Understanding Your 401(k) Choices: Traditional vs. Roth

You already know that when it comes to employee benefits, you have a choice in your healthcare plan. And now, more employers are giving employees options regarding 401(k)s!

More and more employers are offering a choice between a Traditional 401(k) or a Roth 401(k). So, what’s the difference? And how do you know which one is right for you?

Like Traditional and Roth IRAs, the key difference is when you pay taxes. Let’s review how this works for employer-sponsored plans.

Traditional 401(k)

A Traditional 401(k) allows you to make contributions before taxes, which lowers your adjusted gross income (AGI) and creates lower taxable income. However, you’ll pay income tax on the distributions in retirement.

If you anticipate being in a lower tax bracket upon retirement, a traditional 401(k) may be ideal because you’ll save more today. Something else to consider is where you might retire—since some states have lower income taxes than others.

Roth 401(k)

Are you expecting to be in a higher tax bracket after retiring? Or perhaps you’re a young professional expecting to make more money in the future. Either way, a Roth 401(k) may be the smart choice to take advantage of being in a lower tax bracket. This retirement plan is funded with after-tax money, which you can withdraw tax-free. You’ll pay less in taxes upfront and won’t have to worry about them later.

The top tax rate remains at 37% in 2024. Below are the current tax brackets to help you understand which you fall into:

  • 10%: Taxable income up to $11,600
  • 12%: Taxable income over $11,600
  • 22%: Taxable income over $47,150
  • 24%: Taxable income over $100,525
  • 32%: Taxable income over $191,950
  • 35%: Taxable income over $243,725
  • 37%: Taxable income over $609,350

If you find yourself in the 22% bracket or lower, consider opting for a Roth 401(k). With regard to income taxation, consult with your tax advisor.

Additionally, you can take tax-free withdrawals as long as you have had the account for five years or more, and you take them on or after age 59.5 or as a result of disability or death.

Additional 401(k) Considerations

As you evaluate which is the better choice for you, keep in mind that:

  • Employer contributions must go into a pre-tax 401(k), but you may have a Roth 401(k) for your contributions
  • Unlike a Roth IRA, you cannot withdraw from a Roth 401(k) whenever you want (Since you are saving for retirement in these accounts, do your best to NOT make withdrawals until retirement)

In 2024, you can contribute up to $23,000 ($30,500 for those age 50 or older, thanks to catch-up contributions). And if you have a Traditional and Roth 401(k), you can contribute to both accounts in the same year—just be sure to keep your total contributions under the limit.

As you can see, it’s not necessarily a one-or-the-other decision. You can have both types of plans and decide which one you contribute to each year based on the annual limits and your tax situation. You should also consider your time horizon.

Do you need support determining which type of 401(k) is right for you? Reach out to Carlson Investments with all of your retirement questions today!

Carlson Investments does not provide tax, legal, or accounting advice. This content has been written for informational purposes only. Always consult your individual tax, legal, or financial professionals for advice tailored to your situation.

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