How One little word can make a BIG Impact

Sep 14, 2023 | Financial Education

ROTH 401(K) VS TRADITIONAL 401(K) 

When most of us were younger, a Roth 401(k) did not exist.  So, when we are passing wisdom down to the younger generations, it might not be one of the first things that comes to mind.  With that said, it should be near the top of your list. 

Deciding between a Roth 401(k) and a traditional 401(k) depends on your individual financial situation and goals. Here are some considerations for when and why a person might choose one over the other: 

Roth 401(k):

Young and in a lower tax bracket:  If you’re in a lower income tax bracket now and expect to be in a higher one in the future, a Roth 401(k) can be advantageous. Contributions are made with after-tax dollars, so you won’t get an immediate tax deduction, but your qualified withdrawals in retirement are tax-free.

Tax diversification: Having some retirement savings in a Roth 401(k) can provide tax diversification in retirement. This means you’ll have flexibility to choose where to withdraw money from, potentially reducing your overall tax burden.

Long-term growth: Since your contributions and earnings in a Roth 401(k) can grow tax-free, it can be a powerful wealth-building tool over many years.

No Required Minimum Distributions (RMDs): Roth 401(k)s do not require you to take mandatory withdrawals starting at age 73 (the age when RMDs start for traditional retirement accounts). This can be advantageous if you want to leave your money invested for as long as possible or plan to pass it on to heirs.

Traditional 401(k):

Immediate tax benefits: Contributions to a traditional 401(k) are made with pre-tax dollars, reducing your taxable income for the year. This can lead to lower taxes in the current year, which can be especially helpful if you’re in a higher tax bracket. 

Uncertain future tax rates: If you believe that future tax rates will be lower in retirement, a traditional 401(k) might be more advantageous. It allows you to defer taxes until retirement when you may be in a lower tax bracket.

Cash flow considerations: Contributing to a traditional 401(k) can free up more cash flow in your current budget since you get a tax break today. This can be beneficial for budgeting and other financial goals.

Ultimately, the choice between a Roth 401(k) and a traditional 401(k) depends on your current financial situation, future tax expectations, and personal preferences. Some people also opt for a combination of both to create tax diversification in retirement, which provides flexibility in managing taxes during your retirement years. It’s a good idea to consult with a financial advisor or tax professional to make an informed decision based on your specific circumstances.

In addition to these general guidelines, you may also want to consider reviewing your beneficiaries with the help of a financial advisor or estate planning attorney, who can provide guidance on how to ensure that your retirement assets are distributed according to your wishes.

 

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal, or investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.

Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through

Gladstone Institutional Advisory, LLC, a registered investment advisor. Gladstone Institutional Advisory, LLC and Puzzle Wealth Solutions are separate entities from LPL Financial.

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