Deciding Between Traditional and Roth 401(k)s
Virginia Beach, VA (Law Firm Newswire) October 2, 2015 – When faced with the decision of whether to invest in a traditional or Roth 401(k) plan, many U.S. taxpayers find themselves weighing the advantages and disadvantages of each retirement option. A traditional 401(k) plan is offered by an employer to its employees.
Such a plan represents the most typical type of defined contribution retirement plan. The employee decides the amount of the contribution he or she would like to make, and the employer deducts a percentage of the employee’s salary from his or her paycheck; the deducted amount is then deposited into the account on behalf of the employee.
The beneficial tax treatment offered by 401(k) plans consists of the deduction of “pretax” dollars from one’s paycheck prior to the time at which taxes are taken out. The end result is that one will be required to pay taxes on a reduced amount of income. It is only upon retirement that one will have to pay taxes on withdrawals from the 401(k) plan at the taxpayer’s ordinary income tax rate. However, if one were to withdraw funds prior to reaching age 59 ½, one would usually have to pay a 10 percent penalty in addition to any taxes owed.
“It is important to make wise investment decisions with regard to one’s retirement plan. Otherwise, one may make mistakes that could adversely impact one’s future,” said Andrew H. Hook, a Virginia elder law attorney with Hook Law Center, with offices in Virginia Beach and northern Suffolk.
Another retirement plan that provides more favorable tax treatment is the Roth 401(k). While the Roth 401(k) requires one to pay taxes on amounts contributed to the plan, it does not subject one to the payment of tax upon the withdrawal of funds at retirement. In this way, one’s account grows tax-free. However, one must adhere to the minimum distribution rules of Roth 401(k) plans. Thus, after the age of 70 ½, one will have to start withdrawing funds from the account.
In deciding whether to invest in a Roth or a traditional 401(k), one must ascertain whether the tax savings offered by the regular 401(k) will exceed those provided by the Roth. For instance, if one is relatively young or is not in a high income tax bracket, then a Roth may be a wise option. Although one will be taxed on one’s contributions, the tax savings are unlikely to be significant if one is in a low income tax bracket. By investing in a Roth 401(k), one can avoid taxes during retirement.