The most fundamental difference between traditional 401(k) contributions and Roth 401(k) contributions comes down to when those contributions are taxed. Roth 401(k) contributions are made after income taxes have been taken out of your paycheck, whereas traditional 401(k) contributions are made before income taxes come out. (This may not be the case if your employer's plan permits after-tax contributions.)
Here's why that matters:
Traditional vs. Roth 401(k): How does tax treatment differ?
Pretax contributions to a traditional
401(k) could
help reduce the income taxes you pay now by lowering your adjusted gross income. The contributions wouldn't lower your take-home pay as much as contributing to a Roth
401(k), where income taxes have already been taken out.
If you're a younger employee and can afford to pay the income taxes now, it may be better to consider Roth 401(k) contributions. These contributions have already been subject to income tax, so no additional income taxes are due when you withdraw the amount of your contributions. Earnings on Roth contributions can also be withdrawn tax-free if the requirements for qualified distributions are satisfied.
But if you're further along in your career and earning a larger salary, a traditional 401(k) may save you more on income taxes in the long run. It may be to your advantage to defer the income taxes until you retire — especially if you think your tax bracket might be lower.
What are the contribution limits for traditional and Roth 401(k)s?
Both traditional and Roth contributions are subject to a combined maximum annual contribution limit: For 2020 that's $19,500 (up from $19,000 in 2019) and if you are age 50 or older at the end of the year the limit increases to $26,000 (up from $25,000 in 2019).
"Consider participating in at least one of these to help you save and invest more for your retirement goals if your employer offers both."
— Sylvie M. Feist, director, Retirement Client Experience & Communications, Bank of America
What if my employer offers both a traditional and a Roth 401(k)?
Consider participating in at least one of these to help you save and invest more for your retirement goals if your employer offers both. You may choose one or the other or a combination of the two as long as, taken together, they don't exceed the annual contribution limit on 401(k) elective deferrals. In either case, there may be tax liability on your employer contributions, so talk with a financial and/or tax professional.