Updated on 07.13.15

The New Roth 401(k) Versus The Traditional 401(k): Which Is The Better Route?

Trent Hamm

Recently, a number of readers have asked me about the new Roth 401(k). Is it really a good deal, they ask? In a nutshell, it’s a very good deal for almost anyone eligible for it, but let’s walk through the scenario carefully.

What Is A Roth 401(k)?

A Roth 401(k) is not all that different than a regular 401(k). In most regards, it works exactly the same – your employer manages the plan, the money is taken directly out of your paycheck and put into the investment, and once in the investment, you can control the investments to whatever degree you wish (or your employer allows).

The first difference (and this is the one that’s a bit of a negative) is that your contributions to a Roth 401(k) come after taxes. Let’s say that you’re currently contributing 10% of your salary to a normal 401(k) and are thinking of switching to the new Roth 401(k). When you make that switch, you will lose that 10% as a tax deduction, which will increase your tax bill right now.

The second difference (and this one makes up for that downer and more) is that when you make withdrawals from this 401(k), you pay no taxes at all on any withdrawal. Of course, you have to wait until you’re eligible to withdraw money normally from a 401(k), which requires that you have started the plan five years ago or more or are 59 1/2 years old.

If your employer does matching, this will remain in pre-tax dollars and will go into a normal 401(k).

How Does That Work Out?

Let’s use another common straw man example. Let’s say that our hero Joe is in the 28% tax bracket and he puts $10,000 a year into his 401(k) right now – that means that Joe doesn’t have to pay taxes on that $10,000. If he moved to putting that money into a Roth 401(k), he would be able to put in the same $10,000 a year, but he would have to pay taxes on that before it went in, bringing his total bill for that $10,000 contribution up to $12,800. If Joe does this for thirty years, he’ll have paid $84,000 in extra taxes to have the money in a Roth 401(k) versus a regular 401(k).

But trust me, Joe’s going to be happy in retirement. Let’s say Joe retires and he has enough in his 401(k) that he can take out $50,000 a year for the next thirty years, until he’s 90 and passes away. He’s again in the 28% tax bracket. So, when he withdraws the $50,000 from the Roth 401(k), it’s all his! He has $50,000 to spend! But if he were to withdraw the $50,000 from the regular 401(k), he would have to pay $14,000 every year in taxes and only be able to keep $36,000 of the money – over the 30 years, he’ll pay a total of $420,000 (!) in taxes. Let’s even say his tax bracket was lower than that in retirement – let’s put him in the 15% bracket at retirement. He would still have to pay $7,500 each year in taxes and only keep $42,500. He’d still pay $225,000 in taxes over those years.

Basically, by paying $2,800 a year now in extra taxes, Joe saves himself $14,000 a year in retirement.

You can make complex models with inflation and other elements to the point of confusion, but the Roth 401(k) still comes out ahead in almost every scenario – and far ahead in most scenarios. If you still have questions and doubts, contact the retirement counselor in your workplace, who can work you through your specific scenario in detail.

What About A Roth IRA?

If you have access to a Roth 401(k) and your only purpose is to contribute money for retirement, a 401(k) will suit your needs. The one advantage that a Roth IRA has over a Roth 401(k) is the ability to withdraw your contributions without a tax penalty, but the additional benefits of the Roth 401(k) (especially employer matching if your employer offers that) are so great that you should contribute the maximum to the Roth 401(k) first if it’s available to you.

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  1. Corrie says:

    I’m a little confused by your last paragraph:

    The one advantage that a Roth IRA has over a Roth 401(k) is the ability to withdraw your contributions without a tax penalty…

    I thought both Roth IRAs and Roth 401(k)s allow you to withdraw without a tax penalty?

