How to get the best 401k for young adults
What is the fastest way to get rich for most of us? By investing as much as possible into a 401k as early as possible. However, a reader wonders: What is the best 401k for young adults? A traditional 401k or a Roth 401k?
Meet our young adult, Carter
After listening Queer Money™ Episode 61, “5 Steps to Prepare for Financial Emergencies While You Sleep,” Carter emailed us a question from Ohio. As a young gay man, Carter wants to know which type of 401k his employer offers him is the best? Should he invest in a traditional 401K or a Roth 401K?
There is no general answer to this question. After receiving Carter’s question, we asked him a few questions of our own. Carter is 27 years old and graduated from college a few years ago. His current income is $43,000 per year and he has student loan debt funded at 3.5%.
Carter has set up an emergency savings account per our instructions Queer Money™ Episode 61. He is currently saving $40 per month in this emergency savings account and will have $500 in emergency savings by next July.
What is the difference between a Traditional and a Roth 401k?
A Roth 401K is an employer-sponsored retirement account into which you contribute after-tax dollars and the money you invest in this account grows tax-free. Withdrawals from this account are also tax-free.
A traditional 401k account is an employer-sponsored retirement account into which you contribute tax-deferred, pre-tax dollars. Withdrawals from a traditional 401k account, unlike a Roth 401k account, are taxed as ordinary income when withdrawn.
The annual contribution limit for traditional and Roth 401ks is 100% of your income or $18,000 for 2018, whichever is less. If you are currently over 50, additional contributions of up to $6,000 can be made to either account type.
What is the best 401k for young adults like Carter?
As with most things in life, it depends. Ultimately, the question for Cater and all of us who invest in a 401k (or a 403b for government employees) is: Do I want to pay my taxes now or when I’m retired? Ultimately, you want to pay as little tax as possible. Will this be the case when you are younger or when you are older? Will taxes be the same, higher or lower than today?
Nobody can answer these questions with absolute certainty. Therefore, some experts recommend hedging your bets and investing in both a traditional and Roth 401k. Investing a portion in both reduces the risk of misjudging what your taxes will be by the time you retire, and still reaps the benefits of investing in a 401k today.
To hear our top recommendation for the best 401k for a young adult like Carter, listen to this episode of Queer Money™ .