Introduced in 1978, 401(k) plans have grown to become a popular type of employer-sponsored retirement plan. There are a few types of 401(k) plans, including a Traditional 401(k), Safe Harbor 401(k), Simple 401(k), Solo 401(k), and Roth 401(k). In this Building Wealth series, we are going to discuss the difference between a Traditional 401(k) and Roth 401(k).
The Traditional and Roth 401(k) plans are both workplace retirement savings options. With either plan you enjoy the convenience of having your contribution automatically deducted from your paycheck. In addition, both plans offer the same contribution limit. In 2019, the contribution limit is $19,000 per year, or $25,000 for age 50 and older. The opportunity to invest that much each year is a huge perk of a Traditional and Roth 401(k) plan, especially when compared to the $5,500 per year contribution limit of a Roth IRA. The real difference between these two investment options is how they are taxed when you begin to withdraw money.
|Roth 401(k) Plan||Traditional 401(k) Plan|
|Is a post-tax retirement savings account. Plan contributions are taxed before they are directed into your Roth 401(k) account. Taxes are paid now, resulting in a little less money in your paycheck.||Is a pre-tax savings plan. Plan contributions are invested before they are taxed, thus reducing your taxable income. Contributions are taken off the top of gross earnings before your paycheck is taxed. Some employers will make pre-tax contributions into their sponsored plan.|
Why would you want to contribute to a Roth 401(k) plan? The biggest benefit to this plan is taxes are already paid on contributions; therefore, withdrawals made during retirement are tax-free. The money invested along with any accrued earnings is not subject to tax withholdings when used during retirement.
The Roth 401(k) and Traditional 401(k) plans have their advantages and disadvantages. If you would like assistance with determining which option is best for you, our wealth management subsidiary, Independence Financial Advisors, can provide the guidance you need to develop a plan that meets your retirement goals.
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