Hi All!

Let's talk about Roth vs Traditional 401k!

The number of companies offering their employees a choice between Roth and Traditional 401Ks has exploded and now about 75% of companies are offering the option. So which should you choose? Or should you split your contributions and have both types of retirement accounts? 

The rules for contributions are the same for both.

The rules for when you can withdraw funds are almost identical as well. You can withdraw at 59 1/2 years old or younger if you are disabled. There is one difference however. In order to withdraw from the ROTH 401K,  you must have had the account five years.

The BIG difference is the Traditional 401K is Pre Tax. That means you do not pay any taxes on that income the year you contribute to your 401K. You pay taxes when you withdraw  money from your 401K. Some people feel that this would work the best for them as they expect to be in a lower tax bracket when they retire.  They believe this would lower their overall tax burden. Remember, Congress can change the law whenever they want so this may or may not be the case when you retire.

The ROTH 401K is Post Tax. This means you pay taxes the year you contribute to the 401K but do not pay taxes when you withdraw money. This means that when you withdraw money when you retire that this WILL NOT be included as income. This may have a positive affect on your medicare bills or social security payments depending on the laws at the time. The other really big positive is you will not have to pay taxes on any gains you have had on your investments.

Let's give an example:

Traditional 401K                                                ROTH 401K

You contribute $10,000 for 20 years.                 You contribute $10,000 for 20 years.

Your contribution is $200,000.                            Your contribution is $200,000

You invested into a SP 500 index fund.              You invested into a SP 500 index fund.

Conservative rate of return is 8%.                      Conservative rate of return is 8%.

In 20 years, you have $500,000.                        In 20 years, you have $500,000.

As you withdraw money, you will have              You have already paid taxes on the initial 

to pay taxes on $500,000.                                  $200,000 and, even though you earned                

                                                                           an additional $300,000, you will not have to  

                                                                           pay taxes on it! Pretty cool!

One more big difference I want to mention. 

If you withdraw money from a Traditional 401K before 59 1/2 years old you will pay taxes and a 10% fine.

If you withdraw money from a ROTH 401K before 59 1/2 you will pay a 10% fine and pay taxes on any investment returns.

That's it for today!

See you next week!