Traditional 401(k)s have been a staple of modern retirement planning for several decades now, and they are still many people's first choice for a savings vehicle. They offer important benefits, like deferred taxes, high annual contribution limits, and sometimes an employer match.
Like any retirement account, though, traditional 401(k)s have drawbacks. Many employers have begun offering a new type of workplace retirement plan in addition to the traditional 401(k) to give employees more flexibility, but employee participation in this alternative plan lags far behind.
Below, we'll take a closer look at what these plans are, how they differ from traditional 401(k)s, and whether they might be a good fit for you.
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The best of both worlds
Traditional 401(k)s are typically funded with pre-tax dollars. This gives you a tax break today, but you'll owe taxes on your contributions and withdrawals later on. That's different from the popular Roth IRA, where you pay taxes on your contributions up-front to get tax-free withdrawals later.
For years, workers had to choose between the high contribution limits and employer-matching potential of 401(k)s or the after-tax contributions of Roth IRAs. But that's no longer the case. For nearly two decades, employers have been able to offer Roth 401(k)s to their employees. It's essentially the same as a traditional 401(k), but you fund it with after-tax dollars, like a Roth IRA.
Employers have been increasingly offering these plans as a complement to existing traditional 401(k)s. More than 4 out of 5 companies offering workplace retirement plans had Roth 401(k)s in 2023, according to Vanguard's How America Saves report. Yet, only 17% of employees with access to one of these plans actually use them, Vanguard found.
Is it right for you?
The Roth 401(k) could be an excellent option for workers who hope to minimize their retirement taxes without giving up a traditional 401(k)'s perks. These plans still enable you to earn employer matches on your contributions if your company offers them, although your employer might elect to make pre-tax matches even if you contribute to a Roth 401(k).
You can set aside up to $23,000 in a Roth 401(k) in 2024 or $30,500 if you're 50 or older. Anything you contribute is taxable this year, but over time, it could grow to be worth hundreds of thousands of dollars that you can withdraw tax-free in retirement.
These accounts aren't a good fit for everyone, though. Those in their peak earning years who believe they might be in a lower tax bracket in retirement than they are today might prefer a traditional 401(k) instead. By deferring taxes until retirement, you could lose a smaller percentage of your income than you would by paying taxes up-front.
When this isn't the case, a Roth 401(k) could be a better fit for you. Talk with your employer if you're not sure whether it's an option. If it is, all you have to do is contribute to the Roth 401(k) instead of your traditional 401(k). You might be able to do this on your own through your online 401(k) account, or you might have to talk to your human resources department.
Splitting your money between a traditional 401(k) and a Roth 401(k) is also an option if you see the merits of each. However, be mindful that your contributions to both plans don't exceed the limits above when you combine them. You cannot save $23,000 in a traditional 401(k) and another $23,000 in a Roth 401(k). If you would like to save more than the annual limit, you'll have to switch to an IRA or some other type of investment account.
