How to choose between a Roth 401(k) and a Traditional 401(k) - CCCU
Wednesday, February 27 CCCU
How to choose bewteen a Roth 401(k) and a Traditional 401(k)
Pay taxes now, or later? In this piece we break down the determining factors that will help you choose between a Roth 401(k) and a traditional 401(k). Learn more about how to determine what makes the most sense for you, based on your current financial status, employer matching plan, IRA, and more.
While most of us have heard of a traditional 401(k), the new Roth 401(k) option can be a bit perplexing. In this blog post, we’ll explain the differences, advantages and disadvantages of both options, as well as some factors that may impact which one you should choose. Read on for more details!
The difference between a Roth 401(k) and Traditional 401(k)
Simply put, a traditional 401(k) means you're paying taxes later, while a Roth 401(k) means you pay taxes now. Both accounts offer individual benefits. If you choose to go the traditional route, you can get a tax break when it comes time to pay your taxes this year. However, later, when you remove the money, you may be charged more depending on how your financial situation and tax brackets change throughout the years.
Should I pay taxes now or later?
This depends on what you are expecting in the future. The simple rule has to do with how much you are making now, and how much you expect to make in the future.
If you are expecting to move to a higher income and higher tax bracket, a Roth 401(k) tends to make the most sense. Whether you are early in your career, intending to move to a more financially rewarding profession, or simply think that over time your taxes may rise, it may be more advantageous to pay the taxes now.
If you are expecting to stay at the same rate or have your income decrease in retirement, a traditional 401(k) may be the best choice.
As always, this should be discussed with your financial advisor and HR personnel at any business you are working with. With the advice of multiple people, as well as doing your own research, you can choose the option that works best for you.
Another option, if you can, is to contribute to both. This way you are diversifying where your money is going and giving it the chance to grow in both places.
Other things to consider when choosing between a Roth 401(k) and a Traditional 401(k)
As you consider your options, thinking about which makes the most sense hinges on several factors. Contribution limits, taxes, and fees all play a role.
If there’s an employer match difference in traditional versus Roth, choosing whichever gets the better employer match is ideal, as it is free money.
If the fees on your 401(k) account are high, this can mean a less impressive return on investment. Make sure to pay close attention and take into account what the impact of these fees may be on your overall takeaway.
Depending on the type of account, as well as your age, limits may vary. Make sure you’re checking up on current rates, as they periodically get adjusted.
Roths and traditional IRAs are a great additional option for adding to your retirement savings. They can be use in conjunction with your 401(k), and can help you maximize the impact of your savings. Curious about where to start? Learn more here
Finally, remember that ultimately you are making a great choice by contributing to either of the plans. Even if it feels complicated or difficult now, your hard work and savings will pay off in the future.