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The main difference between a Roth 401(k) and a 401(k) rests on when you pay taxes on your employer-sponsored retirement account. With a Roth 401(k), you're contributing after-tax money, and then you can withdraw it tax-free once you reach retirement age. A traditional 401(k) allows you to make contributions before taxes, but you'll have to pay income tax on the distributions you take in retirement.
What is a Roth 401(k)?
A close cousin of the traditional 401(k), the Roth 401(k) takes the tax treatment of a Roth IRA and applies it to your workplace plan: Contributions come out of your paycheck after taxes, but distributions in retirement are tax-free. That means you duck paying taxes on investment growth.
About half of employers now offer the Roth 401(k) alongside the traditional version. If yours does, should you snub the status quo? Here’s a quick briefing on the Roth 401(k) vs. 401(k).
Roth 401(k) vs. 401(k): Where they differ
First, what isn’t different: The 401(k) contribution limit applies to both accounts. You can contribute up to $20,500 in 2022 ($27,000 for those age 50 or older) and $22,500 in 2023.
You can contribute to both accounts in the same year, as long as you keep your total contributions under that cap.
Where the Roth 401(k) and the traditional 401(k) differ is how contributions and distributions are taxed.
Roth 401(k) vs. traditional 401(k)
Tax treatment of contributions
Contributions are made pre-tax, which reduces your current adjusted gross income.
Contributions are made after taxes, with no effect on current adjusted gross income. Employer matching dollars must go into a pre-tax account and are taxed when distributed.
Tax treatment of withdrawals
Distributions in retirement are taxed as ordinary income.
No taxes on qualified distributions in retirement.
Withdrawals of contributions and earnings are taxed. Distributions may be penalized if taken before age 59½, unless you meet one of the IRS exceptions.
Withdrawals of contributions and earnings are not taxed as long as the distribution is considered qualified by the IRS: The account has been held for five years or more and the distribution is:
Unlike a Roth IRA, you cannot withdraw contributions any time you choose.
Which is best for you?
This decision mainly comes down to how you want to put money into the account and how you want to take money out.
Let’s start with today — putting money in. If you’d prefer to pay taxes now and get them out of the way, or you think your tax rate will be higher in retirement than it is now, choose a Roth 401(k).
By paying taxes on that money now, you’re shielding yourself from a potential increase in tax rates by the time retirement rolls around, though your own taxable income may drop, potentially putting you in a lower tax bracket.
You’re also giving yourself access to a more valuable pot of money in retirement: $100,000 in a Roth 401(k) is $100,000, while $100,000 in a traditional 401(k) is $100,000 less the taxes you’ll owe on each distribution.
In exchange, each Roth 401(k) contribution will reduce your paycheck by more than a traditional 401(k) contribution, since it's made after taxes rather than before. If your primary goal is to reduce your taxable income now or to put off taxes until retirement because you think your tax rate will go down, you will do that with a traditional 401(k).
Just know that:
You’re kicking those taxes down the road, to a time when your income and tax rates are both relatively unknown — and might be higher if you advance in your career and start earning more
If you want the after-tax value of your traditional 401(k) to equal what you could accumulate in a Roth 401(k), you need to invest the tax savings from each year’s traditional 401(k) contribution. For more on this, see our study on the Roth IRA advantage, which also applies here.
If you can’t or won’t invest that tax savings — and it could be a considerable amount, for those in high tax brackets making maximum contributions — the Roth 401(k) is a good choice.
It’s not only about taxes
Taxes are important, and they're the primary factor in this debate. But there are other points to consider:
Whether you’re eligible for a Roth IRA. Roth IRAs have income limits; Roth 401(k)s do not. If you earn too much to be eligible for the Roth IRA, the Roth 401(k) is a chance to get access to the Roth’s tax-free investment growth.
Certain income thresholds in retirement. Taking some of your retirement income from a Roth can lower your gross income in the eyes of the IRS, which may in turn lower your retirement expenses. A lower income in retirement may reduce the taxes you pay on your Social Security benefits and the cost of your Medicare premiums that are tied to income.
Access to your retirement money. Unfortunately, the Roth 401(k) doesn’t have the flexibility of a Roth IRA; you can't remove contributions at any time. In fact, in some ways it’s less flexible than a traditional 401(k), due to that five-year rule: Even if you hit age 59½, your distribution won’t be qualified unless you’ve also held the account at least five years. That’s something to keep in mind if you’re getting a late start.
Finally, remember that you can split the difference and contribute to both accounts — and you can switch back and forth throughout your career or even during the year, assuming your plan allows it. Using both accounts will diversify your tax situation in retirement, which is always a good thing.