15 Sep Roth 401(k)—What’s the difference and how do I choose?

In today’s workforce, 401(k) plans are the #1 retirement savings tool for employers and employees alike. From the employer perspective, it’s great for workplace engagement and talent retention. Employees recognize the benefit but often remain unaware of the different plan types that may be available. Saving any amount is always better than none at all, but strategically selecting the most beneficial plan type for your particular circumstance can be a huge advantage when all is said and done. Don’t worry, we’re here to help!

Two of the most popular plans are the Traditional 401(k) and Roth 401(k). The primary difference between the two is when and how your money is taxed. With a Traditional 401(k), employee contributions come out of your check before taxes are calculated. For instance, if your paycheck is $1,000 and you contribute $100 to your retirement account, you only pay income tax on the remaining $900. With a Roth 401(k) however, you do not receive any income tax benefits at contribution. Therefore, if your paycheck is $1,000 and you contribute $100 to your retirement account, you still pay income tax on the entire $1,000. For delaying that benefit, however, with a Roth 401(k) no taxes will be due at the time you make a qualified distribution (after a 5 year wait and at age 59 1/2 or older). This means that the gains you’ve made in your account over the years are 100% income tax free. With a traditional 401(k), on the other hand, you will pay income tax on all gains.

So which plan type is best for you? The general rule of thumb is that a Roth account is advantageous for younger employees and those starting out in a new career, and a traditional pre-tax account is advantageous for those in their peak earning years and nearing retirement. In the middle, factors may vary significantly from person to person. It’s important to note that it doesn’t have to be an either/or situation—you can split your contributions however you’d like, and your future self may thank you for setting up this tax diversification!