401k vs. Roth 401k: Which is Better?

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

What is the difference between investing with a traditional 401k and investing with a Roth 401k?

The main difference between Roth 401k and 401k lies in the tax treatment. While contributions to a traditional 401k are tax-deductible and withdrawals are taxed, Roth 401k contributions are made with after-tax money, and withdrawals are tax-free in retirement. The choice depends on circumstances like the current tax bracket and future income expectations.

Key Takeaway

  • The difference between a traditional and a Roth 401k is when you pay the taxes, now or in the future. 
  • A Roth 401k benefit provides tax-free income during retirement. 
  • If your employer offers a traditional 401k and a Roth 401k, consider splitting contributions between the two.
  • A Roth IRA annuity’s benefit is tax-free income during retirement for the rest of your life.

Roth Vs. Traditional 401k Calculator

A Roth vs. Traditional 401k Calculator is a valuable tool designed to help you compare the potential long-term benefits of Roth and Traditional 401k plans. By inputting factors such as your age, income, tax rates, and contribution amounts, the calculator estimates your retirement savings under each plan, allowing you to make informed decisions about which option best suits your financial goals and retirement needs.

The difference between a Traditional 401k vs Roth 401k

A Roth 401k and a traditional 401k are two retirement savings plans offered by some employers. The main difference between the two is how contributions and withdrawals are taxed.

  • In a traditional 401k, contributions are made with pre-tax dollars, meaning that the money is taken out of your paycheck before taxes are deducted. This reduces your taxable income in the year you make the contribution, and you don’t pay taxes on the money until you withdraw it in retirement. At that time, the money you withdraw is subject to federal income taxes.
  • In contrast, with a Roth 401k, contributions are made with after-tax money, so you don’t get a tax break in the year you contribute. However, the money grows tax-free, and when you withdraw it in retirement, you don’t have to pay income tax on it, including any investment gains.
The Difference Between A Roth 401K And A Traditional 401K

What Are the Similarities Between a Roth 401k and a Traditional 401k?

A Roth 401k and a traditional 401k are both retirement savings plans offered by some employers, and they share some similarities. Here are a few:

  • Contribution Limits: Both types of 401k plans have the same contribution limits set by the IRS. In 2024, the contribution limit is $23,000 for those under 50 years old, and an additional catch-up contribution of $7,500 is allowed for those 50 or older.
  • Employer Matching Contributions: Employers may offer matching contributions to both types of plans, which can help increase your savings. The amount and terms of matching contributions will vary by employer.
  • Early Withdrawal Penalties: Both plans have penalties for early withdrawals made before age 59 ½. In most cases, you’ll owe a 10% penalty in addition to income taxes on the amount withdrawn.
  • Rollover Options: If you leave your job or retire, you can roll over your 401k balance into another qualified retirement plan, such as an IRA or another employer’s plan. This option is available for traditional and Roth 401k plans.

Paying The Taxes: Today or Tomorrow?

The difference between a traditional 401k and a Roth 401k is when you pay the taxes.

Traditional 401k

  • If you save for retirement with a 401k plan, you will contribute money before the money is taxed. This means you get a tax break when you put your income in.
  • Your money will grow without paying taxes (tax-deferred) until you withdraw your income.
  • If you withdraw money from your account, it is considered ordinary income. You must pay taxes on this money at your current tax rate. Use one of our 401k calculators to see.

Roth 401k

  • With a Roth 401k, you make your contributions with after-tax dollars without a tax deduction.
  • Withdrawals of contributions and earnings are tax-free at 59½, and you’ve held the Roth 401k account for five years.

Should I Take The Tax Deduction?

A tax deduction now can seem like a pretty good deal, but you have to think ahead. You may have less money when you retire because of the ever-increasing tax rates. That means that you will need to save more money for your retirement.

If you end up in a lower income tax bracket when you retire, money taken out of your retirement account could make you go into a higher tax bracket. This means more taxes and less money to live off.

When you retire, your Medicare B premiums could be higher. This is because they are based on your taxable income. However, if you give up the deduction now by choosing a Roth 401k, then when you retire, the withdrawals will be tax-free.

When can I take withdrawals from a 401k and a Roth 401k?