  2. Woody says:

    I’m afraid I have to disagree with this one Trent. A Roth is risky for several reasons. Your tax bracket in late life will probably be lower, since you needs will probably be lower (no more house payments, for example). The fact that you lose money up front to taxes means your compound interest is far less too. Not to mention the fact that there’s no guarantee that a Roth won’t be taxed later under different rules. For many it just doesn’t make sense unless your capping out your normal 401K or are getting good matching on it.

  3. I just converted my traditional IRA to a Roth IRA. Roth wins out almost everytime. One thing to note is that if you convert you have to pay some taxes during the tax year which you convert.

    Clark Howard at http://www.clarkhoward.com has great advice on IRA’s.

    I have my RothIRA with Vanguard, which has been awesome.

    My goal is to contribute the full amount next year. I am currently building an emergency fund of 5000 then I am going to plug away 15% of my income into my Roth.

    Saving is fun and empowering.

    helping people break out of debtors prison and achieve financial freedom one dollar at a time.

  4. Trent Hamm Trent says:

    Let me clarify a bit: the Roth IRA differs from the Roth 401(k) in that you can withdraw your contributions from the account and leave the interest income in the account before you are 59 and a half years old and not have to pay any tax (because you are only withdrawing the contributions that were already taxed). With the Roth 401(k), on the other hand, you have to withdraw from contribution and interest in proportion to the actual state of your account, and you’re taxed on that interest, if you withdraw early.

    For example, if you put in $4,000 into a Roth IRA, it grows to $5,000, and you take the $4,000 back out before you’re 59 1/2, you owe no taxes. If it’s a Roth 401(k), however, you owe taxes on $800 of that withdrawal. This only matters if you’re under 59 1/2 or have only had the account for less than five years, though.

  5. MossySF says:

    I wonder if this post is pointless since it’s been commented again and again that the same pre-tax amount comes out the same whether you tax it on contribution (Roth) or on withdrawal (Traditional) if tax rates are the same.

  6. Dan says:

    Trent — Your analysis of the Roth 401k is just wrong. Please go back and do the math.

    The Roth 401(k) and the regular 401(k) are exactly the same for the first scenario that you offer up, where Joe is in the 28% bracket both while working and in retirement. Note that this assumes that Joe invests the $2800 tax deduction “savings” from using the conventional 401(k).

    In your second scenario, where Joe is in the 15% bracket in retirement, he would have clearly been better off NOT using the Roth 401(k) and opting for a conventional 401(k).

    And please, stay away from phrases like, “by paying $2,800 a year now in extra taxes, Joe saves himself $14,000 a year” That statement is absolutely meaningless unless you know the timeframe we are talking about.

  7. Matt says:

    The Roth 401k is not always as good a deal as you’ve stated. For example, my marginal tax rate is 28%. However, my effective tax rate is only 11%. Even if my effective tax rate doubles in retirement I will still be better off paying the taxes later rather than paying them today. If your marginal rate is 15% the Roth 401k is probably a good choice, but at higher marginal rates and is often going to turn out to be a bad choice.

    Frankly, there are too many variables for most people to make a truly informed decision on this issue. Your income will change, your expenses will change, tax rates will change, even the taxability of Roth withdrawals may change. It’s a crapshoot.

  8. Josh says:

    If you are able to put 10% into a traditional 401k I think you may find it difficult to put 10% of after tax money into a Roth 401k. What if the comparison is done differently showing you can afford to put 10% in pretax now but only 8% into a Roth? Even though you are taxed more when you withdraw doesn’t the lower amount put in and compounded over time at least equal that difference?

    This is what confuses me most about this.

  9. Dave says:

    And as MossySF pointed out, there is absolutely no difference whether the taxes are paid out first or last. It’s the commutative property of multiplication (for those of you who remember 7th grade math).

    The Roth 401k offers 2 real advantages:
    1 – You can contribute more money (since it’s post-tax dollars. 15K post-tax is more money than 15K pre-tax)
    2 – If you’re in a higher tax bracket in retirement, it will benefit you (which also means if you’re in a lower tax bracket, it will hurt you).

