You can fear the potential for a tax increase that could be headed your way as the federal government deals with hundreds of billions of dollars in bailout-related debt, or you can do something about it.
A simple option would be to use a Roth 401(k) in your company retirement savings plan if you have a choice. About 29 percent of people who work for large and medium-size companies have that option, according to benefits firm Hewitt Associates.
If you aren't among them, you can turn to a Roth individual retirement account, which you open on your own at a brokerage firm or mutual fund company outside the workplace.
The attraction is this: If you save money in a Roth 401(k), a Roth 403(b) or Roth IRA, and follow the rules, you will be able to keep Uncle Sam from taking any of those retirement savings for as long as you save the money and spend the money.
As you go through retirement, you will not pay taxes on the money you withdraw. So if tax rates head up, you won't have to worry.
That can be a huge advantage for a retiree. Because seniors often live on fixed incomes, a tax shock can upset their lifestyle. A regular 401(k) or IRA, however, does not insulate from taxes in retirement. When you use a typical 401(k) or traditional IRA for spending money in retirement, you pay taxes.
So given the uncertainty of the future tax environment, insulating retirement savings in any type of Roth account holds great appeal. People can shelter more money in Roth 401(k)'s at work. The government allows people to put $5,000 a year into a Roth IRA - or $6,000 if they are 50 or older. And there are income limits. For Roth 401(k)'s, however, no income limits apply and federal rules let people contribute $16,500, or $22,000 if 50 and up. (Individual employers may apply different rules.)
Although the attraction of a Roth account is clear, stashing money in one is sometimes easier said than done. The reason: If you are used to saving money in a regular 401(k), you also are used to obtaining a tax break each year. You don't pay income taxes on the money you contribute. It's the government's way of rewarding you for saving. With the Roth option, you don't receive an upfront tax break. Your reward is delayed until the end of your savings years.
If, for example, you are in the 25 percent tax bracket and have been depositing $1,000 into a regular 401(k), the tax break you receive lets you save $1,000 for retirement while only taking $750 out of your pocket. If you deposited $1,000 into a Roth 401(k), instead, you wouldn't receive the tax break that year and your paycheck would reflect taxes on the full $1,000.
That can be difficult for people to handle. Advisers at a recent conference organized by 401(k) information firm Plan Sponsor said that's one reason why some people experiment with Roth 401(k)'s but have second thoughts once they see the effect on take-home pay.
The solution, they said, is to avoid going cold turkey. Instead of giving up the tax break completely, they suggest putting some money into the traditional 401(k) option for the tax benefit now, and some money into the Roth 401(k) for the tax benefit years in the future. The combined contributions, though, can't exceed the usual limit.
Also, there are stages in your life when you need tax breaks less, and watching for those and maximizing the use of Roth 401(k)s then can provide advantages for the future without as much immediate sacrifice.
For example, young workers in summertime jobs often have relatively low pay. Given the likelihood of low taxes, advisers suggest that's an ideal time to save in a Roth 401(k). And the early savings are powerful. If an 18-year-old was able to invest $2,000 in a Roth 401 (k) or Roth IRA, and made 8 percent a year on the money until retiring, he would have about $94,000 free and clear.
Roth 401(k)'s are also attractive for seniors working in part-time jobs.