Traditional vs. Roth 401(k): What’s the Difference?

There are different wreaths I use to decorate my house throughout the year. In winter, I put up a green wreath with pine needles dusted in snow. In spring, I put out a colorful wreath with a lily to celebrate Easter.

To others, these wreaths may seem like simple decorations. But to me, they are reminders to be thankful that I’ve been granted another season of life. These days, we’re all busier than ever. The seasons go by quickly. We must remember to pause, acknowledge the changing of seasons, and be thankful for them.

We find ourselves approaching a new season right now; though summer is still a few weeks away, we can feel it in the air. The longer days and beautiful weather can inspire some people to refresh everything from their space to their routines and goals.

If you’re one of these people, I encourage you to consider your financial goals during this process.

You might want to examine how much you have saved for retirement. Did you put away more or less than last year? Are you able to increase contributions in any way?

A great way to make improvements to your retirement savings plan is to increase contributions to your 401(k).

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Traditional vs Roth 401(k) Plan

A 401(k) plan is one of the vehicles you can use to save for retirement. With an employer-sponsored plan, you can direct contributions straight from your paycheck into your 401(k) account. Many employers offer matching opportunities as an added incentive.

Many workers, likely including you, have a traditional 401(k) plan. Money contributed to this type of account is tax-deferred. This means you do not pay taxes on the money until you withdraw from the account in the future.

What many workers don’t know is that they could have access to an after-tax option. It’s called a Roth 401(k), and this option is available in more than half of company 401(k) plans. With this type of account, you pay tax on your contributions, but your money grows tax-free and withdrawals are not taxed. This means that during the 10-30 years that you are actively contributing, your money is compounding tax-free.

The Big Difference

You might be wondering, “If I’m going to be paying taxes either way, what’s the big difference?”

Answer: The Future of Tax Rates

Few believe that taxes are going to stay this low forever, and with the federal deficit going up each day, most people are confident that taxes rates will rise over the years. If that happens, having tax-free income from your 401(k) could put you at a great advantage, because it could reduce the worry of jumping into a higher tax bracket.

There are many additional factors to consider when it comes time to start withdrawing from your 401(k) plan. If you’re not careful, you could end up with a hefty tax bill, no matter which type of retirement savings plan you might have.

If you’re retiring this year, we encourage you to schedule a complimentary 15-minute chat with one of our advisors. During this call, we want to learn more about your goals and your financial situation. If we find that your situation warrants further discussion, we’ll start the Retirement Review process, where we give you tools and guidance on how to change course, get your goals in order, and help you transition into retirement with ease.

Click here to schedule a call with a member of our team.

Adapted from Ralph Hicks’ commentary on the Retirement Solutions Show

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