Roth 401(k) vs. Traditional 401(k)

In this post I'll be talking about the differences between a Roth 401(k) and a Traditional 401(k) and which one is better for you.

• About half of employers now offer a Roth 401(k) in addition to the Traditional 401(k).
• So, should you forego the Traditional route and choose the Roth 401(k)?

So, let's talk about the similarities of the Traditional and Roth 401(k)s,

• First, they both have the same $19,500 contribution limit and if you're 50 years or older you can contribute an extra $6,500 making the max contribution $26,000.
• Second, they both have the same withdrawal rule that states you cannot withdraw your money until the age of 59 1/2.
• Third, you will still be able to receive the company match if your company provides it, however that money will always be placed within a Traditional account even if you select the Roth 401(k) option for your own contributions.

The biggest difference between the Traditional and Roth 401(k) has to do with the tax treatments of the contributions and withdrawals.

• Under a Traditional 401(k), the money you contribute is not taxed, however when you go to withdraw the money, you will then pay taxes.
• Under a Roth 401(k), the money you contribute is taxed, which then allows your money to grow tax-free and you pay no tax when you withdraw.

So, which is best for you?

The question at hand is do you want to pay tax now or later?

If you'd rather pay taxes now and get them out of the way, or you think your tax rate will be higher in the future than it is right now, then choose the Roth 401(k).

If you would rather wait to pay taxes because you think your tax rate will be lower in the future, then choose the Traditional 401(k).

Tax rates right now in 2021 are at historical lows and with the recent stimulus spending, it's only a matter of time before tax rates start rising. That is why I have been contributing to a Roth 401(k) because I believe my tax rate will be a lot higher in the future than it is today, and I don't want to take the chance on paying a higher tax rate.

If you're really not sure which to choose, you could actually split your investment 50/50, so that you're contributing to both the Traditional and Roth 401(k)s. Just know that the total maximum contribution of $19,500 still applies.

And you also are free to switch back and forth throughout your career, so if you want to start out contributing to a Roth for a year then switch over to a Traditional, you can do so at any time.

*Disclaimer: I am not a financial advisor. The ideas presented in my articles and videos are for entertainment purposes and not to be taken as financial advice.