What are the differences between traditional 401(k) and Roth 401(k) plans?

If you're saving for retirement, you may have heard of 401(k) plans. These employer-sponsored plans allow you to save money for your future with tax benefits. But did you know there are two types of 401(k) plans: traditional and Roth?

The main difference between traditional and Roth 401(k) plans is how they are taxed.

With a traditional 401(k), you contribute money from your pre-tax income. You lower your annual taxable income and pay less taxes now. However, when you withdraw money from your traditional 401(k) in retirement, you must pay taxes at your ordinary income tax rate.

With a Roth 401(k), you contribute money from your after-tax income, so you don't get any tax deductions now. However, when you withdraw money from your Roth 401(k) in retirement, you don't have to pay any taxes as long as you follow the rules. This means that your Roth 401(k) grows tax-free, and you can enjoy the full benefit of your savings.

So which one is better for you? It depends on your situation and preferences. Some factors to consider are:

1. Current and Expected Future tax rates: If you expect to be in a higher tax bracket in retirement than you are now, a Roth 401(k) may be better for you since you can lock in a lower tax rate now and avoid paying higher taxes later. On the other hand, if you expect to be in a lower tax bracket in retirement than you are now, a traditional 401(k) may be better for you since you can defer taxes until later and pay less taxes overall.

2. Eligibility for other retirement accounts: If you are eligible for a traditional IRA or a Roth IRA, consider contributing to those accounts. A traditional IRA works similarly to a traditional 401(k) but has lower contribution limits and different income limits. A Roth IRA works similarly to a Roth 401(k) but has lower contribution limits and different income limits. Depending on your situation, you can save more money by combining different types of accounts.

3. Flexibility and Preferences: Some people prefer the simplicity and certainty of a Roth 401(k) since they don't have to worry about taxes in retirement and can withdraw their money anytime without penalties (after five years of participation). Others prefer the flexibility and control of a traditional 401(k), since they can adjust their taxable income by choosing how much to withdraw each year and defer taxes until later.

There is no one-size-fits-all answer to which 401(k) plan is best for you. Compare the pros and cons of each option and see how they fit your goals and circumstances. Our mentors can provide personalized advice and answer questions about Roth, Traditional 401(k), and other retirement accounts. With our Mentors, you can feel confident in your retirement planning decisions. Get started with a free account today!