Should I invest in a Roth 401(k)? No, probably not.

Many company 401(k) plans have added a Roth 401(k) option.  I believe most people should NOT use the Roth 401(k) option.  The Roth feature seems very appealing since withdrawals from a Roth account can be made tax-free in retirement.  However, these FUTURE tax-free withdrawals come at a high up-front cost since the employee must pay more taxes right NOW.  Let me go through an example and provide an alternative strategy.

Scenario 1:

Take a married couple, 40 years old, with taxable income of $85,000.  This couple would be in the 25% Federal Income Tax bracket and the 7.75% North Carolina State Income Tax bracket.  Let's assume the couple contributes $15,000 per year to a Roth 401(k).  This means the couple is paying an extra $4,912 in income taxes than if they contributed to a traditional 401(k) plan (15,000 x 32.75%).  So, the couple is paying an extra $4,912 for the privilege of placing $15,000 into a Roth account.

Scenario 2:

My suggestion to this couple is to stop making contributions to the Roth 401(k) and instead switch back to the traditional 401(k).  By switching from the Roth 401(k) back to the traditional 401(k) this couple will have an additional $4,912 in take home pay due to the lower income taxes.  The couple should then take that $4,912 in additional take home pay and contribute that money into a Roth IRA (I suggest doing this at Vanguard and use only low-cost index funds).