Financial experts and writers often tout the Roth 401(k)’s main selling point: when the money is withdrawn in retirement, it won’t be taxed.
Well, that’s not entirely true.
An employee’s own money saved in his Roth account over the years is, indeed, shielded from income taxes when he retires and starts pulling out the money. That’s because the worker had paid the taxes before he put the money into the Roth – and the investment returns on those contributions.
But employer contributions to Roths are different. Employer contributions and any resulting investment earnings are taxed as income in the year that the money is withdrawn.
“Most everyone I talk to is shocked by this and surprised,” said CPA Sean Stein Smith, a business and finance professor at Lehman College in New York. Understanding the difference between the two types of savings plans offered to employees – Roth versus regular 401(k) – is already complicated enough, he said, and the tax distinction only adds to the confusion.
The reason withdrawals of employer contributions to Roths are not exempt from income taxes is because they are no different than employer contributions to regular 401(k)s. They are another form of income, just like your hourly wages. However, no taxes are deducted from a worker’s paycheck for Roth and regular 401(k) contributions when the employer puts them into the account. So the worker eventually has to pay the taxes – they are simply being delayed.
The next logical question is, how do you know how much you owe in taxes? What if you withdraw retirement income from both a Roth and a traditional 401(k) over the course of a year?
Figuring out the tax bite “is not your problem,” said Jaleigh White, CPA for a Louisville, Kentucky, investment firm and member of the National CPA Financial Literacy Commission for the American Institute of CPAs. …Learn More
Mothers often work less because, well, they’re also moms.
Still, they generally work consistently enough to qualify for Social Security pensions based on their own earnings records – rather than on their husbands’, as was common when more women were full-time housewives or worked just a few hours a week while the kids were at school.
Yet today’s working mothers do take a hit to their earnings when they temporarily reduce their hours or take a hiatus from work for childcare. The upshot of lower earnings is less Social Security income later for mothers, according to a new study by researchers for the Center for Retirement Research (CRR supports this blog).
The researchers, Matt Rutledge, Alice Zulkarnain, and Sara Ellen King, used data on all older women – married or single, mother or not. First, they confirmed past studies showing that the typical mom earns about $2,760 per month – or 28 percent less than a childless woman earns. Having two children translates to nearly 32 percent less income, and three children, to 35 percent less. (The analysis adjusts for some things – education is one – but not all the factors that distinguish mothers from non-mothers.)
Mothers’ lower Social Security benefits reflect this earnings penalty, though by a smaller percentage. Mothers’ benefit checks are 16 percent less than women who had no children to care for. Benefits are also lower if they had more children – by 18 percent for two children and nearly 21 percent for three. …Learn More
This New Yorker cartoon by Trevor Spaulding is cute, but – spoiler alert – it’s not quite right.
A company offering a 401(k) retirement savings plan to its workers is a good thing, but it’s no “favor,” noted my long-time editor Steve Sass, an economist with a hawk eye for inaccurate retirement information. Setting up and funding a 401(k) is a big expense for employers. But many think it is worthwhile, because 401(k)s – and, more so, employers’ matching contributions – help them attract and retain the sharpest, most productive, or most-skilled workers.
Another employer calculation is that the income tax deduction employees get for saving, which costs the employer nothing, is especially valuable for those on the payroll who earn the most money and, by definition, pay more taxes. It’s a neat outcome that the tax deduction most helps those presumably doing the most for the bottom line, though the government does limit how much highly compensated employees can contribute based on how much the rank-and-file workers are contributing.
But, it’s no fun to criticize a cartoon!Learn More
A social worker hands Lenny Higginbottom, 52, the keys to a 378-square-foot apartment, the first home of his own after 24 years on the streets.
“Try to fight the tears,” he says, gripping the keys during a video accompanying a story by Boston public radio (WBUR) reporter Lynn Jolicoeur. “Something I thought I’d never be able to do,” Higginbottom says.
His past issues are not uncommon among the homeless: a father who died when he was six, depression, substance abuse, and a failed marriage. He had a Section 8 housing voucher but couldn’t find a landlord willing to rent to him due to minor criminal activity in his past. …Learn More
This Donald Duck cartoon, funded by the U.S. government in 1943, urged Americans to pay their income taxes to support the war effort. Paying taxes was a patriotic act, to build up the inventory of war planes and battleships to defeat the Nazis – “sink the Axis!” the narrator bellows.
Nobody liked paying taxes then, and they still don’t. Yet there was a growing awareness as the war played out in the 1940s that taxes – like saving your scrap metal – were necessary to advance the greater good.
Things are different today. There doesn’t seem to be as much room in the public conversation for the benefits that federal taxes bestow, such as Social Security, Medicare, Medicaid (nursing home funding) and the Part D prescription drug benefit for retirees, or for government investments in education, roads, and research – or about who would suffer more if deprived of these benefits.
“Most people who do in fact receive significant forms of economic security from the federal government don’t know it,” argued Molly Michelmore, an economic historian at Washington and Lee University, in a recent interview on New York public radio. …Learn More
Reflecting a lofty ambition to educate Delaware residents about financial management, state government officials put together some terrific videos.
This is not high-level finance – the speakers tell stories about real people facing up to the dimensional challenges of money and retirement. Viewers outside Delaware might find one of the 10 online Tedx talks valuable to them. Here are three:
Javier Torrijos, assistant director of construction, Delaware Department of Transportation: His take on the immigrant experience in a nutshell: “The parents’ sacrifice equals the children’s future,” said Torrijos, who has two sons and whose own father left Columbia for a tough neighborhood in Brooklyn, New York, in 1964 so his children would have a shot at escaping poverty. Today’s immigrants are no different. But the pervasive ethos of family above all else, he argues, is responsible for some of the Latino immigrant community’s financial instability.
When required to make the impossible choice between going to college or straight to work to support family, family usually wins. “That mentality still exists” but needs to change if Latinos are to improve their lot, he said. …Learn More
As more baby boomers retire, Social Security’s impending financial shortfall will become more pressing.
To restore solvency, Congress can either cut Social Security’s pension benefits or increase the payroll taxes deducted from workers’ pay.
Both policies would impact how much is available for households to spend. Researchers at the Center for Retirement Research find that the benefit reductions would have an appreciably larger annual impact on retirees than would the higher taxes on workers. But the taxes would be spread over a longer time period.
The new study looks at four specific policies, two that cut retirement benefits and two that raise taxes. Each policy analyzed would equally benefit Social Security’s finances.
Gauging their separate effects required using a model to predict workers’ behavior. This was necessary because some workers might feel they should retire earlier if more taxes are being taken out of their paychecks. On the other hand, if their future pension benefits will be trimmed, they might decide to work a few more years to increase the size of their monthly checks.
One option for reducing Social Security payouts would be to delay the full retirement age (FRA) at which retirees are eligible to collect their “full” benefits. A second option is trimming Social Security’s annual cost-of-living (COLA) increases.
A two-year increase in the FRA, to 69, would reduce annual consumption in retirement by 5.6 percent for low-income, 4 percent for middle-income, and 2.2 percent for high-income retirees. …Learn More