What is the difference between a Roth 401(k) and 401(k)? Which one should you choose?

Planning for retirement involves making important decisions about your financial future, and one crucial choice is selecting the right type of retirement account. Two popular options are the traditional 401(k) and the Roth 401(k). While they share similarities, understanding their differences is key to maximizing your retirement savings.

So what are the distinctions between these two pension programmes?

The key differences

The primary contrast lies in the way they are taxed. A traditional 401(k) is funded with pre-tax contributions, meaning the money you contribute is deducted from your taxable income in the year of contribution. The investments grow tax-deferred until you withdraw the funds in retirement, at which point the withdrawals are subject to ordinary income tax.

A Roth 401(k) is funded with after-tax contributions. You don’t get an upfront tax deduction, but the investments grow tax-free, and qualified withdrawals in retirement are tax-free as well.

The contribution limits for both Roth and traditional 401(k) accounts are the same. As of 2023, the annual contribution limit for both types is $22,500 for individuals under age 50, with an additional catch-up contribution of $6,500 for individuals aged 50 and older.

Traditional 401(k) accounts are subject to required minimum distributions (RMDs) starting at age 72or when you retire, whichever is later. RMDs are taxable withdrawals that must be taken annually. In contrast, Roth 401(k)s do not have RMDs during the account owner’s lifetime, allowing the funds to grow tax-free for a longer period.

A similarity comes with employer matches. These are made with pre-tax dollars and are deposited into a traditional 401(k) account. This means that even if you contribute to a Roth 401(k), the employer match will be directed to a traditional 401(k) account, subjecting those funds to future taxes upon withdrawal.