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Here Are The Differences Between A Roth and Traditional 401(K)

ByAshley Hours Categories Investing, Retirement Planning

Have you been hearing more about Roth 401(k)’s lately. There are more and more options in company 401(k)’s recently, including the Roth option, whereas before many companies only provided traditional 401(k) options. More employers are now offering this option to their employees so check out the rest of the blog and then see if it’s a valuable option for you. 

So, you may be asking yourself, what is a Roth 401(k)? A Roth 401(k) is an employer-sponsored retirement savings account that can be funded with after-tax dollars up to its contribution limit. For people who think they may be in a higher tax bracket down the line, this might be the better option for you. On the other hand, in a traditional 401(k) plan, you contribute pre-tax money, which will be taken out based on your future tax-bracket in the future. 

Now that you know what a Roth 401(k) is, you may be wondering, do I qualify for one? As long as your employer offers the Roth options, you are eligible for it if you are also eligible for your company’s traditional 401(K). 

Let’s take a look at this example: 

​​Your yearly base salary, gross income is $50,000.  If you choose to contribute 10% ($5,000) to a traditional 401(k), your taxable income becomes $45,000 for the tax year. You took that 10% and deferred paying taxes on it. That $5,000 now grows tax-deferred inside of your traditional 401(k). When you withdraw the money from your traditional 401(k) at retirement, your total will be taxed then with regards to your tax bracket. 

Within a Roth 401(k), you are paying your income taxes as you should, and then the funds head into your Roth account. So with that same $50,000 salary, if you choose to contribute 10% to your Roth 401(k), you will pay income taxes on your full $50,000.  After income taxes are taken out, your funds for the year ($5000) goes towards your Roth 401(k). When you withdraw the money from your Roth 401(k), you can take both the contributions and earnings out tax-free since you had previously paid them. 

For both Roth and Traditional 401(k)s, the contribution limits are the same, at 19,500.  You can defer $19,500 out of your paycheck into a traditional 401(k). In contrast, you also can contribute $19,500 to your Roth 401(k). Additionally, you are also allowed to contribute to both a Roth and Traditional 401(K), as long as you stay within the contribution limits. 

Considering Roth options when deciding on your 401(k) and IRA contributions is a very important step. If you want your money to grow tax deferred, you should highly consider opening a Roth account. Continue following along to see if there are any tax changes in the near future, and make sure you consult a tax professional to see what options make the most sense for you.  If you have any questions about your personal situation or want to know how to get started, email us at info@shermanwealth.com or schedule a 30-minute consultation here.