Roth 401(k) vs. Traditional 401(k): 6 Questions to Help You Decide Which Is Best for You

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You’re familiar with Roth IRAs, but did you know about Roth 401(k)s?



Introduced in 2006, decades after the traditional 401(k) was introduced in 1980, the Roth 401(k) is now a retirement savings option at nearly 70% of companies that offer traditional 401(k) plans.

The difference between the plans is when you pay taxes on your savings.

With a traditional 401(k) plan, you don’t pay taxes on the money you put into the plan, but you must pay taxes when you withdraw. On the contrary, with a Roth 401(k), you have to pay taxes on the money you make contributions with, but you pay no income taxes on it when you withdraw.

$10,000 in the Roth account will pay $10,000 worth of your bills. But the $10,000 in pretax money in a traditional account is not going to pay $10,000 of your bills because Uncle Sam’s going to take a chunk of that when you withdraw it.

Other than the tax treatment, nearly everything else between traditional and Roth 401(k)s is the same:

  • A contribution limit of $19,500 (plus $6,500 if 50 or older) applies to both. That is the total aggregate limit across both accounts, not for each one.
  • The deadline to contribute to either account for the year is December 31.
  • Your company’s match funds will go into the pretax/traditional account, no matter which account you designate for your own contributions.
  • You’ll have access to the same investment options with either account.
  • Your money grows tax-free in both.
  • With both accounts, you must start withdrawing money at age 72 (recently increased from 70½), unless you’re still working.

6 Questions to Help You Decide Which 401(k) Is Best for You

These questions can help you pinpoint which account is the best option. They are in order of priority, so you can use them as a decision tree.

1. Does my employer’s retirement plan have a Roth 401(k) option?

If your company doesn’t offer it, you can’t contribute to a Roth 401(k). What you can do is lobby your human resources team to add a Roth component in the future.

2. Will one account result in a higher company match?

Typically, it doesn’t matter — you’ll get the same matching amount whether you choose a Roth or traditional 401(k). But there are two situations where it makes a difference:

One is that your employer doesn’t match Roth contributions. Some companies only match contributions to a traditional 401(k), not a Roth. This is very uncommon, but it’s important to ask about it since the match is so valuable. If this is the case with your employer, a traditional 401(k) is the better choice.

Second is that you can only contribute enough to get the full match with the help of the tax deduction. Contributing to a traditional 401(k) means lower taxes now. If saving on taxes frees up additional money to contribute to your 401(k), and that money in turn triggers more matching dollars from your employer, go that route.

That can really tilt the table in favor of a traditional 401(k). If paying tax now, by choosing a Roth, results in you making a smaller contribution and getting a smaller match from your employer, chances are, that’s not worth the tax benefit.

3. How many years am I from retirement?

The longer you have for your money to compound, the more a Roth makes sense.

Think of a snowball rolling down a really long hill. Do you want to pay taxes at the top of the hill when the snowball is the size of your fist? Or do you want to pay taxes at the bottom of the hill, when the snowball is the size of a car?

4. How does my current tax rate compare to my tax rate in retirement?

This is the big question. Obviously, you want to pay taxes at the lowest rate possible, but it’s tricky to predict whether your taxes will be lower now or when you retire.

No one knows what tax rates will be in the future. However, there are situations where you can make an educated guess.

  • Are you on a career path that leads to substantial earnings later on? Your tax bracket may be low by comparison now, making the Roth a good choice.
  • Are you close to retirement and in your peak earning years? Likely you’re in the highest tax bracket you’ll ever have, and a traditional 401(k) contribution would be better.
  • Are you working less and earning less as you transition into retirement? These might be the years to pile up money in a Roth 401(k) because you’re in a lower tax bracket than when you were working full-time.


5. Has my income shifted substantially recently?

Many Americans dealt with periods of unemployment or reduced income in 2020 and even 2021. If you’re one of them, you might be in a lower tax bracket than you’ve been in in a while, so it would make sense to put as much into the Roth this year as you can while you’re in the lower bracket.

This recommendation highlights another key point: You can, and should, reassess your contributions on a year-by-year basis. In low-income years, the Roth may make more sense. In high-income years, a traditional 401(k) may make more sense.



6. How much do I already have in each type of account?

For most people, there’s a big imbalance. Because traditional 401(k)s have been available longer, it’s common to have more money in those.

However, that can cause some trouble when you take out the money, which you are required to do through required minimum distributions at age 72. If all of your assets are built on a pretax basis, you’re setting yourself up for a big tax bomb later.

One way to avoid this tax bomb is to have a decent chunk of money in both traditional and Roth accounts, pulling from each as needed to keep you from being bumped into a higher tax bracket.

If your traditional and Roth assets are imbalanced, include any IRAs you have in this calculation as well, consider tilting your contributions to the less-funded account to give yourself more options in retirement.



Still Can’t Decide? You Can Always Do Both



If you want to cover your bases, you can contribute to both traditional and Roth 401(k) accounts at once.

It’s not all or nothing. You can have one foot in each camp.

The contribution limit for 2021 is $19,500 (plus an additional $6,500 if you’re 50 or older) total — that’s for both types of 401(k) accounts, not for each one.

Keep in mind that all company matching funds go into the traditional 401(k) account.

So if your aim is to fund both accounts at an equal level, you’ll need to tilt your personal contributions in favor of the Roth.

For example, if you ultimately want 15% of your salary to go into your 401(k), and your company offers a 3% match, you’ll need to contribute 7.5% to the Roth and 4.5% to the traditional.


The Takeaway



Both Roth and traditional 401(k)s will provide you with substantial tax savings, so there’s no “wrong choice.”

In the effort to optimize for your situation, don’t lose sight of the big picture.

The hard part is doing the contributing, contributing as much as you can, and then investing that appropriately. The decision between pretax and Roth is more of diversification of your future tax exposure. Don’t let that overwhelm you to the point where you’re not contributing at all, or not contributing as much as you could.