Roth 401(k) vs. 401(k): Which One Is Better?

A 401(k) is a workplace retirement savings plan that gives employees like you the benefit of having retirement savings taken straight out of their paychecks before taxes. And those automatic contributions are a super convenient way to make sure you’re consistently building your retirement savings.

Fast-forward to 2006 and a new heavyweight in the world of employer-sponsored plans enters the arena: the Roth 401(k).

The Roth 401(k) combines some of the features of the traditional 401(k) with the tax advantages of the Roth IRA. In fact, the tax advantages are where the Roth 401(k) separates itself from a traditional 401(k).

We’re big fans of the Roth 401(k). In fact, in a showdown between a Roth 401(k) versus a traditional 401(k), we’d go with Roth every single time! But let’s dig into the similarities and differences between these options so you can make the best decision for your retirement goals.

Roth 401(k) vs. Traditional 401(k): How Are They Similar?

If you’re debating which 401(k) plan to choose, it might be helpful to start by looking at what they have in common. Here are some of the most important features that both traditional 401(k)s and Roth 401(k)s share:

Automatic Contributions

Like we said before, these are both workplace retirement savings options. With either type of 401(k), your contributions are automatically taken out of your paycheck. Who said saving for retirement wasn’t easy? 

Company Match

Both plans usually include a company match. If you’re ready to invest and you work at a place that offers a match, take it. Your employer is giving you free money! 

Contribution Limits 

Both the Roth 401(k) and the traditional 401(k) have the same contribution limit.

• For 2024, you can save up to $23,000 per year (or $30,500 if you’re over 50) in your account.
• The opportunity to invest that much every year is a huge perk of either type of 401(k), especially when compared to an IRA’s contribution limit of $6,500 (in 2023) and $7,000 (in 2024) per year.²

The Roth 401(k) includes some of the best features of a 401(k), but that’s where their similarities end.

Roth 401(k) vs. Traditional 401(k): How Are They Different?

Like we mentioned above, the biggest difference between a Roth 401(k) and a traditional 401(k) is how the money you put in and take out is taxed.

Taxes are already super confusing (not to mention a pain to pay!), so let’s start with a simple definition, and then we’ll dive into the details.

A Roth 401(k) is an after-tax retirement savings account. That means your contributions have already been taxed before they go into your Roth account.

On the other hand, a traditional 401(k) is a pretax savings account. When you invest in a traditional 401(k), your contributions go in before they’re taxed, which makes your taxable income lower.

Roth 401(k) vs. Traditional 401(k)

	Roth 401(k)	Traditional 401(k)
Contributions	Contributions are made with after-tax dollars (that means you pay taxes on that money now).	Contributions are made with pretax dollars (which lowers your taxable income now, but you’ll pay taxes later in retirement).
Withdrawals	The money you put in and its growth aren’t taxed (score!). However, your employer match is subject to taxes.	All withdrawals will be taxed at your ordinary income tax rate. Most state income taxes apply too.
Access	If you’ve held the account for at least five years, you can start taking money out tax- and penalty-free once you reach age 59 1/2. How much will you need for retirement? Find out with this free tool! You or your beneficiaries can also receive distributions due to disability or death.	You can start receiving distributions tax- and penalty-free at age 59 1/2, no matter how long you’ve had your 401(k). You or your beneficiaries can also receive distributions due to disability or death.

Contributions

Since your Roth 401(k) contributions are made after-tax, you’re paying taxes now and taking home a little less in your paycheck.

Pretax traditional 401(k) contributions are taken off the top of your gross earnings before your paycheck is taxed. That will lower your taxable income, meaning a lower tax bill for the year.

So, why would anyone choose a Roth 401(k) if it means they don’t get a tax break now? If you’re only thinking about the years you’re making contributions, that’s a fair question. But hang with us. The huge benefit of a Roth kicks in when you start withdrawing money in retirement—and the years after that.

 

Withdrawals in Retirement

The biggest benefit of the Roth 401(k) is this: Because you already paid taxes on your contributions, the withdrawals you make in retirement are tax-free. That’s right! The money you put in—and its growth!—is all yours. No taxes will be taken out when you use that money in retirement. (But remember, any employer match in your Roth account will still be taxable in retirement.)

