A Quick Comparison Between 401(k) and Roth 401(k) Plans
The traditional and Roth 401(k) IRAs are popular tax-advantaged accounts that help you make the most out of your retirement savings. These plans differ in employer contributions, investment options, and tax treatment.
Someone offering financial planning services will tell you that when you employer offers both plans, it’s perfectly okay to hedge your bets. However, if you must decide between the two, it’s crucial that you have a deeper understanding of what sets these accounts apart.
What is a 401(k) Plan?
401(k) is a retirement plan sponsored by your employer. When contributing to this account, a portion of each paycheck is diverted into the plan. The contributions are made before income taxes are deducted from your paycheck.
There are lots of investment opportunities for different 401(k) plans, and they generally depend on your plan provider. No matter which type of fund – or funds – you select, all investment gains from this plan will not be taxed by the IRS.
What is a Roth 401(k) Plan?
A Roth 401(k) plan is an employer-sponsored investment account funded with after-tax dollars within the plan’s contribution limit. Compared to its traditional counterpart, this savings account is more ideal for individuals who think they will be in a higher tax bracket in retirement because the withdrawals made are tax-free.
When setting up and controlling your Roth 401(k) account, investment choices are not limited to what your provider offers. This enables IRA holders to have more freedom when it comes to investment compared to employees using the traditional 401(k).
How are they Different?
The main difference between a 401(k) and a Roth 401(k) is the method used to tax the money you contribute. A traditional 401(k) is a pre-tax savings account, meaning your contributions go through before they are taxed. This results in a reduced taxable income. A Roth 401(k), on the other hand, is a post-tax savings account. Contributions have already been taxed prior to entering the account.
While your employer might match your contributions on a 401(k), you will be on your own when handling a Roth 401(k). Withdrawing money from a 401(k) plan prior to retirement means you will face a high penalty fee and be required to pay taxes on the cash you intend to withdraw. A Roth 401(k) is the opposite because you can take out money whenever you like.
The good news is, despite those differences, you don’t necessarily have to come up with an all-or-nothing decision. It is possible to have both traditional and 401(k) and decide each year where you want your contributions to go.
The Need for Financial Planning Services
Retirement plans always require close attention. Service providers from a wide range of fields (i.e. payroll, financial advice, administration, etc.) must collaborate to ensure the plan stays in excellent shape. In most cases, a 401(k) advisor works as a coordinator for these providers.
To know more about 401(k) plans and other investing opportunities, look for reliable companies that offer financial planning services. We at Prosperity can be your financial advisor and guide you in boosting your nest egg, so you can make confident decisions as you build your retirement savings account.
