Roth 401(K) Vs. Traditional: Which Is Right For You?

When deciding whether to invest in a Roth 401(k) or a traditional 401(k), it is important to consider your tax situation and future earning potential. Roth 401(k) contributions are made with after-tax dollars, meaning you won't owe any taxes on the money you collect in retirement. This makes Roth 401(k)s incredibly attractive for high net worth individuals, as they cannot have a Roth individual retirement account. However, if you expect your tax rate to be lower when you retire, traditional contributions may be more suitable, as you pay less in taxes every year that you contribute.

Taxes - Roth contributions are after-tax, traditional contributions are pre-tax

Roth and traditional retirement accounts are taxed differently. Roth 401(k) contributions are made with after-tax dollars. Traditional contributions are pre-tax.

If you think your tax rate will be lower when you begin withdrawals in retirement, traditional contributions may make sense. If your tax rate will be about the same (or higher), Roth contributions might be preferable.

Roth 401(k) contributions are made with after-tax dollars. Once you start taking qualified Roth distributions* in retirement, you won’t owe any taxes on the money you collect. Earnings on Roth contributions will be taxed unless withdrawals are a qualified distribution as defined by the IRS.

With a traditional IRA, you pay less in taxes every year that you contribute. But generally, you'll have to pay taxes on the money you withdraw in retirement. A traditional IRA may be better if you're in your peak earning years or expect to have lower taxable income in retirement.

A Roth 401(k) can be “incredibly attractive for a high net worth individual”, Carbonaro says. A primary reason for this is that individuals earning over $146,000 or couples earning over $230,000 are not allowed to have a Roth individual retirement account. This means that if a higher earning person wants to have Roth savings, their 401(k) will likely be their only avenue to do so, Carbonaro says. They can always save into a traditional IRA later to seek a more balanced approach.

Tax rate - Roth for higher earners, traditional for lower earners

If you are a higher earner, you should consider investing in a Roth 401(k). This is because individuals earning over $146,000 or couples earning over $230,000 are not allowed to have a Roth individual retirement account. A Roth 401(k) can be incredibly attractive for a high net worth individual.

If you are a lower earner, you should consider investing in a traditional 401(k). A traditional IRA may be better if you're in your peak earning years or expect to have lower taxable income in retirement.

A Roth account doesn't reduce your taxes today; but in retirement, when you need it, qualified distributions are tax-free. Roth IRAs are best for lower earning years, or if your tax rate will remain the same or increase in retirement.

A traditional IRA may be better if you're in your peak earning years or expect to have lower taxable income in retirement. With a traditional IRA, you pay less in taxes every year that you contribute. But generally, you'll have to pay taxes on the money you withdraw in retirement.

Do you expect your tax rate to be higher or lower when you retire? This factor carries substantial weight in the choice between a Roth and a traditional 401(k) option. If you think your tax rate will be lower when you begin withdrawals in retirement, traditional contributions may make sense. If your tax rate will be about the same (or higher), Roth contributions might be preferable.

Withdrawal - Roth tax-free, traditional taxed

When it comes to withdrawals, the Roth 401(k) is tax-free, while the traditional 401(k) is taxed. This is a key difference to consider when deciding between the two investment options.

With a Roth 401(k), you pay taxes on the contributions when you make them, but any earnings or withdrawals in the future are tax-free. This can be advantageous if you believe that future tax rates will be higher than current rates, as you are essentially locking in a lower tax rate for the future. Additionally, Roth contributions are very useful if you don't plan on spending the money during retirement and want to pass it on to your heirs.

On the other hand, with a traditional 401(k), you defer taxes on contributions until you withdraw the money, which typically means withdrawing it as income during retirement. This can be a concern if you are in a lower tax bracket during retirement and want to maximize your after-tax income.

It's important to note that there are exceptions to these rules, and individual circumstances should be considered. Factors such as future political and economic possibilities, your ability to pay taxes with money in a taxable account, and your expected retirement income can all influence your decision.

In summary, the tax implications of withdrawals are a significant factor to consider when deciding between a Roth 401(k) and a traditional 401(k). Understanding these differences can help you make an informed decision that aligns with your financial goals and retirement plans.

Contribution limits - same for both

Roth and traditional contribution options share many features. Both allow you to:

• Contribute up to a combined total of $23,000 in 2024 (plus an additional $7,500 in catch-up contributions if you’re age 50 or over).
• Invest in the different options your employer makes available through their plan.
• Invest for the long-term with the potential for tax-advantaged growth.

The main difference between Roth and traditional 401(k) contributions is the way each is taxed. In the simplest terms, your decision comes down to whether you’d rather pay taxes now or later.

Roth 401(k) contributions are made with after-tax dollars. Once you start taking qualified Roth distributions* in retirement, you won’t owe any taxes on the money you collect.

Traditional 401(k) contributions are made with pre-tax dollars. You'll pay taxes on the money you withdraw in retirement.

The two categories of savers that should really consider doubling down on Roth saving are those who are very young, say 20s and 30s, and those who are higher earners. A primary reason for this is that individuals earning over $146,000 or couples earning over $230,000 are not allowed to have a Roth individual retirement account. This means that if a higher earning person wants to have Roth savings, their 401(k) will likely be their only avenue to do so, Carbonaro says. They can always save into a traditional IRA later to seek a more balanced approach.

Investment options - same for both

Roth and traditional contribution options share many features. Both allow you to:

• Contribute up to a combined total of $23,000 in 2024 (plus an additional $7,500 in catch-up contributions if you’re age 50 or over).
• Invest in the different options your employer makes available through their plan.
• Invest for the long-term with the potential for tax-advantaged growth.

The main difference between Roth and traditional 401(k) contributions is the way each is taxed. In the simplest terms, your decision comes down to whether you’d rather pay taxes now or later. Roth 401(k) contributions are made with after-tax dollars. Once you start taking qualified Roth distributions* in retirement, you won’t owe any taxes on the money you collect. Roth 401(k)s are best for lower earning years, or if your tax rate will remain the same or increase in retirement. With a traditional IRA, you pay less in taxes every year that you contribute. But generally, you'll have to pay taxes on the money you withdraw in retirement.

A traditional IRA may be better if you're in your peak earning years or expect to have lower taxable income in retirement. If you think your tax rate will be higher or lower when you retire, this factor carries substantial weight in the choice between a Roth and a traditional 401(k) option. If you think your tax rate will be lower when you begin withdrawals in retirement, traditional contributions may make sense. If your tax rate will be about the same (or higher), Roth contributions might be preferable.

A Roth 401(k) can be “incredibly attractive for a high net worth individual”, Carbonaro says. A primary reason for this is that individuals earning over $146,000 or couples earning over $230,000 are not allowed to have a Roth individual retirement account. This means that if a higher earning person wants to have Roth savings, their 401(k) will likely be their only avenue to do so, Carbonaro says. They can always save into a traditional IRA later to seek a more balanced approach.

Frequently asked questions