Whether you have just started saving for retirement, have changed jobs and want to switch up your retirement options, or are exploring new tax-efficient investment methods, you’re probably familiar with the 401(k). A 401(k), a convenient way to help grow your retirement savings, comes in two options: a traditional or Roth. Which type should you invest in based on your financial plan and goals? Before answering that, let’s review the key differences, benefits, and questions that may help you determine which retirement account type to choose.
The Differences Between Traditional and Roth 401(k)s
The key difference between traditional and Roth 401(k)s is when you’ll pay taxes on your contributions and withdrawals.
- The features of a traditional 401(k) include:
- Contributions are made to the retirement account using pre-tax dollars.
- You receive a tax deduction for your contributions, so you can benefit from a tax break in the current year.
- Your savings grow tax-deferred until withdrawn for retirement.
- The features of a Roth 401(k) include:
- Contributions are made using after-tax dollars.
- While you’ll pay taxes upfront, your investments grow tax-free going forward under current tax laws.
Where Should You Invest?
When deciding where to invest, you should first consider your current and potential future tax bracket. Ask yourself the following questions:
- Are you in a higher or lower tax bracket than you expect to be in the future when you need to withdraw these funds for retirement?
- Are you early in your career, in a low tax bracket, and expect to grow your earnings and be in a higher tax bracket in the future?
- Are you currently in a high tax bracket and need a way to reduce your tax burden?
While it may be challenging to gauge where you’ll be in the next 15 to 20 years or what the tax laws will be when you plan to retire, you should aim to pay taxes on your money when you’re in the lowest tax bracket. If you are currently in a lower tax bracket, contributing to a Roth 401(k) may be a good option for you. However, if you expect to drop into a lower tax bracket when you plan to withdraw these funds in retirement, then a traditional 401(k) may be the best option.
As with any investment decision, you will need to evaluate your personal circumstances and discuss your goals and concerns with a financial planner. If you’re interested in learning more about which option might suit you better and how to manage your 401(k) account, please get in touch with a member of our team.
CCMI provides personalized fee-only financial planning and investment management services to business owners, professionals, individuals and families in San Diego and throughout the country. CCMI has a team of CERTIFIED FINANCIAL PLANNERTM professionals who act as fiduciaries, which means our clients’ interests always come first.
How can we help you?