Need help understanding my 401k...Roth or Traditional?
I have two options: go with the Roth (the Wells Fargo guy said would be better for younger people such as myself) or a Traditional 401k. I guess I'm not understanding the definitions of "pre-tax contributions" for Traditonal vs. the "after-tax contributions" of Roth 401k. Can someone explain? Basically I want to know is which one will keep more money in my paychecks now, but will be higher taxed when I begin to withdraw money at retirement?
Public Comments
- Your take home pay will be the same whether you contribute Roth or regular 401(k) if you elect a percentage. So if you make $300 a week and want to contribute 5%, $15 will go into your regular 401(k) account. If you elect Roth, it will be less by the amount of taxes you pay. Let's say it's about $12. So the pre-tax/after tax impacts your contribution amount, not your paycheck. Now if you elect to contribute a flat dollar amount it will have an impact on your take home pay. Let's say you want to contribute $15/week out of $300 gross pay into your account. With regular 401(k), you elect 5% and you get $15. But if you elect Roth, a larger amount must be withheld. So you would be contributing (roughly) $20 of your gross compensation. So if you contribute $20 of your gross wages, Roth will net you a $15 contribution while regular 401(k) will net you a $20 contribution. In other words, it's costing you $15 in take home pay to make a $20 contribution into the 401(k). So who benefits from Roth? The answer isn't that clear cut. You can pay your taxes now or you can pay them later. Regular 401(k) contributions lower your taxable income in the year in which you contribute to it. With Roth you pay higher taxes now. Those who favor Roth are banking on taxes increasing. The more they increase the more you benefit from Roth. Personally, I have both options available to me. I've run a number of scenarios, projecting future taxes, earnings, etc. and I can't seem to come up with any scenario in which Roth yields a significant savings.
- traditional will yield a slightly higher paycheck because of the taxes being lower under the pre-tax traditional option. You will be taxed upon distribution. ROTH you will be taxed now which yields a lower contribution amount if you are choosing a percentage of your pay. That lower contribution will compound at a slower rate. However, because it's not taxed upon distribution the end result is basically the same (as prior poster pointed out). Which should you do? If you can afford it then do both. Diversity amongst money types (pre-tax and after-tax) will allow you more flexibility in your retirement years. You can pull from the accounts in varying amounts and maintain control over your tax rates. At the same time you're taking advantage of both the higher compounding of the pre-tax and the no-tax benefit of the ROTH.
