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Roth 401k Retirement Planning Tips

I've written recently about the pros and cons of contributing to Roth 401k accounts and/or converting your traditional 401k to a Roth 401k. I said that one important advantage of a Roth 401k is that these accounts aren't subject to the IRS's required minimum distributions (RMD) at age 70-1/2, which do apply to traditional 401k and IRA accounts.

Well, sort of. A few readers have pointed out that under current law, Roth 401k accounts are subject to the RMD, but Roth IRAs are not.

There's an easy work-around to this situation. If there's nothing else holding you back, go ahead and contribute to a Roth 401k account or convert existing traditional 401k accounts to a Roth 401k. Then, when you leave your company, you can roll your Roth 401k accounts over to a Roth IRA, which doesn't have the RMD. You'll want to do this before reaching age 70-1/2, though, because at that time, the RMD will start being applied to any money you have in the Roth 401k -- assuming you've already terminated employment with the company that sponsors your 401k plan.

There is one situation where the RMD doesn't apply at age 70-1/2: If you reach age 70-1/2 and are still working for the company where you have your Roth 401k accounts; it won't apply until you actually terminate employment. In this case, it might still make sense to investigate whether your plan allows an in-service rollover distribution from your Roth 401k to a Roth IRA, to avoid the RMD when you do eventually leave your job.

Avoiding the RMD is important because you might like the flexibility of leaving some money in tax-advantaged retirement savings beyond age 70-1/2, for several reasons:

  • You may want to keep some retirement savings in reserve, in case you have high medical or long-term care expenses later in life.
  • You may want to live on just dividends and interest so the principal is passed along to your heirs.
Both Roth IRAs and 401k accounts give you an opportunity to manage your taxes before and during retirement, particularly if your income varies from year-to-year and you flip-flop between high and low income tax brackets.

My best advice is this:

  • While you're working, contribute to a traditional IRA or 401k account if you're in a high income tax bracket, since the contribution isn't subject to income taxes when you make it. On the other hand, if you're in a low income tax bracket, that's the time to contribute to a Roth IRA or 401k since the contribution is subject to taxes.
  • When you're retired, you might have some years in which you're in a high income tax bracket. During these times, withdraw from your Roth accounts, which are tax-free. For the years during which you're in a low tax bracket, though, withdraw from your traditional accounts, which are subject to income taxes.
It's my understanding that some groups are working on legislation that would rule that Roth 401k accounts are not subject to the RMD, to be consistent with Roth IRAs. If that happens, I'll let you know.

Thanks to our readers for commenting on these technical rules regarding Roth 401k accounts. It takes a village to plan for retirement!

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