Should I Choose a Traditional or Roth 401(k)?

Many employer-sponsored 401(k) plans offer two primary options: Traditional and Roth. The core distinction lies in when you pay taxes, a decision with long-term consequences for your retirement income. Choosing the right account depends on your current financial situation and your expectations for the future.

The Traditional 401(k) Explained

A Traditional 401(k) is funded with pre-tax contributions, meaning the money is taken from your salary before federal and most state income taxes are calculated. This directly reduces your current taxable income for the year, providing an immediate tax saving.

The money within the account benefits from tax-deferred growth. Any dividends, interest, or capital gains earned by your investments are not taxed annually, allowing for uninterrupted compounding.

When you make withdrawals in retirement, after age 59½, the funds are taxed as ordinary income. This includes both your contributions and all investment earnings. For example, if you earn $70,000 and contribute $5,000, you only pay income tax on $65,000 for that year. Every dollar you withdraw in retirement will be subject to the income tax rates at that time.

The Roth 401(k) Explained

Contributions to a Roth 401(k) are made with post-tax dollars, meaning you have already paid income tax on the money. Consequently, you do not receive an upfront tax deduction, and your current-year taxable income is not reduced by your contributions.

The primary advantage is that your investments grow tax-free, and qualified withdrawals in retirement are also completely free of federal income tax. A qualified withdrawal requires you to be at least 59½ years old and for your first contribution to have been made at least five years prior. This tax-free status applies to both your contributions and all earnings.

Using the previous example of a $70,000 salary and a $5,000 contribution, your taxable income remains $70,000 for the year. While this results in a higher immediate tax liability, the entire account balance can be accessed in retirement without further tax obligation.

Another benefit is the exemption from Required Minimum Distributions (RMDs) for the original account owner. Unlike a Traditional 401(k), a Roth 401(k) allows your money to remain invested and continue growing tax-free for your entire lifetime, providing greater flexibility in retirement.

Key Factors for Your Decision

Your choice hinges on whether you expect to be in a higher or lower tax bracket during retirement. If you anticipate a lower tax bracket in retirement, the Traditional 401(k) is often preferred. You receive tax deductions now, during your higher-earning years, and pay taxes on withdrawals later at a lower rate.

Conversely, if you expect to be in a higher tax bracket in retirement, the Roth 401(k) is appealing. This is common for young professionals who pay taxes on contributions now while in a lower bracket to secure tax-free withdrawals later when their income might be higher.

Your age and investment time horizon are also factors. A younger employee has decades for investments to generate tax-free growth in a Roth 401(k), making the benefit of tax-free compounding more impactful. An employee closer to retirement may find the immediate tax deduction from a Traditional 401(k) more valuable, as there is less time for growth to accumulate.

Your outlook on future national tax rates can also influence your decision. If you believe federal income tax rates will increase, locking in your tax liability today with a Roth 401(k) can be beneficial. This protects your retirement savings from potentially higher tax rates in the future.

Contribution Rules and Strategies

The annual contribution limit set by the IRS applies to the combined total of your Traditional and Roth 401(k) contributions. For 2025, the limits are:

• $23,500 for individuals under age 50.
• An additional $7,500 catch-up contribution for those aged 50 to 59 and 64 and over.
• An additional $11,250 catch-up contribution for individuals aged 60, 61, 62, and 63.

Your total contributions across both account types cannot exceed the applicable annual limit.

Employer matching contributions follow specific rules. Even if you contribute only to a Roth 401(k), matching funds from your employer are typically made on a pre-tax basis and deposited into a separate Traditional 401(k) account. These matched funds will be subject to ordinary income tax upon withdrawal. Some employers may now offer the option to receive matching contributions directly into the Roth 401(k), which requires you to pay income tax on the match amount in the year it is made.

You are not required to choose only one type of 401(k). Many plans allow you to split contributions between Traditional and Roth accounts, a strategy that provides tax diversification. Holding both pre-tax and post-tax funds allows you to manage your taxable income in retirement. For instance, you could draw from your Roth account in a high-expense year to avoid being pushed into a higher tax bracket.