Employee weighs whether to make the switch to a Roth 401(k)
Q: My employer has given us the choice to switch from a traditional 401(k) retirement savings plan to a Roth 401(k) plan. Can you explain the benefits and negatives of this plan, including withdrawal rights?
I.G., via e-mail
A: There are indeed a few differences between the Roth 401(k) and the traditional 401(k), says Bryant Evans, a financial planner in Champaign, Ill. Chief among them are income tax treatment of contributions, and the tax potential of withdrawals.
With the traditional 401(k) you get a tax deduction for the amount you elect to invest. For the Roth 401(k) you don't. It's that simple, more or less.
Let's say you earn $1,000 a week and invest $100 in your company's 401(k) plan. If it's through the traditional 401(k), the IRS taxes only $900 of your income. The $100 contribution is tax deferred. If you earmark that $100 into a Roth 401(k), however, you owe tax on the full $1,000.
But this tax bite reverses direction when you take money out of the 401(k), says Mr. Evans. For the traditional 401(k), all money withdrawn is considered taxable income (even earnings). When you make withdrawals from the Roth 401(k), though, the money is considered tax-free income.
Either way, you'll invest your dollars into the exact same stocks or mutual funds. So you'll be putting the same amount of money to work.
The question, then, is: Do you want a tax deduction now, with a 401(k), or the opportunity for tax-free income down the road with a Roth 401(k)?
Some experts we spoke with said a Roth 401(k) might make sense if you believe that you'll be in a higher tax bracket after you retire than during your working years. Paying off your house and otherwise losing itemized deductions could cause that to happen. Another expert said that a Roth might make sense if for no other reason than to diversify your approach to taxes.
Q: Last year, I bought a house that's a fixer-upper. I now realize that this lifestyle isn't for me and I'm longing for a condo. Condos here are often priced as high or higher than houses. Should I take the hit in sales commissions, get a condo, and hope for good appreciation? Or should I hire a handyman and stay in my house, where appreciation has averaged at least 12 percent over the last five years?
K.H., Birmingham, Ala.
A: "This is definitely a lifestyle question first and a financial question second," says Anthony LaGiglia, a certified financial planner in Melville, N.Y.
If you have realized that you'd be more comfortable living in a condo, then Mr. LaGiglia says you should make a financial assessment of how much it's going to cost to make this change. If the financial hit is manageable then you should probably move.
You need to understand, however, that you should look at this home primarily as a place to live and then secondarily as an investment.
"The appreciation in the home, in my opinion, is a bonus," says Mr. LaGiglia. This is, first and foremost, a roof over your head. And just because the housing market has appreciated annually the last five years does not guarantee a repeat over the next five years or even five weeks.
From a financial perspective, LaGiglia looks at it this way: Assume that you sell the house for $300,000. A 5 percent commission equals $15,000. Then there are moving and closing costs on the purchase of a new condo; let's assume an additional $5,000. That totals $20,000. Will it cost $20,000 to hire a handyman to complete repairs on this "fixer-upper"?