What’s the Difference Between a Roth and a Traditional 401k?

by Andrea Norris-McKnight

Are you a better candidate for a Roth or a traditional 401k? Not even sure how the two differ? A CFP explains the differences so you can better choose which is likely better for your financial situation.

Q: What is a Roth 401k?

Mr. Cyndecki: A Roth 401k is an employer-sponsored retirement account. The Roth 401k is similar to a traditional 401k in several ways: employees can make contributions via payroll deductions, employers can match employee contributions, investments are not taxed as they grow, and funds within the account enjoy bankruptcy protection.

Q: How is a Roth 401k different from a traditional 401k?

Mr. Cyndecki: Contributions to a traditional 401k are pre-tax, meaning the employee receives a tax deduction for the amount contributed. When money is withdrawn in retirement (after age 59 1/2), the employee reports ordinary income and pays federal income taxes on the amount distributed. Starting at age 72, the employee is forced to withdraw a percentage of funds from the 401k. This is known as a Required Minimum Distribution (RMD).

Contributions to a Roth 401k are after-tax, meaning the employee pays tax today on funds contributed at the applicable marginal tax rate (no deduction). When money is withdrawn in retirement, the employee pays no taxes. Although RMDs also apply to Roth 401ks, the participant will not need to report the distribution as ordinary income for tax purposes.

Q: Are certain people better candidates for a Roth 401k?

Mr. Cyndecki: Each situation is unique. Participants in the early stages of their careers, expecting to have higher income in the future, may be good candidates for a Roth 401k. Traditional 401k contributions typically make sense for individuals at the peak of their earning years looking to defer federal taxes to lower marginal rates in retirement.

Q: What are some certain rules that anyone considering a Roth 401k should be aware of?

Mr. Cyndecki: Unlike a Roth IRA, there is no income phase-out for the Roth 401k.

The maximum contribution amount between both traditional and Roth 401ks is $20,500 for 2022 and $22,500 for 2023. Participants over age 50 can make an additional $7,500 catch-up contribution.

Qualified distributions occur when the individual has reached age 59 1/2, died, or become disabled AND at least 5 years after the first Roth contribution has been made.

The Roth 401k is subject to RMDs at age 72. However, the taxpayer can avoid RMDs and maintain tax deferral by rolling the Roth 401(k) into a Roth IRA.

Employer matching contributions are made on a pre-tax basis and are placed in a separate tax bucket. The money in this bucket will be subject to ordinary income taxes when distributions are taken in retirement (just like a traditional 401k or IRA). However, some employers allow Roth conversions within the plan.

Q: Is there anything that people often forget to consider when they are considering a Roth 401k?

Mr. Cyndecki: Expectations of federal income tax rates should be considered. If one expects federal tax rates to increase in the future, then contributing to a Roth 401k and paying taxes today may make sense.

Because future tax rates are unpredictable, having the flexibility to withdraw between pre-tax and after-tax accounts in retirement is a great advantage.

• What to Do With Your 401k When You Leave Your Job
• Choosing Beneficiaries for a 401k Plan
• 401k Definitions Every 401k Plan Holder Should Know
• How a 401k Loan Affects Future Wealth
• Managing Your 401k In Your 50s
• How to Choose Between a Regular and Roth IRA

Reviewed December 2022

About the Expert

Chris Cyndecki is a Certified Financial Planner® and works with Pioneer Wealth Management Group, a fee-only firm based in Austin, Texas.