When employers offer both Roth and Traditional 401(k) deferral options, many employees struggle to determine which is best for their situation. Both are powerful retirement savings vehicles, but they differ significantly in how and when they provide tax advantages. This is a brief guide to help you decide which approach aligns with your financial goals. To get tailored advice for your situation, consider consulting a qualified financial professional.

The Tax Timing Decision

Traditional 401(k) contributions are made with pre-tax dollars, reducing your current taxable income. This provides immediate tax savings but requires you to pay income taxes when you withdraw funds in retirement.

Roth 401(k) contributions are made with after-tax dollars, providing no immediate tax benefit. However, qualified withdrawals in retirement—including all growth—are completely tax-free.

The central question becomes: When is it more advantageous for you to pay taxes—now or later?

If you expect to be in a higher tax bracket during retirement than you are today, Roth contributions may be more beneficial. Conversely, if you anticipate being in a lower tax bracket in retirement, Traditional contributions might be preferable.

Building Tax Diversification

Of course, it can be difficult to predict your future tax bracket. So one strategy to explore is tax diversification—maintaining both Traditional and Roth accounts. This approach provides flexibility during retirement, allowing you to strategically withdraw from different accounts to manage your taxable income.

For example, in years when you have higher expenses or lower income from other sources, you could draw more heavily from Traditional accounts. In years when you need to keep your taxable income lower (perhaps to reduce Medicare premiums or taxes on Social Security benefits), you might rely more on tax-free Roth withdrawals.

Understanding the True Value of Contribution Limits

For 2025, the employee deferral limit is $23,500 (with additional catch-up contributions permitted for those over 50). This limit applies to the combined total of both Traditional and Roth contributions.

While both contribution types count equally toward this limit, they represent different economic values. For example, a $10,000 Roth contribution effectively represents more retirement savings potential than a $10,000 Traditional contribution. Why? The Roth contribution has already been taxed, whereas taxes will still need to be paid on Traditional contribution withdrawals during retirement.

This means that if you’re able to max out your contributions, a Roth 401(k) effectively allows you to save more in tax-advantaged retirement funds, assuming it makes sense for you to pay the taxes on those contributions today.

Employer Match Considerations

Traditionally, employer matching contributions were made exclusively with pre-tax dollars. However, under the SECURE Act 2.0 (passed in December 2022), employers may permit employees to choose that employer matching and non-elective contributions be made as Roth contributions. This option gives employees the ability to have their entire 401(k) balance—including employer matches—grow tax-free. Remember that Roth employer contributions are also taxable to the employee when they are made, but their earnings are not taxed when taking them out in retirement.

If your employer offers Roth matching, this could be particularly valuable if you expect to be in a higher tax bracket in retirement. Check your specific plan details, as the handling of employer contributions varies between retirement plans, and not all employers have implemented this option.

Additional Factors to Consider

  • Age and Time Horizon: Younger employees often benefit more from Roth contributions due to decades of potential tax-free growth.
  • Future Tax Rate Uncertainty: Tax laws change over time, making it difficult to predict future tax rates with certainty.
  • Estate Planning: Roth accounts can offer advantages for legacy planning, as beneficiaries typically receive tax-free distributions.
  • Required Minimum Distributions (RMDs): Both Traditional and Roth 401(k)s are subject to RMDs, though Roth 401(k) funds can be rolled into a Roth IRA, which does not have RMDs under current law, whereas Traditional IRAs do.

Bottom Line

There’s no one-size-fits-all answer to the Roth vs. Traditional question. The optimal strategy depends on your specific financial situation, retirement timeline, and tax expectations. Many financial professionals recommend a blended approach that provides tax diversification and flexibility for an uncertain future.

For personalized guidance on optimizing your retirement savings strategy, please contact us.

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