While many financial advisors and writers are advocating investing in a Roth 401k, you still might be better off investing in a traditional 401k. But neither does anyone else. Roth vs. Unlike Roth IRAs, both 401(k)s and Roth 401(k)s don’t have income phase-out limits. Roth Solo 401k vs Roth IRA. "So by electing an employee Roth contribution, you’re getting a mix of both Roth and pre-tax funds.". Assuming that he pays 30% in taxes, he will be left with only $40,950 to spend in retirement. "We are experiencing, as a country, some of the lowest tax rates in our history," says Alexander Koury, CFP, of Hosler Wealth Management in Phoenix. My employer just offered a 401k plan for 2021. If you don’t expect any material change in your income tax rate between your working years and retirement, it (generally) won’t make a difference whether you choose a traditional 401(k) or Roth 401(k). "Some employers do not match on Roth 401(k) contributions, because they are unable to get the tax benefit," says Marc Schindler, owner of Pivot Point Advisors in the Houston area. Any prolonged period of low income (such as spending time to raise your children, going on sabbatical, etc.) The popularity of the Roth IRA and the large numbers of Roth conversions, led Congress to apply some of the Roth rules to the regular 401k. This is why the traditional 401(k) vs. Roth 401(k) decision is irrelevant if your income tax rate is the the same in your working years and in retirement. The question about which 401(k) plan is better depends so much on your individual situation. If you couple this with the ability to convert a traditional 401(k) into a Roth IRA, you can play some really interesting tax games. The Battle: Roth 401k vs. With a traditional 401(k) you have far more control over when and where you pay your taxes. In a Roth 401(k), you won't enjoy only tax-deferred growth of your investment gains. The big difference is occurs when you begin withdrawing funds from your Roth Solo 401k. Some employers don't offer matching contributions for 401(k) plans at all. In addition, high savers may find that some of the optionality in a traditional 401(k) is closed off to them. Given that future tax rates are what’s important when choosing between a traditional 401(k) and a Roth 401(k), your next question might be, “So Nick, what will future tax rates be?”  Unfortunately, I have no idea! Roth Solo 401k allows much larger contributions compared to a Roth IRA. If you have a traditional 401k it becomes a traditional IRA; a Roth 401k … The choice between a traditional 401(k) and a Roth 401(k) can depend on a lot of factors that are specific to your individual financial situation. In a Roth 401(k) vs. Roth IRA comparison, both offer tax-free growth & tax-free retirement income. All of it is tax-free at that point. Both the traditional 401(k)s and Roth 401(k) plans are similar, as they are employer-sponsored retirement savings plans that provide tax advantages to employees who make contributions by saving a portion of their paycheck for retirement. The whole traditional-vs-Roth 401(k) question has a lot to do with taxes, and everyone’s tax situation is different. For those with less familiarity, a “traditional “ 401 (k) is funded with pre-tax money while a Roth 401 (k) is funded with post-tax money. This type of plan allows you to make contributions with pre-tax dollars so that you don't pay taxes on money you contribute. Here's when the Roth is probably a better option: "I recommend making Roth contributions when someone is in a low bracket and expecting to later be in a higher tax bracket," says Mark Wilson, CFP and founder of MILE Wealth Management in Irvine, California. For example, if you try to convert a traditional 401(k) with a high account balance to a Roth IRA, you may end up in a higher tax bracket than you initially planned for. However, this will vary from state to state. Individual Roth 401k salary deferral contributions are not tax deductible, but withdrawals are tax free after age 59 ½ provided the 5 year rule is satisfied. Collado says that if you're not disciplined enough to invest that tax savings from the traditional 401(k), "then the tax-free growth [in a Roth] will far outweigh what you could’ve accumulated in a traditional plan on an after-tax basis.". can be utilized for greater tax efficiency. "If someone is in the highest tax bracket (37 percent), and they think they will be earning less as they approach retirement, then it may make sense to contribute on a pre-tax basis," says Ma. The only difference between these account types is when you decide to pay your taxes. New York State residents who are at least 59½ are entitled to a state income tax deduction of up to $20,000, https://github.com/nmaggiulli/of-dollars-and-data, https://ritholtzwealth.com/blog-disclosures/. Wilson defines a low bracket as being taxed at the federal level of 12 percent or less. The reality is that you won't pay taxes on any money that comes out of the account at all. For those with less familiarity, a “traditional“ 401(k) is funded with pre-tax money while a Roth 401(k) is funded with post-tax money. "Considering the massive debt we already have, plus the trillions of dollars the government is spending to help its citizens through the COVID-19 crisis, it is likely in the future tax rates will be higher.". Unfortunately, Sam still has to pay income taxes. Why is this true? The three main differences are: 1. I have friends who used this tactic while they were in business school because they knew they would be temporarily earning next to nothing. Profit Sharing. Spend the time and money to get this right and it can pay you back for decades to come. Even if you don't expect to earn more, you might expect tax rates across the country to increase, and such a rise could make the Roth 401(k) more attractive today. More than 58 million people have one, and they held a collective $6.2 trillion as of Dec. 31, 2019, according to the Investment Company Institute. All else equal, if you think your income taxes will be higher now, then contribute to a traditional 401(k), otherwise contribute to a Roth 401(k). Using Schindler's strategy you can still capture the full employer matching - which advisers universally agree is the thing you must do - with early-year contributions to a traditional plan. https://www.schwab.com/.../roth-vs-traditional-401-k-which-is-better Connect with friends faster than ever with the new Facebook app. "Having said that, even this only makes sense if you are disciplined enough to take the savings associated with making that traditional 401(k) contribution and you save that, too," says Collado. "With perfect information about our career trajectory, future earnings, and future tax rates, we’d simply be able to model whether contributing to our 401(k) on a pre-tax or Roth basis was best," says Roger Ma, founder and financial planner at lifelaidout in New York. So contributing to a Roth IRA will not reduce taxable income. Here’s what we can tell you: If you think your tax rates are going to go up in retirement, consider the Roth. For 2020 and 2021, the annual 401 (k) contributions limits are the same. Notably, 401 (k)s have much higher contribution limits than Roth IRAs. Despite the lack of optionality in a Roth 401(k), there are a few special cases where a Roth might be the way to go. The main difference between Roth 401k contributions and Traditional 401k contributions is when you owe federal income tax on the money. Second, a Roth account owners are not penalized for withdrawing money from a plan, provided they avoid withdrawing from any investment gains. Roth 401k vs. Roth IRA: Which is Better for You? And, as I mentioned previously, because the tax treatment of retirement withdrawals varies by state, a dual strategy might be the best solution to effectively navigate such a complex landscape. The Roth 401(k) contribution limits are the same as the contribution limits of a traditional 401(k). Low income ( such as spending time to raise your children, going on sabbatical, etc. to mix. 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