Broker Check

Traditional 401k or Roth 401k?

| April 26, 2016
Share |
401k Plans

You find out from your employer that they are offering a Roth component to the 401k plan that you are a part of... but what does that mean?  

The most important difference is that contributions made to a Traditional 401k plan are pretax (meaning you don't pay taxes now, but instead pay taxes when you take money out at retirement) and Roth 401k plans are after-tax contributions (you pay taxes now, but retirement distributions are tax-free).    

Let's take a look at Brian, Sara, and Sam to help explain the differences.  You should take take note that the marginal income tax rate for all three of them is 28%.  

Brian has a Traditional 401(k), which means he won't pay taxes on his contributions (he will pay taxes when he takes it out at retirement).  He also uses his tax refund to reinvest into his 401(k).  He ends up with $35,445 at retirement after all taxes have been paid. 

Sara has a Traditional 401(k), which means she won't pay taxes on her contributions (she will pay taxes when she takes it out at retirement).  She has the same monthly contribution as Brian, but uses her tax refund on a vacation instead of reinvesting.  She will end up with $27,404 at retirement after all taxes have been paid. 

Sam has a ROTH 401(k) and will pay taxes now on his contributions, which means the initial monthly contribution amount will be lower than Brian and Sara because taxes have been taken out.  However, since it grows tax-free and distributions are tax free his total amount at retirement is $38,061.

Your tax bracket will likely be higher or lower at retirement than it is now, so it is an important factor to consider when choosing between at Traditional 401(k) and Roth 401(k).  

Find us on Facebook for more informative posts

Related Links

Share |