3 Factors in Choosing a 401k or a Roth 401k

Both the 401k and Roth 401k present you with benefits as an investor. Choosing between them can often be difficult for investors. Here are a few factors to consider when choosing between a 401k and a Roth 401k. 

1. Contribution Limits

When choosing between these two types of accounts, you need to consider the contribution limits that are involved. With both accounts, you can contribute up to $15,500 per year. However, the relation these contributions have to taxes differs from account to account. With a regular 401k, when you put $15,500 into your account, you will eventually have to take taxes out of that money. For example, if you are in the 25 percent tax bracket, this means that you are putting in only $11,625 of after-tax money. With a Roth 401k, you contribute after-tax dollars to the account. Therefore, when you put $15,500 into your Roth 401k, you are dealing with money that you will get to keep in the long run. This provides you with a significant difference in how much money you get to invest and earn tax-free. However, you need to keep in mind that you will actually have to set aside more than $15,500 per year since you will have to pay your taxes in advance.

2. Tax Bracket

Something else to consider when choosing between these two types of retirement accounts is your tax bracket situation. You need to consider what tax bracket you are in now and what tax bracket you expect to be in when you retire. If you were in the exact same tax bracket in both scenarios, it would not matter which account you chose. However, if you will be in a higher tax bracket when you retire than when you start contributing to your account, it would be to your advantage to use a Roth 401k. For example, let's say that you are in the 15 percent tax bracket when you start your career. When you contribute to your Roth 401k, this means you will only pay 15 percent on that money. Imagine that you are then in the 33 percent tax bracket when you retire. Withdrawing the money from the Roth 401k will cost you nothing in taxes. If you had contributed to a traditional 401k in this situation, you would be paying 33 percent in taxes on the money that you withdraw.

It can be difficult for you to predict whether you will be in a higher or lower tax bracket in the future. However, you need to consider this when choosing which type of retirement account you want.

3. Social Security Benefits

When you reach the age of receiving Social Security benefits, which type of retirement account you have can be important. If you have a Roth 401k, you can roll this over into a Roth IRA. The money that you withdraw from a Roth IRA does not play any role in determining whether you pay taxes on your Social Security benefits. The money that comes from a traditional 401k will, however, influence your tax liability on Social Security benefits.

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