Traditional Vs. Roth 401(k): How to Choose the Best Retirement Plan

Are you an investor or soon-to-be investor attempting to understand the difference between traditional and Roth 401(k) plans? You’ve come to the right place! In this video, you'll break down everything you need to know about both of these retirement savings options and uncover why certain investors prefer one over the other, as well as discuss which type of plan could be best for your financial situation. Get comfy—we have all the information you need in order to make a decision that works for you.

Video Transcript: 

Most people are familiar with the advantages of a traditional 401k where you can save money for your retirement before it is taxed. This helps reduce the taxes you pay today. Instead, you pay income taxes during retirement. When you withdraw money from your account. A Roth 401K operates in the reverse.

You may contribute to the Roth with money that has already been taxed. The upside is that you don't pay taxes when you withdraw money from the account later on. So the key difference between traditional and Roth is when you pay taxes on your money, you have a choice. Make tax-free contributions now or receive tax-free withdrawals later.

Here's a simple way to look at it: A traditional 401K means that you pay income taxes on withdrawals. A Roth 401K means that you pay income taxes on contributions. How do you decide which approach to take? The goal is to pay less money in taxes, so consider your current tax bracket and whether you think it will be higher or lower during your retirement years.

The general rule of thumb is that if you think your tax rate will be higher when you retire than it is now, a Roth contribution may be preferable because withdrawals will be tax-free, but if you're betting that your tax rate will be lower in retirement than it is now, a traditional 401k contribution may be more suitable because you'll pay a lower tax rate on the money you withdraw.

People in their early careers may consider contributing to a Roth account because they expect their income to rise over time. That means their tax bracket will rise as well. So they may be better off paying taxes now and receiving tax-free withdrawals later. But if you're looking to lower your taxable income today, a traditional 401K contribution is more suitable for you.

A third option would be to split your contributions between a traditional and a Roth account. With this approach, you'll invest your savings in different buckets, which can help diversify your options and give you more flexibility with your income during retirement. Regardless of the approach you take, saving in your company's retirement plan is a sure way to jumpstart your retirement savings.