You can generally begin withdrawing from a 401k or a Roth 401k without penalty at age 59 1/2. However, it would be best to start taking distributions, also known as Required Minimum Distributions (RMDs), from a traditional 401k at age 73. If you fail to take the RMD, you may be subject to a 50% penalty on the amount that should have been withdrawn.

For a Roth 401k, there are no RMD requirements, so you can keep the funds in the account for as long as you like. This can be advantageous if you want to continue growing your retirement savings tax-free for as long as possible.

What Are 401k and Roth 401k Contribution Limits?

The contribution limits for a 401k plan and a Roth 401k plan are the same. In 2024, the maximum amount you can contribute to either plan is $23,000 if you are under 50. If you are 50 or older, you can contribute an additional $7,500 in catch-up contributions, bringing the total contribution limit to $30,500.

Should I Roll Over My Traditional 401k to a Roth 401k?

Some factors to consider when deciding whether to roll over to a Roth 401k include the following:

  • Current and future tax rates: If you expect your tax rate to be higher in retirement than now, it may make sense to pay the taxes now and convert to a Roth 401k. On the other hand, if you expect your tax rate to be lower in retirement, it may be better to keep your traditional 401k and avoid paying taxes now.
  • Investment returns: The longer you have until retirement, the more time your investments have to grow tax-free in a Roth 401k. If you have several years or decades until retirement, the potential tax-free growth of a Roth 401k may be a compelling reason to make the conversion.
  • Estate planning: If you leave your retirement assets to heirs, a Roth 401k can be more tax-efficient than a traditional 401k since your heirs won’t have to pay income taxes on the withdrawals.

Utilizing Both 401k and Roth 401k Plans At The Same Time

You may be able to have both a traditional 401k and a Roth 401k and split contributions between the two retirement accounts.

  • In 2024, you can contribute up to $23,000 to a 401k.
  • If your employer offers both traditional and Roth, you can split the $23,000 contribution between the two.
Roth Vs Traditional 401K

What Kinds of Mutual Funds Should I Choose for My 401k and Roth 401k?

Choosing mutual funds for your 401k and Roth 401k depends on your financial goals and risk tolerance. However, here are some general guidelines to consider:

  • Diversification: It’s essential to choose a mix of mutual funds to diversify across different asset classes, such as stocks, bonds, and real estate investment trusts (REITs). This can help reduce your overall investment risk.
  • Expense ratio: Mutual funds charge fees for managing the fund, known as expense ratios. Look for mutual funds with lower expense ratios, as these fees can eat into your returns over time.
  • Performance: Look at the mutual fund’s historical performance over several years to determine its track record. Remember that past performance does not guarantee future results, so it’s important to consider other factors when choosing mutual funds.
  • Risk level: Consider your risk tolerance when choosing mutual funds. Generally, stocks are riskier than bonds, but they also offer the potential for higher returns over the long term. If you have a long time horizon until retirement, you may be able to take on more risk in your investments.
  • Target date funds: Many 401k plans offer target date funds, which are mutual funds that automatically adjust their asset allocation as you approach retirement. These can be a good option for those who want a hands-off approach to investing.

What is the difference between a Qualified Distribution from a traditional 401k versus a Roth 401k?

A Qualified Distribution from a traditional 401k and a Roth 401k differ in tax treatment.

In a traditional 401k, contributions are made with pre-tax income, meaning you don’t pay taxes on the money you contribute to the plan. However, when you withdraw in retirement, the money is taxed as income at your current tax rate.

A Qualified Distribution from a traditional 401k occurs after age 59 1/2, and you won’t be subject to the early withdrawal penalty of 10%. Additionally, you can withdraw the money without paying taxes if it is used for certain qualified expenses, such as medical or higher education.

On the other hand, in a Roth 401k, contributions are made with after-tax dollars, meaning you pay taxes on the money you contribute upfront. However, when you withdraw in retirement, the money is tax-free if you meet specific requirements. A Qualified Distribution from a Roth 401k occurs after age 59 1/2, and the account has been open for at least five years.

Required Minimum Distributions

It would be best to take a required minimum distribution (RMD) from a Roth 401k unless you still work for that employer. After that, you must take RMDs from a traditional 401k plan.

