What is a Roth 401 k about? When you know what this is for, then you’ll know what the real meaning of tax-free retirement is. Before you could understand this better, you have to determine first the difference between a tax-free contribution and a tax-free distribution.
Tax-free contribution means that you are making your retirement contributions without any necessary tax deductions but if you would think about it, there is no such thing as tax-free contribution. It is just better term for tax deferred contribution which actually means you are only delaying the tax but once you are ready to receive those contributions you made, tax will be deducted from the amount you get.
Tax-free distribution on the other hand means that the money you will receive upon retirement is indeed not tax deferred but is really free from tax. This happens when you make post-tax contributions on your retirement account through the Roth 401 k plan. This means you are paying the necessary taxes beforehand so that come retirement age, you will no longer be taxed when you get your retirement funds.
What is a roth 401 k for and what benefits you can gain from it?
By default, the Solo 401k contributions are tax deferred but since this plan is an ultimate retirement plan, you can make post-tax contributions on the account because of its Roth sub account feature. Why do you need to do that? Making pre-tax and post-tax contributions has their own advantages and disadvantages depending on the account holder’s financial situation. However, if you would depend on the tax rates these days, you will notice that tax rate pattern is not getting any lower year by year. Tax rates would most likely to increase anytime in the future and who knows, tax rate might soar during your retirement age.
If you assign your contributions in a Roth 401 k, rest assured that even if taxes increase you will still be receiving tax free money. To be on the safe side, tax diversifying your account by making both post-tax and pre-tax contribution will be a much better option. Knowing what is a roth 401 k for is essential for every retirement plan participants.
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