By Adam Shell of Kiplinger’s Personal Finance
Question: My employer is giving me the choice to contribute to a Roth 401(k) or a traditional 401(k). How can you decide which is best for me?
Answer: Any investment in Roth 401(k) vs 401(k) is taxable. As Americans today’s pensions disappear, it’s standard to save either type of 401(k). However, the 401(k) comes in two different flavors. And that means that the Saber must do a story of a comparison of two optional tapes: traditional vs. Ross 401 (k).
Nilay Gandhi, senior wealth advisor at Vanguard, said both 401s (ks) are “a good retirement savings vehicle.” But which one is correct for you?
Roth 401 (k) vs. 401 (k)
Let’s start with the commonalities of the two 401(k). The contribution limits are the same. In 2025, you can donate $23,500 (an increase of $500 from 2024). Savers over 50 can take up to $31,000 (up from $30,500 in 2024). Due to the special super catch-up provisions in Secure 2.0 (safe communities refer to setting up all communities to enhance retirement), savers ages 60-63 could potentially donate up to $34,750 in 2025.
However, the major difference between the two types of 401(k)s is that they are tax treatment. Or paying taxes to the IRS. Using the traditional 401(k) will defer taxes until later, but using the Roth 401(k) will pay taxes in advance.
“This is a trade-off,” said Rob Williams, managing director of financial planning at Charles Schwab. “You’ll be taxed or taxed in advance when you withdraw money.” (The IRS allows for penalty-free withdrawals from both the traditional 401(k) and Roth 401(k)s after the age of 59½).
The difference between Ross and the traditional 401(k)
The traditional 401(k) is funded in pre-tax dollars deducted from your salary, allowing for immediate tax deductions. “If you put money in a traditional 401(k), that income is not included in your taxes,” Williams said. “It’s a prepaid tax system.” So, if you make $100,000 and donate $10,000 to 401(k) this year, your taxable income will be reduced to $90,000. However, there is no free lunch. If you withdraw money when you retire, you will be paying income tax at your normal income rate.
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In contrast, Roth 401(k)s is funded in dollars already taxed. However, the power of Roth 401(k) is that tax exemptions can be revoked upon retirement. Additionally, Roth 401(k), a relative of Roth Personal Retirement Account (IRA), tends to be used more frequently than traditional 401(k), but 80% of 401(k) plans managed by Fidelity Investments offer the Roth 401(k) option. However, only 15% of Fidelity 401(k) participants contributed to the Roth IRA.
How to choose between Ross and the traditional 401(k)
When determining the traditional one and Loss 401(k), you need to identify the current tax rate and estimate the potential tax rate for retirement. Other factors that may affect your decision include what your income will look like at retirement, how your cash flow will be during the savings year, whether you are expecting a large inheritance that could potentially be placed in a higher tax range later in your life, and whether you have a Loss 401(k).
The final point is important for those who choose the Roth 401(k) option later in life. reason? You will not be eligible for a penalty-free withdrawal until you have opened an account for at least five years.
That’s all about tax provisions in the future.
But the most important information is related to your personal tax situation, says Gandhi. “Do you think you’ll be in a higher or lower tax bracket in the future than you are today (for example, during your retirement)?” Gandhi said.
The answer to that question is important due to the different tax treatments of traditional vs. Ross 401(k).
The rule of thumb is that if you think you’re retired and in a lower tax range than you are now, the traditional 401(k) makes more sense. why? You will be paid less tax on withdrawing your 401(k) at retirement. Plus, when tax rates get higher, you can enjoy tax credits here and now.
In contrast, if taxes are likely to be higher at retirement (often for young 401(k) savers who think they will be lower in salary or that Congress will increase tax rates in the future). Reason: You don’t pay taxes on your Roth 401(k) withdrawals, so you can minimize taxes on other forms of income and avoid jumping into higher taxes.
How are RMDs different?
The Roth 401(k) has another advantage. Starting this year, thanks to the Secure 2.0 Act, you no longer need to get the required minimum distribution (RMD) from the Roth 401(k) during your lifetime. However, traditional 401(k) savers are eligible for RMD. The minimum distribution required is the minimum amount that IRA and retirement plan owners must withdraw annually after reaching age 73.
“It gives you a lot more flexibility (the Loss 401(k) account holder) because it’s not forced to withdraw,” Williams said.
Roth 401(k) offers tax diversification
Having a portion of your retirement savings in Roth 401(k) can also benefit from “tax diversification.” If you have multiple sources of income for your retirement, such as the traditional 401(k), taxable securities accounts, cash savings, and Roth 401(k), for example, you have more flexibility in deciding which accounts to withdraw to minimize your tax burden. Let’s say you need $50,000 for a down payment for a villa or a new electric car. Cutting the full amount from the traditional 401(k) will increase your taxable income by $50,000, which could boost you with a higher tax system.
However, if you have enough savings on a Roth 401(k), you can get an RMD and withdraw the remaining money you need from a Roth 401(k), making your large purchases more tax-efficient.
“We call it a tax harvest,” Williams said. He mentioned strategies to withdraw from more tax-efficient accounts to avoid generating additional revenue that could boost the tax bill. “What you’re doing is diversifying your tax risks and providing more flexibility when you leave.”
Can contribute to both the Ross and the traditional 401(k)
Future tax rates are difficult to predict, so there’s nothing that says that bets cannot be hedged by contributing both traditional and Loss 401(k), Williams adds. Even if you go this route, you will still need to comply with the maximum contribution restrictions imposed by the IRS. For example, you can’t take $23,500 for a traditional 401 (k) or $23,500 for a Roth 401 (k).
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The views and opinions expressed are those of the author. They are for general informational purposes only and should not be interpreted or interpreted as recommendations or solicitations. Epoch Times does not provide investments, taxes, legal, financial planning, real estate planning, or other personal financial advice. Epoch Times is not responsible for the accuracy or timeliness of the information provided.
