The main difference is the income taxes you pay for your contributions. With a traditional 401 (k) plan, you pay income taxes on any contribution or profit you withdraw. With a Roth 401 (k), income taxes only apply to your earnings, since you've already prepaid the money you put into the account. A Roth 401 (k) is a type of 401 (k) that allows you to make contributions after paying taxes and then withdraw money tax-free when you retire.
Traditional 401 (k) plans, on the other hand, allow pre-tax contributions, and retirement withdrawals are taxable. A Roth 401 (k) is a relatively new addition and allows you a different type of tax relief. With a Roth 401 (k) plan, you'll make after-tax cash contributions, so you won't get a tax break today. In exchange, any money you withdraw during retirement will be tax-free.
This example shows that a Roth 401 (k) is probably the best option for those who save a lot, as they get more total benefits from tax-deferred. Second, people who save a lot may find that they can't take advantage of some of the options of using a traditional 401 (k) plan. For example, you can convert a traditional 401 (k) plan with a high account balance into a Roth IRA. However, this conversion may place you in a higher tax bracket than you originally planned, meaning you are losing out on tax advantages.
If the answer is lower, then a traditional 401 (k) plan would make more sense. However, if you expect to have a higher tax rate during retirement, a Roth 401 (k) may be the best option. If your company allows you to choose between a traditional 401 (k) and a Roth 401 (k), try to assess whether the initial tax relief of the traditional plan is likely to outweigh the secondary benefits of the Roth. A traditional 401 (k) plan is funded with pre-tax money, so you pay taxes when you retire, while a Roth 401 (k) plan is funded with after-tax money, so that during retirement, withdrawals are tax-free.
However, if you start saving for retirement late or have started working for a new employer around age 59 and a half, you may want to stick with a traditional 401 (k) plan to avoid this 5-year rule. When a Roth 401 (k) maxes out, more dollars are deposited in total into a tax-deferred account than if the maximum limit of a traditional 401 (k) were exhausted. In addition, if you don't plan to use the funds yourself, you can convert a Roth 401 (k) to a Roth IRA to meet the 72-year minimum distribution requirement. I generally recommend customers contribute to a traditional 401 (k) plan because a Roth doesn't have the same conversion option.
For many of us, the added flexibility associated with a traditional 401 (k) plan is what, in my opinion, makes it the employer's preferred retirement plan. By choosing a traditional 401 (k) plan during these high-income years, you'll get a tax deduction right now, when it benefits you most. If you can commit to investing the tax savings of a traditional 401 (k) contribution, this debate is mainly focused on comparing your current tax bracket with your future tax bracket. Using both accounts, especially if you're not eligible for a Roth IRA due to income limits, can allow for tax diversification during retirement.
Even if you don't expect to earn more, tax rates across the country are expected to rise, and such an increase could make the Roth 401 (k) more attractive today. A traditional 401 (k) plan is the original version of the plan and is usually simply referred to as 401 (k). With a Roth 401 (k), you'll enjoy not only tax-free growth in your investment earnings, but also tax-free withdrawals. .