Traditional vs. Roth 401(k)

The plain answer

Traditional and Roth 401(k) contributions differ mainly in when you pay income tax.

• Traditional 401(k): You generally receive an income tax benefit today. You pay ordinary income tax when you withdraw the money.
• Roth 401(k): You contribute money after income tax. Qualified withdrawals in retirement are tax-free.

Neither option is automatically better. The choice depends mostly on whether paying tax now or later is likely to be more valuable to you.

How it actually works

Traditional contributions generally reduce the income subject to federal income tax in the year you make them. They do not avoid Social Security and Medicare taxes. The investments can grow without annual tax on dividends or capital gains inside the account. Withdrawals are generally taxed as ordinary income.

Roth contributions do not reduce your taxable income today. The investments also grow without annual tax inside the account. A Roth withdrawal is tax-free when it meets the rules for a qualified distribution, including the applicable five-year requirement and a qualifying event such as reaching age 59½.

If your plan permits it, you can contribute to both types. Your payroll election determines how each employee contribution is treated for income tax purposes. The investment menu and workplace plan rules usually remain the same.

What this means for you

Traditional contributions may be attractive when the current tax deduction is especially valuable, such as during higher-income years. Roth contributions may be attractive when your current tax rate is relatively low or you want more tax-free income available in retirement.

You do not need perfect knowledge of future tax rates. A mix of traditional and Roth savings can give you flexibility when choosing which account to draw from later. Review your choice after major changes in income, tax filing status, or retirement plans.

Your employer’s match is valuable regardless of whether you choose traditional or Roth employee contributions. Check the plan documents to learn how matching contributions are treated.

Common mistakes

• Assuming Roth is always better because qualified withdrawals are tax-free.
• Comparing today’s tax rate with no estimate of your tax situation in retirement.
• Forgetting that a traditional contribution can improve current cash flow through lower income tax withholding.
• Expecting Roth contributions to lower this year’s taxable income.
• Treating the choice as permanent instead of revisiting it when your circumstances change.

Related pages

• How a 401(k) works
• The order of operations for your money
• 401(k) guide