    Anyway, I think this is typically overthought. Both 401k plans are great. The best plan would probably be “tax diversification” where some money is put into each.

  10. Eugene says:

    The Roth and the Traditional are the same if brackets don’t change. Comparing the $2800/yr now to $14000/yr later is misleading. If you save $2800/yr now and invest in the same vehicles as your Roth to give you a 5xprincipal ($10,000->$50,000) return per year, that $2800/yr will be equivalent to the $14000/yr that you save later. So you save nothing from going to roth — you can either pay now or pay later, but the bite is going to be the same if the tax brackets are the same.

    Rather, the advantage of the Roth with equal tax brackets is that you get to put in MORE MONEY in a tax-sheltered fashion. At 28% marginal rates, contributing $10,000 of pre-tax dollars into a traditional 401k is equivalent to contributing $7200 of post-tax dollars into a Roth 401k — but the contribution cap is the same for Roth and traditional, so the Roth lets you shelter more of your money. That’s the big advantage of the Roth.

  11. MossySF says:

    Josh, you’ve hit it on the head. The difference happens when you have enough money to max out the 15.5K 401K limit. If you can’t hit this limit, that means taking a tax hit on the contributions means you can put less in a Roth 401K. If your tax is 25%, the choice is between 10% in a 401K or 7.5% in a Roth IRA. Not 10% versus 10%. And yes, because multiplication is commutative, applying the 25% reduction before contribution/before growth or at widthdrawal/after growth gives you the same result.

    Now you also have to consider the impact of tax bands and how money is used during retirement. While working, 401K contribution money sits ontop of your income minus deductions. During retirement, the 401K withdrawals sits ontop of social security minus deductions. I suspect for 99% of peoplpe, social security will be a much smaller amount so you end up paying less overall effective taxes during retirement.

  12. Joe says:

    One more thing to consider is risk. We all know that all investments have risk. One risk that a Roth IRA is subject to is that of taxation. With social security on the ropes, congress may reconsider the tax-free withdrawal status of Roths at some point in the distant future. They do have a history of changing their minds on things like this. I’m not saying this will happen, I’m just saying it is at risk.

  13. Trent Hamm Trent says:

    Dan, my math is completely right. If you change the scenario, like you’re doing by adding in additional investments, then that changes the math, obviously.

    As I said in the article, the more complicated you make a scenario, the less comprehensible it is, so I chose to make it as simple as possible and make the message clear – by putting into a Roth 401(k) instead of a regular one, you’re functionally prepaying your tax bill on the earnings for that money. In the scenario, you’re paying $2,800 a year now in taxes to save yourself a $14,000 tax bill later.

  14. MossySF says:

    Trent, you are letting the tax tail wag the dog’s body. The specific tax amount now or later is irrelvant — it’s how much you have after taxes. Paying $2800 now versus $14K later? I have no idea what is better without knowing all the details. If I have to pay more tax because I earned more, hell yes I’d pay more tax. Do not report the tax bill as the final result — report the after-tax gains.

  15. rwindley says:

    I have devil’s advocate scenario of sorts, based on a movement I’m a big proponent of…

    What if at retirement, there were NO federal income tax? a la the Fair Tax (www.fairtax.org)

    If you haven’t read the book already, the Fair Tax proposes to do away with the federal income tax and go to a federal sales tax.

    The point is, assuming the gov’t were to pass this and doesn’t cover everyone that might get screwed, wouldn’t there be a large risk in paying tax now on something that might not be taxed in the future?

    I’m in agreement that either this scenario or the scenario where the gov’t does not honor the tax-free status of a Roth IRA put in the hands of people an arguable 50/50 gamble. Thoughts?

  16. MossySF says:

    Luke, here’s the simple math:

    Traditional: earn 10K, contribute 10K. 30 years of growth at 10% = 174.5K. Take 25% tax off and you are left with 130.8K.

