This morning I saw the headline 2 Reasons to Save in a Roth 401(k) in 2024, and 2 Reasons Not To. Before I jumped in to the article, I got angry. Is this a misleading headline? I think so. Let me tell you why.
My Mission – Simplify
I’ve done some teaching, coaching and writing to help simplify personal finance. The industry itself is overly complicated and while most in the financial industry and in government agree that saving is a good thing, we’re the same folks that make it hard. Let’s start with a bit of background.
Who has?
Who has read a mutual fund prospectus from cover to cover, or read through their company’s retirement plan document? They’re horrible. Our government and industry lawyers develop these to protect us. Many industry professionals don’t understand everything that’s in them, how can the people that they’re meant to protect get value from them?
It Scares People Away!
The result: the everyday person decides it’s too much work. On my first day at my brief stint as a car salesman post-retirement, I was with several other new hires and the business office manager was taking us through a mountain of paperwork. One sheet was to sign up for the company 401k plan (which offered a healthy match). No one, including the business office manager, understood the info, so most people took the info home and likely chucked it. I took mine home and signed-up immediately. Gold star for me.
The point is, in an effort to protect and inform, we’ve made it scary. People have important things to do. They are anxious about starting a new job, they need to pick up the kids at school, they have appointments, and maybe a second job, they want to read fascinating blog posts like mine…we’re busy. Things like the retirement plan info that we put aside to look at later, often is never seen again.
Let’s Get Back On Track
I’ll reel it back in, but to summarize, It is important to me to simplify so that everyone can take advantage of saving opportunities. The industry makes it tough enough, we don’t need bloggers making it tougher.
2 Reasons to Save in a Roth 401(k) in 2024, and 2 Reasons Not To
Personal financial professionals and fans will likely read this headline and be intrigued. Sadly, I was and I clicked. But the average person who is juggling dozens of things in their life and is looking for some simple advice may not be as excited. In fact, someone who has finally made the decision to choose a Roth 401k over a traditional, may read the headline and start rethinking their decision.
The end result is a decision to save is deferred to a later date. Read the post on compounding. Time is your biggest weapon in building wealth. Go back and review the Al and Peg story. Peg put away twice as much money but started later. Al, by starting early, ended with twice as much money as Peg in retirement.
Headlines like this one cause people to delay saving. That’s bad.
Save Now
Saving at your local bank is great. Putting money aside will prepare you to handle an emergency and your money will grow over time to help you take a vacation, buy a car or put a down payment on a home.
Saving in a high yield savings account is even better. You’ll likely get several percentage point higher returns and your money will grow faster.
Saving in a retirement account is even better. Whether it is a traditional account or a Roth account, you will have a tax advantage over your bank savings account or your high yield savings account.
Retirement Plan Advantage – Payroll Deduction
We’ll talk about traditional v. Roth tax advantages in a sec, but first let’s talk about the magic of payroll deduction. When you sign up for your 401k or other defined contribution retirement plan at work, you decide how much will be taken out of your pay each pay period and deposited into your retirement account. This is magic because you don’t have to think about it. It automatically goes into savings and gets invested. If this money went to us, we’d find something to do with it and it likely wouldn’t be saving.
Traditional Retirement Account Tax Advantages
As a general rule, traditional retirement account contributions go in pre-tax, meaning that you don’t pay taxes on the amount you contribute so it reduces your taxable income in the year you contribute. Traditional retirement account redemptions will be taxed at your income tax rate. Assuming your earnings, and thus your tax rate, will be lower in retirement, there is a tax advantage for the saver.
Roth Tax Advantages
A Roth account contribution goes into the account after tax. It does not reduce your taxable income in the current year. There are however, no taxes when the money is withdrawn.
Taxes can take a size-able bite out of your savings, so retirement accounts, whether traditional or Roth, will help you build more wealth. And depending where tax rates go, one could be more advantageous than the other, but I would strongly argue that saving now is far more advantageous than deferring for a while to make the “right” decision on traditional v. Roth v. a plain old bank savings account.
You Don’t Have to Pick Just One
At the risk of overcomplicating this, you can mix and match. Start with a bank savings account, find a high yield savings account at an online bank and add some money there as well. Get a new job with a 401k match, reduce the money going into savings and defer enough salary into the 401k to take advantage of the match. Don’t know whether traditional or Roth is best, pick one. You can often switch later. Many 401k s support both traditional and Roth contributions so you can have some traditional money that goes in pre-tax and some Roth money that goes in after tax but will be tax free in retirement.
Wrap Up
Money that you put into a retirement plan or a savings account is your money. Retirement accounts are not like the old Flexible Spending Accounts where you lose the money if you don’t spend it. Any money you contribute is yours. You may have to pay taxes and penalties if you take it out before a certain age, but it is your money.
Saving today is always better than saving tomorrow. Don’t let a complicated mutual fund prospectus, retirement plan document or news article headline stop you.
For the record, the article had some good points. For example, it warned investors about the risk of high fees. This is something we talked about in the post on mutual funds here. However, in the choice between saving in a retirement plan with higher fee funds and not saving at all, the retirement plan wins every time.
I’m curious to know what you think. What causes you to hesitate in saving? Do you think the title is fine?
Updated 3/6/24: I thought about both the headline and the article quite a bit after I wrote this. Am I being fair?
I stand by my complaint about the headline. I think it causes folks to reconsider a decision to invest in their retirement.
I went back and reread the article and I considered the overall message.
Limited Investment Options
The point on limited investment choices is true of defined contribution retirement plans in general. Both your employer and your retirement plan administrator have a duty to ensure that plan participants are given suitable investment choices. Individual stocks and bonds are typically not viewed as suitable investments for a retirement plan. so, Roth or traditional, you will likely be limited in your investment options, but at the same time you will likely have suitable fixed income and equity alternatives to help you meet your investment goals. If this is not the case, let your company HR department know. They’ll often accept input on plan investment choices.
Costly Fees
The text says “you could face costly fees” and this is true. Again, if fees seem excessive, contact your HR department. While retirement plan administrators prefer higher fees, they rely on your company’s business and may be willing to negotiate.
My biggest concern with this paragraph is that it does not provide alternatives. First I would send concerned readers here to learn more about the impact of fees on investment growth. I’d also talk about the alternative of investing in an IRA, and then supplementing that with an investment in non-tax advantaged investment in a brokerage account or a high yield savings account. You could invest up to the $7,000 in your IRA and put $16,000 in non-tax advantaged savings/investments to ensure you are still contributing the $23,000 each year that you would contribute if you were maxing out your 401k.
The intention is good – making folks aware of high fees, but readers are owed some alternatives. I try not to fall into this trap, but please keep me honest and let me know if I do.
Have you done an analysis comparing Roth to traditional 401K’s, similar to the followup on taking SS early or later?
I guess it’s about buying power in your 20’s versus your 60’s.
Which is the smart way to go?
Thanks for the comment. I have done the analysis – with traditional, you get the tax break now, which theoretically allows you to invest more – take the tax savings and invest it. Roth has no tax benefit today so you need to pay tax now instead of investing that portion. So far, traditional wins as long as you invest the tax savings. The big unknown is taxes at retirement. If tax rates go way up, Roth would have been the better choice. If they stay low or go lower, traditional wins. The beauty is that many plans allow you to switch or even split contributions. I have some Roth, some traditional. I’ll post again in 20 years when I take it out.