You’re probably familiar with the traditional 401(k) plan.  If you work for a corporation or other private employer, you likely have one.  A 401(k) plan is an employer-sponsored retirement savings plan that qualifies for tax benefits.  Traditional 401(k)’s have been around for some time, but a more recent addition to the retirement planning landscape is the Roth 401(k).  The main difference between these two accounts has to do with when you pay taxes on your savings:

Traditional 401(k)

A traditional 401(k) is a tax-deferred retirement savings plan.  This means that when contributions are deducted from your paycheck and put into your 401(k), they’re also subtracted from your taxable income.  You don’t pay tax on the money that goes into your 401(k) until much later, when you withdraw it.  What’s the advantage to you?  For many people, income during the working years is considerably higher than it is during the retirement years.  So, once you’re retired, you drop into a lower tax bracket.  By waiting to pay taxes on your 401(k) funds until you withdraw the money during retirement, you likely will pay less in income tax on the money.

Roth 401(k)

Income taxation for a Roth 401(k) is exactly the opposite.  With a Roth, your contributions are still made through payroll deduction, but those contributions are taxed as regular income in year they go into your 401(k).  When you retire, you withdraw the money you contributed, as well as the interest earned on your contributions, tax-free.  This makes a Roth 401(k) an attractive option for people who anticipate being in a higher tax bracket once they retire.  It’s also a good option for those who plan to use the account for long-term investing, because their retirement savings is allowed to grow, tax-free, over many years.

Both types of 401(k) plans carry with them restrictions concerning rollovers and withdrawals, as well as other limits. As with any investment decision, the choice between a Roth 401(k) and a Traditional 401(k) is specific to your situation.  It’s best to seek the advice of a qualified financial planner before making any investment decision.Â
Did you know we have a Certified Financial Planner on staff?  Meet Linus Whitlock and call (336) 547-9999 to schedule an appointment.

The Law Offices Of Cheryl David is a member of the American Academy of Estate Planning Attorneys.

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