    Roth: earn 10K, pay 2500 in tax, contribute 7500. 30 years of growth at 10% = 130.8K

    Sure if you look at it from at tax point of view, it sounds crazy that paying 43.7K of taxes 30 years from now is the same as paying 2500 in taxes now as the size of the number makes you want to cringe. But if you ignore tax paid and just look at how much money you have left over, it’s all a matter of the tax rate now versus what you think the tax rate will be in the future.

    But how can you guess what your taxes will be in the future? Who knows what the future government will do? Or what your expenses and withdrawal rates will be? Or how much social security you will get? The best advice you can get is to tax-diversify. Have some in traditional, have some in Roth, have some in taxable. Cover all bases.

  17. kim says:

    I’ll use a small Roth IRA as a diversification, but I am keeping the main body of my retirement funds in the traditional 401K. Why? I do not have very much faith in the US government to follow through with the tax free withdrawls at retirement. The country needs to raise money right now. That is the only reason Roth is in existence. The government is essentially borrowing from us. They are taking the tax money that they should be collecting from us in retirement and using it right now. What are they going to do when all of Roth IRAs and 401Ks start taking a major chunk out of the government’s income during our retirments? Will they keep their promise or will they slowly start adding new rules and exceptions. I do not want to be taxed on my money twice. It can happen folks. The great state of Maine already makes you claim a state income tax refund as income on the next year’s taxes. That’s money legally taxed twice. It won’t happen suddenly, but mark my words…ROTH MONEY WILL BE TAXED!!!

  18. Erika says:

    Two things:

    1. Legally, choosing between a Roth and normal 401k is not an all or nothing decision. If your employer lets you, you can contribute a bit to both (combined contributions still cannot exceed the maximum for any given year).

    2. Tax rates are not terribly stable (see the graph at the bottom of the Top US Marginal Income Tax Rates, 1913–2003 page). Your tax rate, regardless of your bracket, may be much higher than it is now or it may be lower.

    Combining these two points, deciding which 401k plan to contribute too depends on how you want to manage risk. If you contribute to a normal 401k, you are banking on the belief that you will pay less in taxes when you retire. If you contribute to a Roth 401k, you are banking on the belief that you will pay higher taxes when you retire.

    Trying to minimize your total payed taxes is a risky business that involves predicting the future. My opinion is that you should diversify. If you contribute to both types of 401k, you will not end up paying the minimal amount of taxes, but, by paying some now and some later, you will amortize your tax burden across both your working years and your retirement years, and you will reduce the risk of your prediction of the future being wrong.

  19. Dave says:

    By comparing investing $10,000 pre-tax and $10,000 post-tax, you’re comparing two different amounts.
    $10,000 pre-tax and $7,200 post-tax are the same amount, you should compare those two.

  20. lorax says:

    MossySF and Dave are exactly right. As long as you aren’t hitting the max, if you are in the same tax bracket Roth and traditional are exactly the same. You can use simple algebra to prove this.

    At the max, the Roth is only better by the small amount of additional money you can put into the Roth. If you invest the difference in a tax efficient fund (eg Vanguard Capital Appreciation), then the difference is a VERY SMALL advantage for the Roth.


    There are two more things to consider. 1) You are paying taxes to the government currently in charge, not the government running the show in 30 years. Not everyone will care about this, but some might. 2) If you are in a lower tax bracket when you retire, the ROTH IS ACTUALLY WORSE. You paid taxes at the higher rate. It’s likely that this dwarfs the small Roth advantage mentioned earlier.

    It’s not possible to forecast tax rates, so you might want to hedge your bets. We use a Roth IRA and a trad 401k, but at a 1:5 ratio.

