Traditional 401(k) plans are typically employee-sponsored, according to Investor.gov. They allow employees to invest some of their paycheck on a pre-tax basis, meaning no taxes are paid on the contribution and earnings grow on a tax-deferred basis. Taxes are paid when funds are withdrawn according to ordinary income rates.
Roth 401(k) plans are similar, but taxes are paid when contributions are added to the account. These earnings also can grow tax free until retirement, and no taxes are due when funds are withdrawn.
James Royal, a principal writer at Bankrate, said many are drawn to Roth 401(k)s since there is no future tax on the balance.
Royal added that the contributor’s tax bracket helps decide which option is best for their retirement plan.
“Typically, it makes a lot of sense for individuals in higher tax brackets to go with the traditional 401(k) because they avoid that larger tax hit today for an uncertain tax rate in the future,” Royal explained. “In contrast, for people in lower tax brackets the Roth 401k is a better option.”
A financial advisor can help people determine which accounts are right for them.
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