When Does A Roth 401(k) Make More Sense?
You’re probably aware that many employers offer a 401(k) plan to help employees save for retirement.
However, there may be another option available that you’re less familiar with — the Roth 401(k). In some cases, it could be a better choice for you.
According to CNBC, as of 2023, around 93% of 401(k) plans now offer a Roth savings option, up from 62% a decade ago. This shift is largely due to changes in retirement laws like Secure 2.0, which are expected to encourage more employers to offer it in the future. Despite this, many employees are not taking full advantage of the Roth 401(k) option: about 21% of eligible workers contributed to a Roth 401(k) in 2023, compared to 74% who made pretax contributions.
While both Roth and traditional 401(k) contributions offer benefits for retirement savings, there are important differences between the two, and in some cases, one might be more advantageous than the other.
What Is A Roth 401(k)?
A Roth 401(k) is a retirement savings account where you contribute after-tax dollars. This means you don’t receive a tax break on your contributions now. In contrast, with a traditional 401(k), you contribute pre-tax money, and taxes are due when you withdraw funds in retirement. The key benefit of a Roth 401(k) is that any withdrawals in retirement are tax-free.
Roth 401(k) contributions are deducted from your paycheck like traditional 401(k) contributions and are subject to the same annual contribution limits. For 2025, the contribution limit for both types of accounts is $23,500, with additional catch-up contributions allowed for those 50 and older.
Withdrawals from a Roth 401(k) are penalty-free if the account has been held for at least five years and you’re withdrawing funds due to disability, death, or after reaching age 59 ½. Additionally, thanks to the SECURE 2.0 Act, Roth 401(k) holders no longer need to take required minimum distributions (RMDs) during their lifetime, which is a requirement for traditional 401(k)s.
What Are the Benefits of a Roth 401(k)?
A Roth 401(k) doesn’t offer immediate tax benefits because contributions are made with after-tax dollars. However, there are several key advantages to this type of account:
- Tax-free Withdrawals In Retirement: With a Roth 401(k), all withdrawals are typically tax-free. This means that $100,000 in a Roth 401(k) is worth exactly that amount, while in a traditional 401(k), you’d owe taxes on the distributions.
- Tax-free Growth: Since you’ve already paid taxes on your contributions, both your contributions and any investment gains are tax-free when withdrawn.
- Potentially Lower Taxes Now: A Roth 401(k) may be beneficial for individuals who expect to be in a higher tax bracket in the future. In this case, paying taxes now at a lower rate could be more cost-effective than paying taxes later at a higher rate.
- Employer Match: Just like with traditional 401(k)s, some employers offer matching contributions to your Roth 401(k), helping to boost your retirement savings.
When Is A Roth 401(k) Better Than A Traditional 401(k)?
The decision between a Roth 401(k) and a traditional 401(k) primarily depends on your current tax bracket and what you expect your tax rate to be in the future.
Financial experts often recommend Roth contributions for individuals currently in a low tax bracket who expect to be in a higher one in the future.
“If you’re paying taxes at 12% now but expect to face a 25% tax rate later, contributing to a Roth 401(k) may be a smart move,” suggests Mark Wilson, CFP and founder of MILE Wealth Management. “Similarly, if you believe tax rates will rise in the future, a Roth 401(k) might be the better option.”
It’s also worth noting that you don’t have to choose just one — many financial planners recommend diversifying between pretax and Roth accounts. This strategy provides flexibility and tax advantages during retirement.
Source: The Week