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

A 401(k) plan is essential to maximizing your retirement savings. There are two types of 401(k) contributions that can be made: a traditional 401(k) and a Roth 401(k). They are similar in many respects but have several key differences and tax implications that are important to consider. Learn more about these differences to make an informed decision about your future.

What Is a Traditional 401(k)?

A traditional 401(k) is a type of workplace retirement savings plan. Employees contribute a portion of their earnings to their 401(k) account, and the employer may match some or all of the employees’ contributions. Traditional 401(k) contributions and earnings are added to an account pre-tax and therefore a traditional 401(k) is not taxed until you withdraw money.

What Is a Roth 401(k)?

A Roth 401(k) is an option within the retirement savings plan that allows you to contribute your earnings after they’ve been taxed. This means that you can withdraw money from your Roth 401(k) tax-free when you retire.

The Roth 401(k) is a combination of a traditional 401(k) and a Roth IRA. It was created in 2006 to allow for employer matching with the added benefit of tax-free withdrawals.

What Are the Similarities Between a Traditional 401(k) and a Roth 401(k)?

Traditional and Roth 401(k) plans are both options for an employer-sponsored retirement savings plans. Employer-sponsored plans offer the convenience of having your contributions deducted directly from your paycheck. They can also provide employer matching to increase your potential savings. Traditional (also referred to as “pre-tax”) and Roth 401(k) contributions have the same limits. The limit is the maximum amount an employee or employer can contribute each year. Contribution limits are set by the Internal Revenue Service (IRS) and adjusted periodically to account for inflation. The 401(k) contribution limits for 2021 were $19,500 for workers under age 50 and $26,000 for workers age 50 and older.

What Are the Differences Between a Traditional 401(k) and a Roth 401(k)?

There are several key differences to consider when you compare Roth 401(k) vs. traditional 401(k) contributions:

• Contributions: Roth 401(k) contributions are made after tax has been deducted. Traditional 401(k) contributions or “Pre-tax” are, as the name implies, made before taxes have been paid.
• Withdrawals: Withdrawals from a Roth 401(k) are not taxed as the taxes were paid before they were contributed to the account. Withdrawals from a traditional 401(k) are taxed since no tax was removed at the time of contribution. Company contributions fall into the “pre-tax” bucket as well regardless of whether you are making Roth or Pre-tax deferrals.
• Access: You may be able to withdraw money without penalty from a traditional 401(k) starting at age 59 1/2. You can withdraw funds from your Roth 401(k) penalty-free at the same age, but you must have held the account for at least five years.

Which One Should I Use?

If you must choose between a traditional or Roth 401(k), a Roth 401(k) offers greater potential savings. Since a Roth 401(k) plan allows you to avoid paying taxes when you take money out for retirement, you’ll have more money at your disposal when it’s time to retire.

Some companies allow you to split your contributions between the two types of retirement savings plans. Your contribution limit, however, remains the same whether you contribution pre-tax (traditional), Roth or a combination.  Keep in mind that contributing to either type is an important step in saving for retirement.

Contact Fort Pitt Capital Group for 401(k) Advisement

At Fort Pitt Capital Group, we specialize in retirement planning. We can help you navigate pretax vs. Roth 401(k) decisions and develop strategies to ensure your long-term financial security. Contact us today for more information.