The Roth 401k: 3 Decisions to Optimize Your Contributions

So you've decided to contribute to the Roth side of your 401k. I love it, but there are some tag-along decisions that you need to make as well. I've got three of them. That and more coming up. My name is Mike Bernard. I'm the host of The Wise Money Show. I'm also one of the certified financial planners right here at Core Horn Financial Group. Make sure you hit that subscribe button, turn on notifications, and smash that thumbs up button. Oh my goodness. The Roth 401k, I think, is a game changer. I really do. Not that it's one size fits all. I do love the Roth, but there are certainly times when you should be contributing pre-tax. But gosh, all things equal, love the Roth. And here's why the Roth 401k is a game changer. One, it has a contribution limit that's three times the amount you can do in a Roth IRA. So you can put even more into a Roth 401k. Even if you also have catch-up contributions, or now the new super catch-up contribution, even more, you can do backdoor Roth as well. Not backdoor, mega backdoor Roth into your 401k. And also, there's no income limit, which is the thing that snags a lot of people as they make more income and they're not eligible to contribute to a Roth IRA. But that income limit doesn't apply to the Roth 401k. So work with your CFP. Confirm that it makes sense for you to contribute to the Roth side of your 401k. But that's not enough. There's tag-along decisions. So it's like going to Chipotle and saying, yeah, I want a burrito. It's, well, chicken, steak, or whatever. Okay, I didn't know. Okay, what type of bean? What type of rice? There's tag-along decisions. And most people don't know this. But there's tag-along decisions or plans that you need to make. I've got three of them that once you decide to do Roth 401k, you need to attend to these things as well. The first is your tax withholdings from your paycheck, right? If you're contributing to the Roth 401k, that means you've got earned income. You've got paycheck money. I have no idea if you have interest income or capital gains or other things going on on your tax return. But what I do know is that if you were contributing pre-tax before you shifted to Roth, and it probably didn't feel like it on a day-to-day basis. It just like automatically happened. But your federal tax withholdings and state as well, state and local as well, were being adjusted because of that deduction into your 401k, the pre-tax. Well, when you shift that to Roth, that deduction is no longer there. And so you're gonna see your tax withholdings tick up. But here's the thing. Is it gonna tick up enough? Is it the right amount? Are you having the right amount withheld? A lot of that can be masked over or covered up or concealed in a way if you're doing pre-tax 401k. When you shift to Roth, there's no more veil. There's no deduction. You are paying the tax on your contribution. You're paying the tax on this money that doesn't land in your pocket. It's going into your Roth 401k. And so you've gotta make sure that you've got your tax withholdings right. Otherwise, you're gonna end up with a tax surprise when you prepare your taxes that next year. So work with your CFP and do a tax projection or a withholding analysis to make sure that your tax withholdings are right when you're doing the Roth 401k contribution. Second tagalong decision that you need to make sure you get right if you're contributing to the Roth side of your 401k is the right investment mix. And you might say, that's obvious. And whether I'm doing pre-tax or Roth, I've gotta make sure I have the right investment mix. Sure, but what's the benefit of the Roth? Tax deferred and tax-free growth. And I cannot tell you how many times working with someone brand new, they come in and they're talking about their Roth or their Roth 401k. And yet the investments in the Roth IRA or Roth 401k are not set up for growth. They're lower risk. And it might be appropriate for their risk tolerance. Yeah, I'm a little nervous right now, or I'm getting close to retirement or whatever the reason may be. But their Roth is set up for very little growth, not the purpose of the Roth. The Roth 401k, the benefit is on the growth. So those dollars need to be positioned for growth. And you might say, yeah, positioned for growth. But if the investments go down or if the stock market goes down, then I'm actually getting the opposite. I'm losing money and I can't do that. I know, but in order to give yourself the opportunity for growth, you've got to make yourself susceptible to the short-term volatility and short-term downturns that the market inevitably brings. So even if you're near retirement or you're more conservative, more conservative as an investor, have some of the other dollars in maybe other parts of your portfolio, maybe your IRA, maybe the pre-tax side of your 401k, have that be lower risk, if you will, and ensure that your Roth 401k is set up for growth, for long-term growth so that you can achieve the true benefit that the Roth 401k provides. And then the final tag-along decision or planning issue that you need to attend to once you decide to do the Roth side of your 401k is you have to decide whether, if you get a company match, whether you want that company match to go into the Roth 401k as well. By default, your company match is going to be pre-tax. And that doesn't make a lot of sense to a lot of people. They just assume, well, the match is going to follow what I'm doing. So if I'm doing pre-tax, the match will be pre-tax. If I'm doing Roth, the match will be Roth. No, the default is the match is going to be pre-tax. In fact, up until last year, 2024, I believe 2024, you didn't even have a choice. Your match had to go in pre-tax. Even if all of your own contribution was Roth, your match had to go in pre-tax. And now it's legal. You can choose how you want your match to go in pre-tax or Roth. And some companies, not a lot, some companies are starting to make that option available. I think later this year, the technology will catch up and these plans will be updated such that more and more companies will give you that choice. And you'll have to make that decision. And to me, I love the idea. If it makes sense for you to do Roth with your contributions, it may likely make sense for you to have your match be Roth as well. You've got to have a plan for the withholding. You've got to have a plan for the investment mix. But you've got to make this decision. This is a tag-along decision so that as your account continues to grow, your 401k, your contributions are Roth, and then you have the right structure for the match dollars too. Well, there you go. I love the Roth 401k. I absolutely do. Given, you know, all things equal, I would, oh gosh, I love it. Work with your CFP on that. But make sure you attend to these three tag-along decisions and any others like getting the right beneficiary and all that sort of stuff as well. So work with your CFP on that. If you don't have a CFP on your team, you can contact one on my team. Find us online, kohorn.com. That's Kohorn with Kay, wisemoneyshow.com. You can find us there as well, or give us a call, 574-247-5898. All right, there you have it. Go out and take your next wise step in your financial life.