Traditional 401K retirement savings plans make use of tax-free deferred contributions from employees to fund the savings account. The fund itself, as well as all profits to be gained through it, are tax exempt. Taxes will only be imposed when upon reaching the age of 59 ½ the holder of account makes “distributions” or withdrawals from the account. The amount of tax deducted will correspond to the tax bracket to which you belong. And even if, by the time you reach 59 ½ year of age your income has dwindled to an insignificant amount, the taxable value of the funds you withdraw may be big, considering that at that time you may no longer be claiming deductions due to dependents , loans and other details that are used for minimizing tax dues.
Roth 401k retirement plans deposits after-tax funds or the money left over after taxes have been deducted from the original amount into the retirement savings account. If the account has been continuously maintained for 5 years before the holder reached 59 ½ years of age, all withdrawals will be tax free for so long as the total of what has been withdrawn is less than or equal to the total of all the contributions you have made to it. In other words, earnings are taxed when they are withdrawn.
Termination of employment or the desire to eventually Rollover to Roth 401k, can be reason for people to do a 401k rollover to ira (Individual Retirement Arrangements). Terminated employees need to do this so that they can continue their contributions on their own. For others this is a necessary step for a roll over to a Roth IRA arrangement. For 401 plans the switch to Roth IRA will involve the payment of taxes. This is obviously due to the fact that from a pre-tax system the holder is transferring to an after-tax system. It also follows that the transition from Roth 401 to Roth IRA can be done without any tax expenses being incurred.
The type of 401k that is right for one person may be wrong for another. This will all depend on how he anticipates his financial status to be upon reaching distribution-eligible age. For instance, young employees who are working hard to further their career should expect their tax bracket to go up by the time they retire. These people will benefit more from the tax less distributions of the Roth 401 system. Being in a high tax bracket upon retirement coupled with the amount that is withdrawn from the retirement savings account will cause the holder of a standard 401k plan to pay enormous taxes. By the way, it’s good to consider a fee-free investment vehicle like a no load mutual fund when investing in these types of retirement accounts.
On the opposite end, people who think their tax bracket will go down as they age, should stick to a standard 401k plan, on condition that they keep constant track of their investments to see to it that their earnings remain constant or improve. What they will be paying in taxes when they retire can be offset by the amount of earnings that they will have made.