe a small enough amount to pay 0% tax), and when that's gone, they'll live off Social Security and survive on the Medicaid benefit. In my opinion, this is a terrible plan. Why on earth would you want to be broke for 25+ years of your life?? Instead, why not just pay some taxes now and get it over with? This is exactly what the Roth 401k option does for you. Take care of those tax payments now and withdraw your piles of money carefree in retirement.
4) Simple Estate Planning
Because the Roth 401k is an after-tax benefit, it becomes an excellent tool for estate planning. If you would like to will your kids some money upon your death, then why not leave them the remains of your Roth 401k? Since the tax was already paid on the money, your kids will owe no money upon the transfer of those dollars. In fact, they can inherit up to $5,000,000 from you without seeing one single dollar of that go toward taxes! With this single benefit, maxing out your Roth 401k might become completely worthwhile.
The One Reason Not to Max Out Your Roth 401k
As I stated in the first paragraph, in response to the question, “Should I max out my Roth 401k?” sometimes the answer is “no”. Why would this be the case? For me, it's the simple reason of diversification.
Within your Roth 401k, you could invest in stocks, bonds, mutual funds, index funds, and probably even some foreign markets, and you would consider yourself diversified. I, on the other hand, would not. While this diverse platter of investments is certainly better than buying a single stock and hoping for the best, I still don't consider it to be diverse enough. After all, if the stock market crashes tomorrow, do you think any part of your “diverse” purchases would rise in value? Probably not. Even the most “safe” investments will likely fall when the global market crashes.
If you barely have enough money to max out your Roth 401k, then I would suggest not doing it. It would be wiser to invest a comfortable amount in the 401k, and then investing the remainder of your money in other investment options like real estate, collectibles, precious metals, or even a side business. It is never wise to put all of your eggs in one basket, so be sure to invest some of your money outside of the Roth 401k as well.
Are you currently maxing out your Roth 401k?