Traditional vs Roth 401(k)
There are two main kinds of 401(k) plan, which differ in when they provide you with a tax break.
Traditional 401(k). As the name suggests, this is the original and most common type of 401(k) plan. With a traditional 401(k), you get a tax break when you contribute. Your contributions are taken from your paycheck before taxes are deducted, so they reduce your taxable income. Your money also grows tax-free while it’s in the 401(k) plan. However, you’ll pay income tax on the money you take out.
Roth 401(k). You get a tax break when you withdraw the money, but not when you contribute – the opposite to a traditional 401(k). You pay taxes on the money that you invest in the plan, but you can withdraw money tax-free when you retire, as long as you meet certain conditions.
A growing number of companies offer Roth 401(k) options in addition to traditional 401(k) plans. You can choose one or the other, or contribute to both, as long as the combined total doesn’t exceed the 401(k) contribution limit of $19,500 (or $26,000 if you’re 50 or more). You may pay less tax overall with a traditional 401(k) if you expect to be in a lower tax bracket after you retire – which may be the case if, like many people, you earn less after retirement. If not, you could pay less tax with a Roth 401(k).4