By Adam Shell
From Kiplinger’s Personal Finance
Question: My employer is giving me a choice to contribute to a Roth 401(k) or a traditional 401(k). How do I decide which one is best for me?
Answer: Investing in a Roth 401(k) vs. a 401(k) all boils down to taxes. It’s the norm today for working Americans to save in either type of 401(k) as pensions fade away. But 401(k)s come in two distinct flavors. And that means savers must do a tale of the tape comparison of the two options: traditional vs. Roth 401(k).
Both 401(k)s are “great retirement savings vehicles,” says Nilay Gandhi, a senior wealth advisor at Vanguard. But which one is right for you?
Roth 401(k) vs. 401(k)
Let’s start with what the two 401(k)s have in common. The contribution limits are the same. In 2025, you can contribute $23,500 (up $500 from 2024). Savers 50 and older can sock away up to $31,000 (up from $30,500 in 2024). Due to a special super catch-up provision in SECURE 2.0 (SECURE refers to Setting Every Community Up for Retirement Enhancement), savers aged 60-63 may be able to contribute up to $34,750 in 2025.The big difference between the two types of 401(k)s, though, is their tax treatment—or when you pay taxes to the IRS. With a traditional 401(k) you postpone taxes until a later date, whereas with the Roth 401(k) you pay the taxes upfront.
“It’s a tradeoff,” said Rob Williams, managing director of financial planning for Charles Schwab. “You’re either taxed upfront or taxed when you withdraw the money.” (The IRS allows penalty-free withdrawals from both traditional 401(k)s and Roth 401(k)s after age 59½).
Differences Between Roth and Traditional 401(k)s
Traditional 401(k)s are funded with pre-tax dollars deducted from your paycheck, netting you an immediate tax break. “If you put money in a traditional 401(k), that income is not included in your taxes,” said Williams. “It’s an upfront tax benefit.” So, if you earn $100,000 and you contribute $10,000 to your 401(k) this year, your taxable income will fall to $90,000. But there’s no free lunch: you’ll pay income taxes at your ordinary income rate when you withdraw the money in retirement.
In contrast, Roth 401(k)s are funded with dollars already taxed. The power of a Roth 401(k), though, is you can make tax-free withdrawals in retirement. And while Roth 401(k)s, which are a close relative of the Roth individual retirement account (IRA), tend to be less frequently used than traditional 401(k)s, 80 percent of 401(k) plans managed by Fidelity Investments offer a Roth 401(k) option. However, just 15 percent of Fidelity 401(k) participants contribute to a Roth IRA.
How to Choose Between a Roth and Traditional 401(k)
When deciding between a traditional vs. Roth 401(k), you’ll need to identify your current tax rate and guesstimate your potential tax rate in retirement. Other factors that could impact your decision include what your income will look like in retirement, your cash flow situation during your saving years, whether you’re expecting a big inheritance that could put you in a higher tax bracket later in life, and how long you’ve had your Roth 401(k).The last point is key for those who choose the Roth 401(k) option later in life. The reason? You won’t be eligible for a penalty-free qualified withdrawal until you’ve had the account open at least five years.
It’s All About Tax Brackets Now and Later
The most critical piece of information, though, relates to your personal tax situation, says Gandhi. “Do you believe you will be in a higher or lower tax bracket in the future (e.g., during retirement) than where you’re at today?” said Gandhi.The answer to that question is crucial because of the different tax treatments of a traditional vs. a Roth 401(k).
The rule of thumb is if you think you’ll be in a lower tax bracket in retirement than you are now, then a traditional 401(k) makes more sense. Why? You’ll pay less taxes on your 401(k) withdrawals in retirement. Plus, you’ll enjoy a tax deduction in the here and now when tax rates are higher.
In contrast, if you believe your tax bracket will be higher in retirement (which is often the case for younger 401(k) savers who earn smaller salaries or those who think Congress will boost tax rates in the future), then a Roth 401(k) is the way to go. The reason: Since you don’t pay taxes on Roth 401(k) withdrawals, you’re better able to minimize taxes on your other forms of income and avoid jumping up to a higher tax bracket.
How Do RMDs Differ?
There’s another advantage of a Roth 401(k). Starting this year, thanks to the SECURE 2.0 Act, you no longer must take required minimum distributions (RMDs) from Roth 401(k)s during your lifetime. Savers in traditional 401(k)s, however, are subject to RMDs. Required minimum distributions are minimum amounts that IRA and retirement plan account owners must withdraw annually starting with the year they reach age 73.“It gives (the Roth 401(k) account holder) a lot more flexibility because you’re not forced to take withdrawals,” said Williams.
Roth 401(k)s Offer Tax Diversification
Having some of your retirement savings in a Roth 401(k) also allows you to benefit from “tax diversification.” If you have multiple sources of income in retirement, from say a traditional 401(k), taxable brokerage accounts, cash savings, and a Roth 401(k), you have more flexibility in deciding which account to withdraw from to minimize your tax burden. Say you need $50,000 for a down payment on a vacation home or a new electric car. Yanking the entire amount out of a traditional 401(k) will create $50,000 more in taxable income that could push you up in a higher tax bracket.However, if you have ample savings in a Roth 401(k), you could take your RMDs and then pull the rest of the money you need from the Roth 401(k) to make your large purchase more tax-efficient, said Williams.
“We call it tax bracket harvesting,” said Williams, referring to the strategy of pulling from more tax-efficient accounts to avoid generating additional income that could boost your tax bill. “What you’re doing is diversifying tax risk and providing yourself more flexibility when you get to retirement.”
You Can Contribute to Both a Roth and Traditional 401(k)
Since future tax rates are tough to predict, there’s nothing to say you can’t hedge your bets by contributing to both a traditional and Roth 401(k), adds Williams. If you go this route, you still must adhere to the maximum contribution limits imposed by the IRS. You can’t, for example, sock away $23,500 in a traditional 401(k) and another $23,500 in a Roth 401(k).©2025 The Kiplinger Washington Editors, Inc. Distributed by Tribune Content Agency, LLC.
The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