SECURE Act 2.0 made a change to the distribution rules. In 2023, individuals not already 72 can take their first RMD at 73. This is different from before when the age was 72.

Tax-Free Retirement Income For The Rest Of Your Life

If your employer does not offer a Roth 401k, an individual can open a Roth IRA annuity with similar benefits instead. Once the Roth IRA requirements are met, the annuity will distribute a tax-free income for the rest of the retiree’s or married retirees’ lifetimes, even after the Roth IRA annuity has run out of money.

Next Steps

To summarize, regarding retirement savings, both the 401k and the Roth 401k have benefits and drawbacks. It’s important to remember that no one plan is suitable for everyone, so consider your individual needs when deciding what option is best for you. All this being said, getting straightforward advice from a professional can help you determine which type of retirement account would benefit your particular circumstances. If you want tailored financial advice based on your personal retirement goals and risk tolerance, request a free quote from a knowledgeable financial advisor today. With proper planning, you can develop a savings strategy that will enable you to retire comfortably and secure your future.

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Frequently Asked Questions

Is there a downside to Roth 401k?

One potential downside to a Roth 401k is that contributions are made with after-tax dollars, reducing your take-home pay in the short term.

Should I do 401k or Roth 401k deferral?

It depends on your individual financial goals and tax situation. Factors to consider include your current tax rate, expected future tax rate, and retirement goals.

Is it wise to have a 401k and a Roth?

Yes, it can be wise to have both a traditional 401k and a Roth 401k to diversify your retirement savings and manage your tax liability in retirement.

How do I convert my 401k to a Roth 401k?

To convert a traditional 401k to a Roth 401k, you typically need to contact your plan administrator and request a rollover. In addition, you’ll need to pay taxes on the amount of the conversion in the year that you make the conversion.

Is it worth contributing to Roth 401 K?

You can contribute to a Roth 401k anytime if your employer offers it, and you are eligible to participate.

What are the benefits of saving more in a Roth or 401k?

Saving more in a Roth or traditional 401k can provide significant benefits for retirement savings, including tax-deferred or tax-free growth of investment earnings and potential employer-matching contributions. The optimal choice will depend on individual financial goals and tax situation.

Can I have a Roth 401k and a Roth IRA?

Yes, you can have both a Roth 401k and a Roth IRA.

How does choosing a Roth 401k versus a traditional 401k affect someone in a higher tax bracket regarding tax-free withdrawals in retirement?

Choosing a Roth 401k means tax-free withdrawals in retirement for someone in a higher tax bracket; traditional 401k withdrawals are taxed.

What are the income limits for contributing to a Roth 401k versus a traditional 401k?

Roth 401k and traditional 401k have the same gross income limits for contributions, which the IRS determines.

How does choosing a Roth 401k versus a traditional 401k affect tax deduction?

Choosing a traditional 401k allows tax deductions for contributions; choosing a Roth 401k does not.

How should I split my 401k contribution?

How you split your 401(k) contribution depends on your financial goals, risk tolerance, and investment horizon. Generally, it is recommended to diversify across asset classes (stocks, bonds, cash). Younger investors might lean heavier into stocks for growth, while older investors might prioritize stability with more bonds. Always consult a financial advisor.

What are the advantages of a Roth 401k?

A Roth 401(k) offers tax-free withdrawals in retirement, allowing savings to grow and be accessed tax-free, provided conditions are met. Contributions are made with after-tax dollars, benefiting those anticipating higher retirement taxes. It has no income limits for contributions, higher contribution limits than a Roth IRA, and it allows for employer matching, enhancing employee retirement savings potential.

Can I contribute to a Roth 401k and a traditional 401k?

Yes, it is possible to contribute to both a Roth 401(k) and a traditional 401(k) simultaneously. However, you must consider the annual contribution limits and your eligibility for each type of account. Consulting a financial advisor can help you determine the best allocation for your retirement savings.

Should I split my 401k between Roth and Traditional?

If you can afford not to take the tax-deductible contribution of a traditional 401k, splitting between a Roth and a traditional 401k is an excellent strategy, as taxes will likely increase over time.

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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