When planning for retirement, understanding the many types of retirement savings accounts accessible is essential. Let’s discuss two common employer-sponsored plans: standard 401(k) and Roth 401(k). The tax treatment of these two options is the primary distinction between them and may have a major influence on your retirement funds.
In a standard 401(k), payments are made before taxes are taken out. This lowers the amount of money you must pay taxes on for the year. This instant tax break can be helpful, especially for people with a high tax rate who make a lot of money. You won't have to pay taxes on the growth of your savings until you begin withdrawing money in retirement. On the other hand, both your payments and any gains are charged when you take them out. The rate depends on your tax bracket when you leave, which can be hard to predict.
A Roth 401(k) has a different approach to taxation. This type of account lets you put money in after taxes. Even though you won't get a tax break right away, you can take out your payments and gains tax-free when you leave as long as you're at least 59 1/2 years old and have had the account for at least five years. This function can be very helpful, especially if you think your tax rate will be higher when you leave.
When deciding between a standard 401(k) and a Roth 401(k), your current tax situation and your projected tax situation in retirement are usually the most important factors. If you expect to be in a higher tax rate in retirement, this feature may be quite helpful. But if you think your tax rate will be lower when you retire, standard 401(k) payments may be better for you.
Keep in mind that there is usually some leeway in this choice. Many companies let workers split their payments between a standard 401(k) and a Roth 401(k), which gives them a bit of tax diversity. If you would like some assistance with what combination of standard and Roth contributions to make to your 401(k), please reach out to a member of our team.