Money To Live

September 17, 2008

Roth vs Trad 401(k)

Filed under: investments,retirement,savings,taxes — by moneytolive @ 5:00 am
Tags: , , ,

There are two kinds of employer sponsored defined contribution retirement accounts: the Roth and traditional 401(k). These two options are analogous to the Roth and Traditional IRA accounts:

  • With a Roth 401(k), taxes are paid on the contribution, and withdrawals in retirement are tax free.
  • With a traditional 401(k), contributions are not taxed, but withdrawals in retirement are.

In Money Magazine, Walter Updegrave compares the two types of accounts:

Investing $11,625 in after-tax dollars in the Roth 401(k) is the equivalent of making the maximum $15,500 contribution of pre-tax dollars into a regular IRA. But you’re not limited to contributing $11,625 in after-tax dollars to the Roth.

Which means that as long as the dollar amount you can contribute to a regular 401(k) and a Roth 401(k) are the same, the Roth 401(k) effectively gives you the chance to sock away more money on a tax-advantaged basis for retirement, assuming you’re willing to part with the extra bucks. [emphasis added]

At my new job, I have the option of opening a retirement account of either type. Last summer I worked out my budget assuming that I would open a traditional IRA (because I did not know the Roth was an option). The immediate benefit of the traditional 401(k) is the tax savings, leaving more money in my pocket each month.

But since a Roth 401(k) is available and it allows me to ultimately save more money for retirement, I am going with a Roth. That makes my take home pay a bit smaller, but in the long run I will appreciate having more money in retirement.

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