It can be tough to know where to start if you’re trying to decide whether a Roth 401(k) or Traditional 401(k) is right for you.
According to RetireWire.com, “There’s 5.4 trillion dollars in IRA’s Assets in IRA’s have grown 10% per year. Nearly 49 million households have a traditional IRA”.
You can see great potential for return, especially in the long run.
Both the Roth 401(k) and the Traditional 401(k) have their pros and cons, and it cannot be easy to figure out the best option for your specific situation.
This post may contain affiliate links; please see our disclaimer for details.
If you prefer to watch my video instead, you can check out my YouTube video!
Table of Contents
What is a Roth 401(k)?
A Roth 401(k) is a retirement savings account that offers tax-free growth and tax-free withdrawals in retirement.
Roth 401(k)s are funded with after-tax dollars, which means you won’t get a tax deduction for your contributions. However, all earnings and withdrawals are tax-free in retirement.
Roth 401(k)s are an excellent way to save for retirement, especially if you’re in a high tax bracket now and expect to be in a lower tax bracket in retirement.
They are also a good choice if you’re young and have many years to let your money grow tax-free.
However, Roth 401(k)s are not right for everyone. If you’re in a low tax bracket now and expect a higher tax bracket in retirement, you may be better off with a traditional 401(k).
With a traditional 401(k), you get a tax deduction for your contributions now, but you’ll pay taxes on your withdrawals in retirement.
What is a Traditional 401(K)?
A traditional 401(k) is a retirement savings account that offers tax-deferred growth and taxable withdrawals in retirement.
Traditional 401(k)s are funded with pre-tax dollars, which means you get a tax deduction for your contributions. However, all earnings and withdrawals are taxable in retirement.
With a traditional 401(k), you get a tax deduction for your contributions now, but you’ll pay taxes on your withdrawals in retirement.
When you are ready to retire, you may be in a higher tax bracket and owe more taxes on your withdrawals.
However, traditional 401(k)s may not be the best choice for everyone. If you’re in a high tax bracket now and expect a lower tax bracket in retirement, you may be better off with a Roth 401(k).
Related Content: Roth IRA vs. Traditional IRA | The Ultimate Guide
Related Content: How To Manage Your Money Using The 50/30/20 Rule
What Is the Difference between the two?
The main difference is that Roth 401Ks offer tax-free growth, while traditional 401Ks offer tax-deferred growth.
Tax-free growth: You will never have to pay taxes on the money you contribute or the earnings it generates.
Tax-deferred growth: You won’t have to pay taxes on the money you contribute or the earnings it generates until you withdraw it from your account.
The Roth 401K is unique because it allows you to contribute after-tax dollars to your retirement account. This means that when you retire and begin taking distributions, you won’t have to pay any taxes on the money you withdraw.
A traditional 401K, on the other hand, uses pre-tax dollars. This means you will be taxed on the money you withdraw from your account when you retire.
Should You Choose A Roth 401(K) or a Traditional 401(K)?
The Roth 401(k) was created in 2006 as an addition to the traditional 401(k). Both types of accounts are employer-sponsored retirement savings plans that offer tax advantages.
So, which is better for you? Roth or traditional?
Questions to First Ask Yourself:
- When do you plan on retiring?
- What is your tax rate now?
- What do you think your tax rate will be in retirement?
- How much money do you think you will need in retirement?
- What is your investment strategy?
- Are you comfortable with the idea of having your money invested for the long term?
The Roth 401(k) offers more flexibility and tax-free growth, while the traditional 401(k) offers tax-deferred growth.
Consider your retirement goals, tax situation, and investment strategy when deciding between a Roth 401(k) and a traditional 401(k).
What are Roth 401(k) and Traditional 401(k) Contribution Limits for 2022?
These two accounts share the same contribution limits for 2022 at $20,500.
Can I contribute to both a Roth 401(k) and a Traditional 401(k)?
Yes, you can contribute to a Roth 401(k) and a traditional 401(k), but your total contributions cannot exceed the $20,500 limit.
For example, if you’ve already contributed $10,000 to your Roth 401(K) this year, you can only contribute an additional $10,500 to your traditional 401(K).
M1 Finance is a great investment opportunity with its robust yet simple app. There are ZERO commissions or account management fees.
Deposits $1,000 or more into your M1 Invest account within two weeks of signing up and get a cash bonus of $30-$500 to that account.
It is not just a trading stock brokerage account but also offers an IRA option that allows you to invest in your retirement.
We highly recommend using M1 Finance to open a brokerage or retirement account! M1 Finance can undoubtedly help you on your financial independence journey.
In Conclusion
Choosing between the two options depends on your circumstances. If you think you will be in a higher tax bracket in retirement, then a Roth 401(k) can offer significant tax savings.
If you are young and just starting your career, you may be in a lower tax bracket now than when you retire. The traditional 401(k) can offer significant tax savings.
Deciding Based On Your Tax Bracket: Roth 401(k)s offer tax-free growth and tax-free withdrawals in retirement, which can result in significant savings over the traditional 401(k).
Talk to a financial advisor if you’re unsure which is right for you. They can help you determine the best option for your unique circumstances.
Disclaimer:
We hope the information in this article provides valuable insights to every reader but we, the Biesingers, are not financial advisors. When making your personal finance decisions, research multiple sources and/or receive advice from a licensed professional. As always, we wish you the best in your pursuit of financial independence!
