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

Fact checked by Suzanne KvilhaugReviewed by David KindnessFact checked by Suzanne KvilhaugReviewed by David Kindness

Roth 401(k) vs. 401(k): An Overview

Roth 401(k) and traditional 401(k) accounts are employer-sponsored plans for retirement savings. Employees can contribute to both accounts, and employers have the option to match some portion of the employee’s contribution. 

The key difference between the two accounts is how they are taxed. Employee contributions to a Roth 401(k) are made with after-tax dollars, while contributions to a traditional 401(k) are made with pre-tax dollars. Regardless of the account, all employer contributions are made with pre-tax dollars.

Key Takeaways

• Retirement contributions to Roth 401(k)s are made with after-tax dollars, while traditional 401(k) contributions are made with pre-tax dollars.
• Roth 401(k) withdrawals in retirement are tax-free, as long as you’ve had the account for five years, while traditional 401(k) withdrawals are subject to income tax.
• Employer matching and contributions can vary between Roth 401(k) and traditional 401(k) accounts.

401(k) Contributions and Tax Treatment

Contributions to Roth 401(k)s and traditional 401(k)s are taken out of employees’ paychecks and deposited into the appropriate accounts. For a Roth 401(k) account, contributions are made with after-tax dollars, meaning you will pay taxes on those contributions. For a traditional 401(k), contributions are made with pre-tax dollars, meaning you won’t pay any taxes on that money until it’s withdrawn. 

The maximum contribution for both 401(k) plans is $23,000 in 2024. If you are age 50 or older, you can make a an additional $7,500 catch-up contribution, for a total maximum contribution of $30,500.

Potential Tax Advantages 

• Roth 401(k): Earnings are not taxed.
• Traditional 401(k): Because contributions are made with pre-tax dollars, they are deducted from your gross income for the year, reducing how much income tax you pay for the current year.

Potential Tax Disadvantages

• Roth 401(k): Contributions are made with after-tax dollars so you will pay taxes on that money at the time you make the contribution.
• Traditional 401(k): Contributions and earnings will be taxed when withdrawn.

Withdrawals and Tax Implications

Withdrawals from a 401(k) differ based on the type of account. For a traditional 401(k), you will pay income taxes (federal and possibly state) on any funds taken out. This includes contributions and earnings. 

All withdrawals, including earnings, from a Roth 401(k) are tax-free, provided they are a “qualified distribution.” A qualified distribution must meet the following requirements: 

• The account has been held for a minimum of five years; and 
• The withdrawal is made due to disability; or
• The withdrawal is made on or after the account holder’s death; or
• The withdrawal is made on or after the account holder is age 59½.

Note

A qualified distribution is a withdrawal from a qualified retirement plan that meets certain IRS conditions and restrictions.

Regardless of type, if you withdraw money from your 401(k) account early, before age 59½, you will have to pay a 10% early distribution penalty.

For a traditional 401(k), you must start taking required minimum distributions (RMDs) at age 73. There is no RMD requirement for a Roth 401(k) as long as the account holder is alive. The RMD requirement does apply to any beneficiaries of the Roth 401(k).

Employer Matching and Contributions

Your employer may match a portion of your 401(k) contribution regardless of account type. However, employer contributions for either 401(k) type are pre-tax dollars. For a traditional 401(k), that means the employer contribution is deposited in your account just as your contribution is.

Because employee contributions to a Roth 401(k) are after taxes and employer contributions are pre-tax dollars, a second 401(k) account–a traditional 401(k)–must be set up in your name for your employer’s contributions.

Employer contributions do not count toward the employee’s contribution limit. However, when employer and employee contributions are combined, they cannot exceed $69,000 in 2024. For those age 50 or older, that limit increases to $76,500.

Conversion Options and Rollovers

If you have a traditional 401(k) and want a Roth 401(k), you may be able to convert your existing account. First, your employer must offer a Roth 401(k) for you to convert your traditional 401(k). Second, if your employer matches your 401(k) contributions, you’ll still need a traditional 401(k) for your employer’s contributions.  

If you do convert accounts, you’ll have to pay taxes on the amount you move into the new account because, up until now, you haven’t paid any taxes on it. 

If you change jobs and your new employer offers a 401(k), you can roll over the money to the new plan provided it accepts transfers. If the rollover is direct from your old account to your new account, there typically are no tax penalties. 

Likewise, if the account trustee from the financial institution of the existing account makes the payment directly to the trustee with the financial institution of the new account, you won’t pay taxes on the transferred amount.

However, if the money from the first account is paid directly to you, you have 60 days to deposit some or all of it into a new 401(k) account. In this case, 20% of the amount will be held for taxes. When you deposit the remaining distribution amount into your new 401(k), you’ll also need to pay the 20% that was withheld. The 20% will be reported as paid taxes on your income tax return.

If you don’t, the 20% will be considered an early distribution, and you’ll have to pay an additional 10% as an early withdrawal penalty.

Choosing Between Roth 401(k) and 401(k): Which One Is Best for You?

There are several factors to consider when deciding between a Roth 401(k) and a traditional 401(k). 

Consider Your Goals 

What are your financial goals for the near future? Buying a house? Paying for your child’s college tuition? Taking an extended vacation? If you choose a traditional 401(k), you could have more money in your paycheck to pay for those financial goals than you would with a Roth 401(k). 

Look at Your Tax Situation

Examine the tax benefits of a Roth 401(k) and a traditional 401(k) to help determine which is the best choice. If you start saving for retirement early, for example, you likely have an income in a low tax bracket. As you get older, your income could increase along with your tax bracket. With a Roth 401(k), you could pay less in taxes early on than you might when you start withdrawing from a traditional 401(k) and have to pay taxes on those funds.

Think About Your Retirement Plans 

If you have a firm idea of what you want to do when you retire, choosing a Roth 401(k) now could help you better prepare for those plans. Why? By paying taxes on your retirement savings as you go, you will know for certain that all the money you saved for your retirement will be yours when you’re ready to access it. That means you can set goals now for how much you want saved and can take steps to meet that goal.

Can I Max Out Both My 401(k) and My Roth 401(k)?

No. The contribution limit for all 401(k) plans is $23,000 ($30,500 for those age 50 or older) in 2024. Therefore, regardless of how you spread the money between the two accounts, the total for the year cannot exceed the contribution limit.

Should I Split My 401(k) Between Roth and Traditional?

Splitting your retirement savings between a traditional and Roth 401(k) allows you to enjoy the benefits of both. You’ll defer taxes on some of the money, while saving you from having to pay taxes on all of your withdrawals when you do retire.

Is It Smart to Have Both a 401(k) and a Roth 401(k)?

Having both a traditional 401(k) and a Roth 401(k) can limit your total tax obligation by diversifying your retirement savings. 

The Bottom Line

Both traditional 401(k) and Roth 401(k) accounts are employer-sponsored plans that allow you to save money for retirement. With a traditional 401(k), you defer paying taxes on those savings until you withdraw them. With a Roth 401(k), you pay taxes on the money you deposit in your account as you go. Qualified withdrawals are completely tax-free. 

Both accounts have advantages and drawbacks, so it’s important to consult with a financial advisor to determine which would best suit your financial circumstances and goals. 

Read the original article on Investopedia.