What To Know: Traditional 401ks Vs Roth 401ks
We’ve continually discussed in previous posts, the importance of having your investments and assets in check, when building out your financial bandwidth. While stocks and cryptocurrencies are a few ways to build up your portfolio, conventional retirement accounts will also pay dividends for your financial health as well. The types of retirement accounts that are available to consumers is enough to make all of us feel stressed out, because there are so many choices. This is where a certified financial planner in Connecticut comes into the fold.
With their expertise and guidance, putting together a comprehensive plan is not only feasible, but it will put you and your loved ones on the path for success. Two investments that can be yours for the taking are both traditional 401ks and Roth 401ks. While all 401ks are retirement accounts, there is a distinction between the types and we’re going to be discussing this at length.
Traditional 401ks Vs. Roth 401ks: The Overview
401Ks and Roth 401ks are two of the most popular savings plans for retirement. While both types of accounts offer tax advantages, knowing the difference between these two types can help you determine which plan works best for your personal needs and financial goals. We always emphasize the importance of educating our consumers on what their options are and how a certified financial planner in Connecticut can handle most of the heavy lifting. This doesn’t need to be a painful experience and you’ll come to know that learning about these rules and regulations will make you feel more secure with your financial choices.
Before we discuss the differences & similarities between regular 401ks and Roths, it’s important to know how they’re defined and how they function. A traditional 401k is a type of employer-sponsored defined contribution plan that allows employees to defer paying taxes on income that they contribute to their account within the plan. Contributions made by both the employee and employer are typically tax deductible. Employees do not pay income tax on either their contributions or earnings until they withdraw money from their account, which must begin no later than age 70½. Employers offering a traditional 401K typically also match a portion of an employee's contributions up to a certain percentage.
Conversely, Roth 401k is a type of employer-sponsored defined contribution plan with after-tax dollars and allows employees to defer paying taxes on income that they contribute to their account within the plan. In other words, you pay the taxes when you fund your account, but not when you withdraw money from your Roth 401K at retirement. Employers offering a Roth 401k typically do not match an employee's contributions into the account.
The basic difference between the two is when you pay the taxes. You will pay at your current tax rate, and state taxes can apply depending on where you live. Roth 401ks require no upfront tax deductions, and as previously stated, contributions are made with after-tax dollars. On a Roth, withdrawals of contributions and earnings are tax-free at age 59.5, as long as the account has been held for 5 years. With a traditional 401k, contributions are made with pre-tax dollars and you will get a tax break up front, which will lower your current income tax bill. The money will grow tax deferred until you draw it. The Roth can be a good option for younger investors because they’re starting off in a lower tax bracket, and the up-front tax deduction of a traditional retirement account is less valuable now, compared to the tax-free withdrawal of a Roth down the road. Let’s take a closer look at how you can decide on a plan, and why having both can potentially benefit your financial situation. One of the greatest benefits is that you will always have a choice.
Hedging Your Chances With Both
The good news is that you aren’t expected to make an all or nothing choice. You can have both types, but the conversation needs to be had with your financial advisor to decide how you make your contributions year by year. If your employer’s plan approves it, you can potentially split your contributions between your Roth and Traditional account. Back in 2020, you can contribute as much as $19,500 to a 401k, coupled with an additional $6500 if you’re 50 and older.
Some added thoughts that will aide in your decision making:
If you’re looking ahead to estate planning, inheriting money in a Roth could pay dividends for heirs, provided that the account is at least 5 years old, they are not required to pay income taxes on the distributions from the inherited Roth.
If you’re young and confident that you’ll earn more in the future and as a result, will slide into a higher tax bracket. However, if you end up in a lower income tax bracket by the time you retire, withdrawals from the traditional accounts can kick into the higher tax bracket, which can augment your overall tax bracket-including your taxes with social security. Talk to your financial planner to learn how you can better plan for these situations.
Securing Your Retirement Plans With A Certified Financial Planner In Connecticut
If you are looking for comprehensive guidance on formulating your financial plans, look no further than Armah Financial Services. We are committed to providing you with much-needed “financial therapy” to ensure that your assets and retirement are locked in. Contact us today to learn more!