401 (k) vs. Roth 401 (k): Similarities Both the traditional 401 (k) and the Roth 401 (k) are retirement plans that could be offered by your employer. This makes them considerably convenient to use since your contributions can come directly from your paycheck without any work required on your part.
Full Answer
For those with less familiarity, a “traditional“ 401 (k) is funded with pretax money while a Roth 401 (k) is funded with post-tax money. The only difference between these account types is when you decide to pay your taxes.
On the other hand, a traditional 401 (k) is a pretax savings account. When you invest in a traditional 401 (k), your contributions go in before they’re taxed, which makes your taxable income lower. Contributions are made with after-tax dollars (that means you pay taxes on that money now).
Access to a Roth option is becoming more and more common, so you’re in the majority if you have this option at work. Just over the last five years, the number of plans offering a Roth 401 (k) option has increased by 32%. As of 2021, about 3 out of 4 workplace retirement plans now offer a Roth option—which is great news for you! 1
You'll often hear that a Roth account, whether an IRA or a 401 (k), may be a good option for young investors. That's because, typically, they're currently in a low income tax bracket, and the up-front tax deduction of a traditional retirement account is less valuable now than the tax-free withdrawal of a Roth down the road.
A Roth 401(k) is a type of 401(k) that allows you to make after-tax contributions and then get tax-free withdrawals when you retire. Traditional 401(k)s, on the other hand, allow pre-tax contributions and the withdrawals in retirement are taxable.
Roth IRA: An Overview. Both 401(k)s and Roth IRAs are popular tax-advantaged retirement savings accounts that differ in tax treatment, investment options, and employer contributions. Both accounts allow your savings to grow tax-free.
A big difference between Roth IRAs and 401(k)s lies in their tax treatment. You fund Roth IRAs with after-tax income, meaning your withdrawals are not taxable retirement income. Conversely, you fund 401(k)s with pre-tax income. This makes your 401(k) withdrawals subject to taxation in retirement.
In summary, a Traditional 401(k) uses Pre-Tax dollars are pays income taxes when money is withdrawn from the account. A Roth 401(k) uses After-Tax dollars are no taxes are paid when money is withdrawn.
With a Roth IRA, you contribute after-tax dollars, your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½. With a Traditional IRA, you contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as current income after age 59½.
Key Takeaways. A Roth 401(k) has higher contribution limits and allows employers to make matching contributions. A Roth IRA allows your investments to grow for a longer period, offers more investment options, and makes early withdrawals easier.
If you expect to be in a lower tax bracket in retirement, a traditional 401(k) may make more sense than a Roth account. But if you're in a low tax bracket now and believe you'll be in a higher tax bracket when you retire, a Roth 401(k) could be a better option.
If you're self-employed, or if a 401(k) or 403(b) isn't offered where you work, you may need to choose between a traditional or Roth IRA, or both. While a 401(k), 403(b), and IRA are different types of accounts, the basic principles of a traditional and a Roth account apply to all.
Both accounts are retirement savings vehicles, but a 401(k) is a type of employer-sponsored plan with its own set of rules. A traditional IRA, on the other hand, is an account that the owner establishes without an employer's involvement.
401(K) Plan. An employer established plan similar to an individual retirement account (IRA). It gives a special tax break to employees who are saving primarily for retirement.
You can contribute to a Roth 401(k) as well as a traditional 401(k), and your employer can contribute to both if they offer matching. However, employer matches to your traditional 401(k) go directly into your account, whereas with a Roth 401(k), matched funds are deposited into a separate tax-deferred account.
A Roth 401(k) is an employer-sponsored savings plan that gives employees the option of investing after-tax dollars for retirement. Although you pay taxes on your contributions, withdrawals that you take after age 59½ will be tax-free if the account has been funded for at least five years.
Introduced in 2006, the Roth 401 (k) combines the features of a Traditional 401 (k) and the Roth IRA.
The biggest difference between Traditional 401 (k) and Roth 401 (k) contributions is how your money is taxed.
Now that you have complete clarity about the similarities and differences between these plans, the big question is which plan is the best for you? While there is no single right or wrong answer, the decision is based on several factors.
For those with less familiarity, a “traditional“ 401 (k) is funded with pretax money while a Roth 401 (k) is funded with post-tax money. The only difference between these account types is when you decide to pay your taxes.
Sally placed more total dollars into the tax-deferred account to begin with. For Sam to have $58,500 after taxes in retirement using his traditional 401 (k), he would have had to contribute $27,857 into his account initially.
In retirement, Kate withdraws the $300 but has to pay 30% of it in income taxes. The final (post-tax) money that she can spend in retirement is $210 (or 70% of $300). Roth 401 (k): Kevin earns $100 and pays a 30% tax rate on it to have $70 after-tax.
Despite all the back and forth on which 401 (k) account is right for you, the only right answer is to talk to a tax advisor. Though I can generalize my advice as much as possible, every person’s financial situation is different. There are differences in state tax treatment, differences in income and differences in retirement expectations that all affect what the “right” choice is.
This simple example demonstrates that the Roth 401 (k) is probably the better choice for high savers, as you get more total tax-deferred benefits.