The HR Orientation

    You have just attended the HR Orientation at your new job, and you learned that your employer offers a defined contribution retirement savings plan: a 401k. Your employer will match 100% of your contributions to the plan up to a maximum of 5% of your salary. You are offered two options: a traditional 401k, which allows you to contribute pre-tax money and defer paying taxes until you begin taking withdrawals in retirement. a Roth 401k, which allows you to contribute money that has already been taxed and take tax-free withdrawals in retirement. You are also offered the option of choosing to increase your initial contribution amount by 1% annually, to a maximum of 15% of your salary. After completing the chapter readings and viewing the "Saving for Tomorrow, Tomorrow" video linked in the Module resources, respond to the following questions: Will you choose the traditional 401k or the Roth 401k?  What factors did you consider in making your decision? What percentage of your salary will you contribute? Will you choose the automatic 1% annual increases to your contribution? Provide specific rationale for your decisions.  

Sample Solution

 

Decision: Roth 401k

After careful consideration, I have decided to choose the Roth 401k over the traditional 401k. This decision was based on several factors, including my current tax bracket, expected future tax bracket, and investment goals.

Tax Considerations

The primary difference between traditional and Roth 401ks lies in the timing of taxation. Traditional 401k contributions are made with pre-tax dollars, meaning they reduce your taxable income in the year you make them. However, you will have to pay taxes on the money when you withdraw it in retirement.

Full Answer Section

   

Roth 401k contributions, on the other hand, are made with after-tax dollars, meaning you will not receive a tax deduction in the year you contribute. However, your withdrawals in retirement will be tax-free.

Considering my current tax bracket, I am in a relatively low tax bracket compared to where I expect to be in retirement. This means that I would benefit more from the tax deferral of a traditional 401k now, as I would pay taxes on the money at a lower rate. However, I anticipate being in a higher tax bracket in retirement, making the tax-free withdrawals of a Roth 401k more appealing.

Investment Goals

My investment goals are to accumulate a significant nest egg for retirement and provide financial security for my future family. With a Roth 401k, I can benefit from tax-free compound growth over time, allowing my savings to grow more efficiently. Additionally, the tax-free withdrawals in retirement will provide me with more flexibility in managing my finances and planning for my future.

Contribution Percentage

I plan to start with an initial contribution of 10% of my salary, which is within the recommended range for Roth 401k contributions. This will allow me to take advantage of my employer's matching contribution while still having enough disposable income to meet my current expenses.

Automatic 1% Annual Increases

I believe that the automatic 1% annual increases to my contribution are a valuable option. These gradual increases will help me maximize my contributions over time and take advantage of the power of compound growth. Additionally, increasing my contributions by 1% each year will be relatively painless, as I will likely have adjusted to my living expenses and income by then.

In conclusion, I have decided to choose the Roth 401k due to its tax-free withdrawals in retirement, which align with my investment goals and anticipated tax bracket. I believe that an initial contribution of 10% of my salary, along with the automatic 1% annual increases, is a manageable and effective strategy for maximizing my retirement savings.

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