Roth vs. Traditional IRA

Should you choose Roth or traditional 401(k) contributions?

Nov 2, 2021
Empower Insights

The answer depends on your tax situation and expectations for the future.

Many companies offer a 401(k) plan with both Roth and traditional contribution options. You can choose between one or the other, or — as long as you don’t exceed the combined contribution limit — you can choose to fund both at once.

Roth and traditional contribution options share many features. Both allow you to:

  • Contribute up to a combined total of $20,500 per year in 2022 (plus an additional $6,500 if you’re age 50 or over).
  • Invest in the options your employer makes available through their plan.
  • Invest for the long term with the potential for tax-advantaged growth.

The main difference between Roth and traditional 401(k) contributions is the way each is taxed. In the simplest terms, your decision comes down to whether you’d rather pay taxes now or later.

Roth contributions: Pay taxes now

Roth 401(k) contributions are made with after-tax dollars. As with the traditional option, the Roth option provides the potential for tax-free growth for every dollar you contribute. But once you start taking qualified Roth distributions in retirement, you won’t owe any taxes on the money you collect.

Roth vs. Traditional IRA - calculator of tax implications

Traditional contributions: Pay taxes later

Traditional 401(k) contributions are typically made with pretax dollars, which reduces that year’s taxable income. Your contributions are not taxed until you begin making withdrawals, at which point you’ll pay ordinary income tax on every dollar you withdraw.

Choosing the account that’s right for you

As you consider which type of contribution will be best for you, give some thought to the following questions:

Do you need to reduce your taxable income this year? If you need to reduce your taxes for the current year, or to lower your income to stay eligible for benefits such as Affordable Care Act healthcare subsidies or the Child Tax Credit, traditional 401(k) contributions can help you do that. Roth 401(k) contributions don’t affect your taxable income or current tax liabilities.

Can you afford to make pretax contributions? If you take the Roth 401(k) contribution route, your taxable income won’t be reduced. Because you pay the taxes upfront, you may want to consider traditional 401(k) contributions if your income is already stretched.

How long do you have until you retire? The longer you have to save for retirement, the more you may benefit from the Roth option’s potential for tax-free growth. You pay your taxes up front on the current dollar value of your contribution, but any potential future appreciation is tax-free when you take a qualified distribution. Over many years — or even decades — that potential appreciation may offset the front-end tax liability.

Do you expect your tax rate to be higher or lower when you retire? This factor carries substantial weight in the choice between a Roth and a traditional 401(k) option. If you think your tax rate will be lower when you begin taking withdrawals from your plan, traditional contributions may make sense. If your tax rate will be about the same (or higher), Roth contributions might be preferable.

Still undecided? This Roth vs traditional 401(k) calculator can help you assess whether the traditional option, the Roth option or a combination of both is best for your specific situation.

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