Roth Vs. Traditional: Which 401(k) is Right for You?

Planning for retirement can be confusing: Which investments do I pick? How much do I contribute (always enough to get the match if one is offered!)? What does asset allocation even mean? This process can be complex to navigate even when you just have one option: the traditional 401(k) plan, in most cases. But...your employer may even offer another option: The Roth 401(k). 

The Roth is becoming an increasingly popular addition to employers' retirement plan options: Since its inception in 2006, the percentage of employees contributing to a Roth when it's made available continues to grow. So, what can make the Roth a better choice for some people over the traditional 401(k) we've come to know so well? Choosing between these two options may not be as difficult as you think. Here's the breakdown: 

Traditional 401(k)

• Pre-tax contributions: When you contribute money to this type of 401(k), it's before withholding taxes, which means you're receiving a tax benefit today. When you start taking money out of your account, you'll pay income tax on it based on the tax bracket you fall into for that calendar year.

  In 2024, you can contribute a maximum of $23,000 annually, and if you're at least 50 years old, you can contribute an extra $7,500 for a total of $30,500, reducing your tax liability in the current year. These limits may increase slightly in 2025 due to cost-of-living adjustments, so check for updates closer to the new tax year.

Roth 401(k) 

• After-tax contributions: When it comes to Roth, you are saving money after taxes have already been taken out, which means you are delaying your tax benefit until down the road. When you take the money out in retirement, there will be no additional tax consequences (State, Federal, or capital gains, under current IRS law).

  However, if your company offers a match, those match contributions are required to be made on a pre-tax basis. If you are getting a match for your Roth investments, it will work the same way your pre-tax match works according to your retirement plan's Summary Plan Description (SPD). Confirm with your HR team if you're unsure about your company’s matching formula.  

  The same contribution maximums apply for Roth as for the traditional 401(k). You can designate savings as Roth, pre-tax, or a combination of the two as long as they don't surpass these dollar limits. 

Which is right for you?

When it comes to deciding between Roth vs. traditional 401(k), the strategy is essentially about one thing: Which one allows you to pay the least amount in taxes over your lifetime?

If you're in a lower tax bracket and aren't a high earner, Roth may be the smarter option since you're paying taxes upfront. This makes it an excellent choice for younger employees, those just starting their careers, and those who haven't reached their full earning potential yet. For younger savers, or those who are ahead of track in saving for retirement, allocating at least a portion of contributions into the Roth is preferable. Plus, you'll benefit from all the years ahead of tax-free compounding interest and growth on your investments.

If you expect your income to remain fairly stagnant throughout your career or anticipate higher tax brackets upon retirement, you should also lean toward Roth contributions.

Conversely, if you're a high earner, you will likely benefit more from the immediate tax breaks that a traditional 401(k) offers. For those in a higher tax bracket today, who may not be fully on track to replace 100% of their needed income in retirement (i.e., living off of less when they stop working, adjusted for inflation), saving into a pre-tax account is preferable. For example, if you've been contributing to a Roth and are nearing retirement, it may be a good time to reevaluate switching to a traditional 401(k) to maximize your tax efficiency at the height of your earning capacity. If you'll be living on less in retirement, it often makes sense to pay taxes on your investments later while taking advantage of current pre-tax benefits.

The Roth 401(k) is undoubtedly a great tool for retirement savings, with benefits touted by many professionals in personal finance. However, it’s not always the best choice. While the Roth makes a lot of sense for employees in their 20s or early 30s, the ultimate decision depends on whether you're ahead or behind in saving enough for a secure retirement.

As always, your unique circumstances will determine the best strategy for you. Don't rule out the Roth if your employer offers it—it’s an excellent option, especially for younger employees or those expecting significant growth in income over time.

The above material is provided for informational purposes only and should not be construed as advice. For more information on this topic or your particular circumstances, please consult your financial professional. We do not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.