Should You Invest Your 401(k) Contribution In Your Traditional 401(k) or Roth 401(k)?

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The biggest difference between a Roth 401(k) and a traditional 401(k) is how and when you get a tax break. Thus, most advice on the Roth 401(k) vs. traditional 401(k) topic depends on the following question: Does the benefit of a tax-deductible contribution now, outweigh the benefit of tax-free withdrawals in retirement, after your account has grown?

Contributions to traditional 401(k) are made with pre-tax dollars and help reduce your current income tax liability as a result. Those pre-tax contributions will also grow tax-free. However, any withdrawals made in retirement from a traditional 401(k) will be included in as ordinary income for income tax purposes in the year that you make the withdrawal, and you will owe a tax on the amount of your distribution based on your income tax rate at that time.

In contrast, contributions to Roth 401(k) are made with after-tax dollars, after taxes have already been calculated. Since the government has already collected the tax on these funds, the withdrawals in retirement are tax-free; when you take money our of a Roth 401(k) there will not be any income tax liability.

Thus, most advice on the Roth 401(k) vs. traditional 401(k) topic depends on the following question:

Does the benefit of a tax-deductible contribution now, outweigh the benefit of tax-free withdrawals in retirement, after your account has grown?

Without question, the before tax contribution helps lower your taxable income by the amount of your contribution resulting in meaningful income tax savings. It is the way to contribute for most plan participants because the Federal government subsidizes your contribution.

Even so, the income benefit of withdrawing retirement funds that have grown and can be withdrawn tax-free cannot be ignored. If you do not need the income tax deduction a traditional 401(k) offers, you may want to explore with your tax adviser or Investment Advisor the benefits of contributing to a Roth 401(k). Your plan allows you to contribute to both your traditional 401(k) and Roth 401(k).