Roth vs. Traditional 401(k): Weighing Your Retirement Savings Options
The 401(k) was built on a simple idea – set aside money from each paycheck to save for tomorrow and get a tax break today. However, many workers now have another option – save the tax break for tomorrow too. Enter the Roth 401(k), a relatively new retirement tool funded with after-tax money that grows tax-free in the years after. In many ways, it resembles the Roth IRA but allows workers to save significantly more, thanks to the company match.
With thousands of companies offering Roth 401(k)s as part of their retirement plans, there’s no shortage of options for workers looking to secure their financial future. But the decision between Roth and traditional 401(k)s can be complex and daunting. To make the right choice, you must consider various factors, such as current spending, future taxable income, life expectancy, and other unpredictable variables.
Sharon Lee, a 48-year-old engineer with the U.S. Navy, found herself seeking guidance from a financial advisor when evaluating her retirement income projections. Despite being math-savvy, she felt unsure about understanding all the variables involved.
While the Roth option adds complexity, it can potentially lower lifetime tax bills and leave more money for retirement or heirs. Tax-free withdrawals from Roth accounts can supplement taxable income in years when retirees would otherwise face higher tax brackets. Starting in 2024, Roth 401(k)s will also be exempt from required distributions, unlike traditional accounts.
Roth 401(k)s are accessible to employees across all income levels, including high earners who are ineligible for Roth IRAs. However, this doesn’t mean everyone should contribute to a Roth. It’s generally more suitable for those who anticipate higher tax rates in retirement, particularly younger workers with increasing incomes.
For mid-career workers, predicting future tax rates can be challenging. Changes in circumstances, such as moving to a different state or working during retirement, can impact tax considerations.
Surprisingly, only 17% of workers with access to Roth 401(k)s made contributions to them last year, according to Vanguard Group.
When to Consider a Roth:
- If you expect higher tax rates in retirement.
- If you believe tax rates are heading higher.
- To leave your 401(k) to heirs.
- To protect your spouse from higher tax rates.
- To maximize your savings.
On the other hand, a traditional 401(k) may be more suitable for peak-earning workers, especially when planning for opportunities to convert savings into Roth accounts at a lower tax cost. Various strategies, such as mega-backdoor Roth conversions, can help high earners build tax-free retirement savings while benefiting from tax breaks.
In uncertain times, dividing contributions between Roth and traditional 401(k)s can be a smart hedge against unpredictable tax scenarios. Even a small portion in a Roth account can provide flexibility during retirement, helping retirees avoid higher tax brackets and Medicare premiums.
Congress is also introducing changes that may impact retirement savers. A law taking effect in 2026 will require people aged 50 and older with salaries above $145,000 to contribute extra money to a Roth 401(k).
Please note that all investment decisions carry inherent risks. It’s essential to consult with a financial advisor or tax professional to determine the best approach for your specific situation. This article does not constitute financial advice and should not be considered as such.
In conclusion, whether you opt for a Roth or traditional 401(k), careful consideration of your unique circumstances and goals is key to securing your financial well-being in retirement.