  21. Luke says:

    Is here not ONE example that can be used to make this scenario bullet proof? My head is spinning, but not nearly as much as the arguments that say taxes will change in the future. It’s like hitting a moving target. If someone brings to the table a discussion about Roth IRA’s and 401k’s and someone starts to tear it down because what will happen in 2043 with taxes, how can everyone get on the right page if everything is a variable?

    So, is there just a simple example that spells out which one is better without getting into taxology 40-years from now and a ton of what-if scenarios?

  22. plonkee says:

    As has been stated several times:

    Assuming that tax rates stay the same, then they are exactly the same from a tax point of view, except if you can afford the maximum after tax, in which case you are allowed to contribute more to the Roth.

    If your marginal tax rate is 15% and you can only afford $100 before tax, you can only afford $85 after tax.

    And I’m glad someone used the word ‘commutative’ :)

  23. Baba Ghanoush says:

    I’ve requested my company consider a Roth 401K to supplement the traditional 401K.

    some Roth 401K advantages over Trad 401K:

    1) *If* you’re maxing out your Trad 401K and (if eligible) a Roth IRA, it allows you to put away more tax-advantaged dollars (because $15500 post-tax is worth more than $15500 pre-tax).

    2) Even if you expect to earn less in retirement in real purchasing power, there is still uncertainty as to whether you’ll pay more or less in taxes in the future. Historically, tax levels have gone up over time. Thus, it makes sense to tax diversify your retirement dollars — some pretax, some posttax.

    3) Highly Compensated Employees (somewhere around $100K) are not eligible for a Roth IRA, but may contribute to a Roth 401K.

    4) At age 70-1/2, a Roth 401K can be rolled into a Roth IRA to avoid required minimum distributions.

    5) When you make a non-qualified withdrawal before age 59-1/2 from a Roth 401K, you will have to pay taxes on the earnings, but not on the contributions. The earnings portion of your withdrawal is considered to be proportional to the percent earnings on the full account. With the traditional 401K, there would be a 10% penalty on the full amount of the withdrawal. Thus, it functions as a second-tier emergency fund.

  24. Jim Lippard says:

    Baba: The criteria for Roth IRA eligibility and what constitutes a Highly Compensated Employee (HCE) for 401K regulations are different (though there’s likely considerable overlap between HCEs and non-eligibility for Roth IRA contributions).

    Highly Compensated Employees (HCEs) in 2007 are those who made $100,000 or more in 2006–with the exception that a company where more than 20% of its employees make more than $100,000 can specify that only the top 20% count as HCEs. This definition is used for Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests to make sure that an employer’s non-Safe Harbor 401K complies with government regulations; if they don’t, some HCEs end up having to have some of their deferred contributions paid back out to them.

    The Roth IRA eligibility limit for a full contribution is $99,000 for single filers and $156,000 for joint filers; you can make partial contributions if you’re a single filer with income from $99,000 to $114,000 or a joint filer with income from $156,000 to $166,000.

  25. Bill says:

    You can shield more after-tax dollars from creditors using the Roth 401K, if you can afford to contribute the maximum amount.

  26. Mike says:


    I like your column but you’re really confused on the 401K plans. You’re comparing apples to oranges. In the regular 401K scenario Joe is using $10,000 of his income towards retirement. In the Roth 401K case he is using $12,800 of his income towards retirement; $2,800 goes to the government in taxes, the other $10,000 into the Roth IRA.

    As a few people have already pointed out, if you are in the same tax bracket before and after retirement then your choice of Roth vs regular 401K plans DOES NOT MATTER as long as you save the same amount. You will have exactly the same amount of money.

    “the more complicated you make a scenario, the less comprehensible it is, so I chose to make it as simple as possible”. You want simple, here’s simple. Joe makes his first and only contribution to his 401K on January 1, 2007 and retires 2 years later on January 1. Joe earns 10% annually on his investment. Which is better, Roth or traditional?

