Roth 401(k) vs Traditional 401(k)
Knowing when to contribute to your 401(k) is one of the biggest questions facing participants. This flier discusses the differences between a Roth 401(k) or Traditional 401(k) and how to use each.
One of the most common questions people ask is, “What’s the difference between a Roth 401(k) and a Traditional 401(k)?”
The answer is simple: when taxes are paid on the contribution.
Straightforward Advice for Retirement Planning
With a Roth 401(k), you pay taxes up front, just like the rest of your salary. Once in your account, the money grows tax-deferred. Once you start making withdrawals in retirement, you are able to take the money out tax-free. This allows you to use a portion of your Roth in retirement to pay for large expenses such as a down payment on a house or medical expenses, without having to pay taxes on the money withdrawn.
With a traditional 401(k), it’s the opposite. You contribute pre-tax dollars to your account and pay taxes when you start to withdraw at retirement. Like the Roth, this money grows tax-deferred in your account. An added benefit to this approach is it lowers your current taxable income.
So, is it better to pay taxes now or later?
Unlike distinguishing between the two tax structures, this answer is not so simple. The short answer is: it depends on your situation.
Consider these options:
- If you believe you’ll be in a higher tax bracket at retirement (younger workers, for example), you may want to look at Roth 401(k) contributions
- If you believe your tax rate will be lower when you retire, traditional 401(k) contributions might be more appealing to you
- Or you may want to consider contributing to both, up to the contribution limit. Diversifying can give you the best of both worlds by lowering a portion of your current taxable income and diversifying your tax exposure in retirement