Traditional 401K vs Roth 401k Retirement Plans
When it comes to making important financial decision we all want to make the best decisions. One of the most important financial decisions anyone can make is how to invest in a good retirement plan. Perhaps the most common means by which people save for retirement is investing in a Traditional 401K or Roth 401k plan. We all know a 401K plan is a savings specifically for retirement. However, believe it or not many people do not really understand how a 401K plan really works. Deciding which type of 401K plan you wish to open is a matter of preference. It should be decided based on how you are willing to save for your future.
The most popular types of retirement accounts are the Traditional 401K and the Roth 401K. In a nutshell the main difference between these two types of accounts is in the way in which they are taxed. To determine which one the right one is for them many people ask the famous question “Do I want to eat my cake now, or later?” This question refers to the time value of money. We should all be aware that inflation and taxes affect the future value of the dollar. This is why when you are thinking about opening a 401K account you need to decide if you want more money now or later?
In a Traditional 401K every contribution you make will go into your 401K account pre-taxed. This means that you will not be paying taxes on the yearly contributions you make into your 401K account; because of this it will lessen the amount of income you will be taxed on for each year. To many this may seem like a good deal, and it might be if you are thinking in the present. However, you have to realize that eventually you will get taxed when you begin to receive your 401K retirement payments. When you retire and begin receiving your Traditional 401K payments, those payments will be taxed as ordinary income. Over the years people tend to advance in positions of their jobs and usually begin to earn more. This causes them to reach a higher tax bracket, which means more income, but it also means more percent of your earnings are taxed. So with a Traditional 401K you will be taxed less each year and have more money to take home, but you are sacrificing the amount of money you could potentially have in the future by not having a Roth 401K.
With a Roth 401K you still pay taxes on all of your income for the year, including your yearly contribution to your 401K. This means that after your take home income is taxed, you will end up taking home less money than you would if you had invested in a Traditional 401K. Here, is where the question arises about whether you want your money now or later. Although it may not seem as attractive as a Traditional 401K at the beginning, it is the ideal account for people willing to wait for the future. With a Roth 401K account you will pay taxes on your yearly contributions, however after that money is locked in the account it will grow tax deferred and you will never have to pay taxes on it after that. This means that no matter which tax bracket you have fallen into over the years you will not have to worry about your retirement payments getting taxed. Once you retire you will receive retirement money from your 401K account for more years than you would if you had invested in a Traditional 401K. So in the long run a Roth 401K seems like the way to go. However, there is much debate concerning the Roth 401K, which mainly deals with the age of retirement. Most people worry that they will never reach retirement age and therefore they lean more towards investing in Traditional 401K plans.
Both of these retirement accounts have their pros and cons, but ultimately it is up to you to decide which of these accounts will best fit your needs. If you want more money now go with the Traditional 401K, if you want more money later go with the Roth 401K. Remember many companies will match your monthly contribution towards your 401K, so if you don’t have one yet, it may be a good idea to get one.