On the other hand, if you have a traditional 401(k), you’ll have to pay taxes on the amount you withdraw based on your current tax rate in retirement.

Here’s an example: Let’s say you have $1 million in your nest egg when you retire. That’s a pretty nice stash! If you’ve got it invested in a Roth 401(k), most of that $1 million is yours free and clear since you already paid taxes on it.

What if that $1 million was in a traditional 401(k)? Well, you’ll have to pay taxes on every penny you withdraw in retirement. Depending on your tax bracket and what the tax rates are when you retire (and who knows what those will be), you could wind up sending hundreds of thousands of dollars in taxes to Uncle Sam throughout your golden years. That’s a hard pill to swallow, especially after you’ve worked so hard to build your nest egg!

It goes without saying that your retirement savings will last longer if you’re not paying taxes on your withdrawals. That’s what gives a Roth 401(k)—and a Roth IRA, for that matter—a huge advantage over a traditional investment account! And it’s why we always say you should take advantage of all the Roth options you have.

Access

Another slight difference between a Roth and traditional 401(k) is your access to the money. In a traditional 401(k), you can start receiving distributions at age 59 1/2 no matter what. With a Roth 401(k), you can start withdrawing money without penalty at the same age . . . as long as you’ve had the account for at least five years.³

If you’re still decades away from retirement, you have nothing to worry about! But if you’re approaching 59 1/2 and thinking about starting a Roth 401(k), it’s important to be aware that if you take money out of the account within the first five years of opening it, you’ll pay a penalty. We’ll break this down more when we go over the Roth 401(k) withdrawal rules in a minute.

It's also important to remember that traditional 401(k)s have required minimum distributions (RMDs). That means the IRS will require you to take money out of your traditional accounts once you hit age 73 (if you turn 72 in 2023 or later).

What about all you Roth 401(k) owners out there? Well, you used to be subject to the same RMD rules as traditional 401(k) holders. But thanks to the SECURE 2.0 Act, employees with a Roth 401(k) will no longer be forced to take RMDs starting in 2024.

Why We Recommend the Roth 401(k)

If you’re investing consistently every month—whether it’s in a Roth 401(k), a traditional 401(k), or even a Roth IRA—you’re already on the right track! The most important part of wealth building is consistent saving every month, no matter what the market is doing.

We’ve already talked through the differences between these two types of accounts, so you’re probably seeing why a Roth 401(k) is such a great investing option. But just to be clear, here are the biggest reasons the Roth comes out on top.

Tax Benefit

It may be tempting to get a tax break now so you can get a little more in your paycheck today. But think about it this way: You’re already doing the hard work of saving for retirement. Why wouldn’t you do all you can to make that money go even further when you retire?

Here’s something else to think about: No one knows how the tax brackets or tax percentages will change in the future, especially if you’re still decades away from retirement. Do you want to take that risk? It may hurt a bit to pay taxes on your contributions now, but your future retirement self will thank you.

Emotional Toll

Like it or not, it’s hard to separate emotions from investing. Imagine getting to your retirement years and watching your $1 million nest egg reduced to less than $800,000 because of taxes! You’d much rather pay taxes now than see all that money fly out the door later. You’ll miss $100,000 in retirement a lot more than $100 in a paycheck now.

Once you can get into the habit of investing 15% of every paycheck to your Roth 401(k) early on, you won’t even miss the money you’re paying in taxes. And when you get to retirement, you’ll be glad you don’t owe the government part of your hard-earned nest egg.

Work With an Investment Pro

We’ve gone over all the pros and cons of both traditional 401(k)s and Roth 401(k)s. The Roth option wins top prize in our book because of the tax advantages you’ll enjoy when you start making withdrawals in retirement.

But if you still have questions about how a Roth 401(k) works or which plan works best for you, reach out to an investing expert. Our SmartVestor program can connect you with a financial advisor or investment pro who has years of experience and can walk you through your options.

 

This article provides general guidelines about investing topics. Your situation may be unique. To discuss a plan for your situation, connect with a SmartVestor Pro. Ramsey Solutions is a paid, non-client promoter of participating Pros.