Roth 401(k) vs. 401(k): Which Retirement Account Is Right for You?

Cecilie_Arcurs / Getty Images

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

A Roth 401(k) and a traditional 401(k) are both employee-sponsored retirement plans that help individuals grow their money in retirement. The traditional 401(k) plan allows for pre-tax contributions, while the Roth 401(k) are contributions are made after taxes. While the plans are similar in many ways, there are significant differences to understand between Roth 401(k) vs. 401(k).

How Does a Traditional 401(k) Work?

Contributions to a traditional 401(k) are made with pre-tax money, meaning that participants don’t have to pay income tax on the part of their paychecks they direct to the plan. Your funds in this IRA will grow tax-free within the account. This means you won’t pay taxes on earnings– which includes interest, dividends and capital gains–until withdrawal.

Many employers may match your contributions to further growth in your 401(k). Matching programs vary from company to company, but you should take advantage of this perk because it means free money in retirement. 

In terms of taxes, you will be taxed in retirement when you withdraw your funds. A withdrawal will be taxed as ordinary income based on your tax bracket during retirement. You must take a distribution at 73. 

Those who withdraw from their 401(k)early (before age 59½ ) will face an early withdrawal penalty of 10% (unless you qualify for an exception) plus income tax. 

 How Does a Roth 401(k) Work?

Contributions to a Roth 401(k) are after-tax payments, meaning that participants who withdraw in retirement can do so without paying taxes. A Roth 401(k) is different from the standard 401(k) in that after-tax money is used to contribute to a Roth 401(k). This means that employees don’t get a tax break at the time they put money into the plan. Their tax benefit comes when they take money out tax-free. Investment earnings grow tax-free in the account. 

Qualified withdrawals can occur after age 59½, and your Roth 401(k) must be at least five years old. You will be penalized if you withdraw earnings prior to age 59½, and you will be assessed a 10% penalty and income tax. 

Employers can match contributions you make to your Roth 401(k), but these funds must be placed in a separate traditional 401(k) account. The funds in your employer’s matching 401(k) will grow tax-free, but withdrawals will be taxed in retirement. 

Key Differences Between Roth 401(k) and a Traditional 401(k)

Both a Roth 401(k) and a traditional 401(k) are sound investment options but they do have key differences. Let’s take a look at how they compare. 

Pros and Cons of a Traditional 401(k)

It is a good idea to evaluate the pros and cons before deciding which 401 (k) works best for you.

Pros

• Immediate tax benefits. Contributing to a 401(k) reduces your taxable income. 
• Employer matching. Employers will often match your contribution. This is free money for your retirement. 
• Tax-deferred growth. You don’t pay tax on earnings until you withdraw this amount in retirement. 
• High-contribution requirements. For 2025, you can contribute $23,500. If you’re 50 and older, you can contribute an additional $7,500. 

Cons

• Taxes on withdrawals. Since contributions are made with pre-tax dollars, you will be taxed when you make a withdrawal.
• Early withdrawal penalties. If you withdraw your funds prior to 59½, you will pay a 10% penalty as well as taxes. Some exceptions may apply.
• Must take a required minimum distribution. You must withdraw at age 73, even if you don’t need the money. This withdrawal could put you in a higher tax bracket, causing you to pay more in taxes. 
• Limited investment options. Your employer’s investment options are limited to small-selection mutual funds. 

Pros and Cons of a Roth 401(k)

What are the pros and cons of Roth 401(k)? Let’s take a look at the advantages and disadvantages of a Roth 401(k). 

Pros:

• Eligible for tax-free withdrawals. Contributions to a Roth 401(k) are made after taxes. This allows you to withdraw amounts in retirement without paying taxes. 
• Investment earnings grow tax-free. You keep 100% of all gains in a Roth 401(k). 
• There are no income limits on contributions to a Roth 401(k). Anyone can contribute regardless of salary. 
• No required minimum distributions. Unlike a traditional 401(k), you are not required to take a minimum distribution at age 73. 
• Employer matching. Your employer can match contributions to your Roth 401(k). 

Cons

• No immediate tax deduction. Contributions are made after taxes. You don’t reduce your taxable income in the year you make the contribution. 
• Higher taxes are paid now. Since you have to pay taxes upfront, you may pay more if your taxable income pushes you into a higher tax bracket. 
• Early withdrawal rules. If you withdraw prior to age 59½ and have held the account for less than five years, you will pay a 10% penalty. 

How to Choose Between a Roth 401(k) and a Traditional 401(k)

Making a decision between opening a Roth 401(k) or a traditional 401(k) requires an analysis of your tax rate, diversification and how much you plan to withdraw in retirement. 

Current Tax Rate vs. Expected Rate in Retirement 

If your current tax rate is higher than the tax rate you expect in retirement, a traditional 401(k) plan makes more sense. Contributions are pre-tax and reduce your current taxable income today. If your current tax rate is lower than the tax rate you expect in retirement, a Roth 401(k) plan is the more strategic move. Contributions are after-tax, so you pay taxes now. Withdrawals in retirement are 100% tax-free, avoiding higher future tax rates.

Importance of tax diversification 

Future tax laws are difficult to predict, and taking a balanced approach may be best. You may want to take tax advantages right now, as well as in retirement. You could potentially put 50% of your funds in a traditional 401(k) and the other 50% in a Roth 401(k). 

How much you plan to withdraw in retirement

If you plan to withdraw minimally in retirement,  keeping funds in a tax-deferred fund allows that money to grow. However, if you choose to withdraw a substantial amount in retirement for health expenses and travel, a Roth 401(k) is a better fit. You don’t have to pay taxes on your withdrawals during retirement, maximizing the amounts you can use for your needs. 

How to Split Contributions Between Roth 401(k) and Traditional 401(k)

If you plan to contribute to a traditional 401(k) and a Roth 401(k), you can look at a few different strategies to do so. If you’re unclear about future tax rates, embrace a measured approach by contributing 50% of your funds to a Roth 401(k) and 50% to a traditional 401(k). 

Another approach is to review your current and future tax brackets. If your income is high now,  you may want to place more than half of your funds in a traditional 401(k) and the remainder in a Roth 401(k). You would take the opposite approach if you’re in a lower tax bracket now but may be in a higher tax bracket in retirement. 

A third option is to contribute based on your age and career stage. When you’re starting your career, more contributions in a Roth 401(k) may be a better fit. Mid-career, you may want to take a balanced approach between contributing to a traditional 401(k) and a Roth 401(k). Later in life, toward retirement, when you want to catch immediate tax breaks, a traditional 401(k) is advisable. 

Roth 401(k) vs. 401(k): Which Is Better for You?

If you want immediate tax savings today and expect to be in a lower tax bracket during retirement, a traditional 401(k) will allow you to maximize employer-matching contributions in a tax-deferred account.

Contributing to a Roth 401(k) may be better if you want tax-free income in retirement. It is also a better approach if you expect to be in a higher tax bracket in the future and want more flexibility in withdrawals.  

Share This Article: