When we meet with employees during retirement plan education meetings, we are often asked whether they should contribute to a traditional 401(k) or a Roth 401(k) if their workplace retirement plan offers a Roth option. Similar to any financial question, the answer will depend on the participant’s personal situation.
How does a Roth 401(k) and a Traditional 401(k) differ?
The main differentiation is taxes.
In a Traditional 401(k), contributions are pretax, reducing your tax liability now. Your money grows tax deferred, but you will have to pay income taxes on withdrawals once you’re retired.
In a Roth 401(k), contributions are taxed up front, so your tax liability is not reduced in the present. Your money grows tax free, so you won’t have to pay taxes on qualified withdrawals once you’re retired.
Who should consider the Roth 401(k)?
- A younger investor in a lower tax bracket who expects his or her tax bracket to be higher in retirement.
- An investor looking for estate planning options. The Roth 401(k) passes tax free to beneficiaries.
- An investor whose household income is too high to contribute to a Roth IRA.
Who should consider a Traditional 401(k)?
- An investor in a higher tax bracket who is looking for a tax shelter.
- An investor on a tight budget who is trying to contribute more to retirement.
- An investor looking for a good place to begin retirement contributions, while he or she researches the Roth 401(k) option.
Do I have to just pick one?
No, depending on the plan, you may be able to contribute to both at the same time. I often suggest that employees contribute to both a Roth and Traditional 401(k), if possible, in order to have tax diversification when they hit retirement.
As you make your decision, remember that there is no wrong answer. Whether you contribute to a Traditional 401(k) or a Roth 401(k), you are still saving for your retirement goals and taking advantage of a great employer benefit.
Do you have questions about your retirement plan at work? Contact us at email@example.com.