Many people have aspirations to build up their tax-free investments and do so inside of a Roth 401k. However, you may be surprised to learn that your Roth 401k contributions are not actually going into the Roth (tax-free) bucket, but instead into the Traditional (pre-tax) bucket.
If you’ve followed my blog, then you know I promote a 3-Bucket Strategy when it comes to investing. I want you to have money in a pre-tax accounts (taxable in the future), Roth accounts (tax-free in the future), and Taxable Accounts (taxable now and in the future).
A key reason for this strategy is that you don’t know where tax brackets will be in the future when you start withdrawing from your investments. A common thought is that taxes will rise due to the rate at which the government spends money. If that pans out then having money in a tax-free bucket like a Roth 401k could prove to be very beneficial!
If you contribute to your 401k on a Roth-basis then be sure to verify this on your pay stub and your 401k statement.
We’ve had a couple clients that chose to contribute to their 401k on a Roth-basis, but later found out that the contributions were still being made on a pre-tax basis. Had it not been discovered, it could have a detrimental impact on retirement.
If it is a mistake on behalf of the 401k company, then they should be able to reverse it and retroactively apply your contributions to the Roth component. However, I’m not that confident that all 401k companies will know how to properly handle this.
As such, it’s much better to catch this up front.
Have your 401k contributions ever been handled incorrectly? Please feel free to share below.
Brad Tinnon
CERTIFIED FINANCIAL PLANNER™