    Let’s suppose Joe is willing to save $1,000 of his income that cold January day. In the traditional 401K, all $1,000 goes into the plan and 5 years later he has $1,000 * (1.1 * 1.1) or $1,210. He takes a lump-sum distribution and pays 28% in taxes ($339), leaving him with $871.

    In the Roth 401K $280 of the amount Joe earmarked for saving goes to taxes, so he invests $720. It grows after 2 years to $871, which he can withdraw tax-free. Surprise, surprise! It’s the exact same amount as he had with the traditional 401K.

    Trent, if the Roth is better why doesn’t it show up in this simple case? You can pile on complexity, talking about taking distributions over multiple years and making contributions over many years instead of just one, but it doesn’t change the fundamentals. If you’re tax rate will be the same before and after retirement, it simply doesn’t matter which way you choose.

    Furthermore, applying your argument about taxes to this example you’d be claiming Joe is “better off” paying $280 in taxes today to save $339 in taxes 2 years in the future. You’re missing the idea of present value here; the amounts are exactly the same in present value!

  27. Shawn says:

    Trent I like you’re blog but I think every time I’ve seen you try to prove something out with math you’ve been wrong. I believe you were even wrong on this point once before.

  28. Baba Ghanoush says:

    Jim, thanks for setting me straight on the difference between HCEs and income limits for Roth IRA eligibility. I’m glad you corrected my details, but the point is still the same — that highly paid individuals can contribute to a Roth 401K while being ineligible to contribute to the Roth IRA.

    Since my previous comment I did learn that I was mistaken about the final point (no 10% penalty for non-qualified withdrawals). Apparently, just like the traditional 401K, there would be a 10% penalty assessed for non-qualified withdrawals of earnings, in addition to taxes on the earnings.

    I’d still contribute to a Roth 401K if I had the opportunity for 2 reasons:
    1) I could put more future purchasing power into tax-deferred accounts.
    2) I prefer to evenly tax-diversify my retirement funds.

    I believe that employer contributions cannot be applied to the Roth 401K, so if you have both 401K plans, be certain to use the traditional 401K to the point of your company match.

  29. goldi says:

    There is a great book dedicated to this topic called “It’s Your IRA”. It is an excellent resource for those wanting to learn more about investing in Roth and Traditional IRAs. It is available through Amazon or you can go to ItsYourIRA.com for more details. It is definitely worth a look.

  30. Gman says:

    I enjoyed reading this posting. It’s comforting to know that there are people who are actively planning and saving for their golden years. I have been socking money away for myself, wife and three boys.

    I have been saving money in a 401k and a Roth IRA. I only recently, two years ago, found out about the Roth IRA. I think that it is an incredible tool.

    Does any one know if the IRS will be able to change the tax free status of the Roth IRA in the future, or is it always going to be tax free for payouts?

  31. lorax says:

    @Gman: Will Roth tax free withdrawals change?

    It’s hard to make predictions, especially about the future. Obviously there are no plans to change it, but there are two forces at work 1) forces to keep income taxes low and 2) libertarian forces for pay-per-use.

    Combine these two and you may very well have the current low (or lower) income tax rates along with more toll roads, a federal sales tax, a federal networking tax, a very high federal gas tax, and so on. These would make the Roth IRA and 401k a poor choice.

    On the other hand, my crystal ball is cloudy. Diversification is good.

  32. Snowballer says:

    Now here’s a question that might change the whole thing.

    One of the big perks of a Roth IRA is that you’re not forced to take a distribution unless you want to. Does the Roth 401k offer the same benefit? I honestly don’t know.

    The reason I ask is because a lot of retirees had to take forced distributions from their standard 401ks in 2008 when everything hit rock bottom and lost a big chunk of their portfolio’s principle. A lot of them had emergency funds saved up for such a bad time that they could have used while waiting for the worst to pass.

    That said I’m mostly with the people who say try to do part Roth and part traditional and tax diversify. If a Roth 401k helps someone do that, more power to them. I know I’d sure take advantage of it.

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