Choosing a right retirement account could be a confusing and troublesome task at times, as numerous retirement plans are available today. A 401(k) is the most popular form of retirement account, which gets its name from the IRS section of tax code. Two forms of 401(k) accounts are Roth 401(k) and Traditional 401(k). The basic difference between the two accounts is that Roth 401(k) accounts are funded with after tax money while Traditional 401(k) accounts are funded with pre-tax money.
In Traditional 401(k) account, an individual pays the tax on the retirement fund at the time of withdrawal, while in case of Roth 401(k) account, the money is taxed at the time of contributing. An individual contributes to these accounts through deductions in their payroll. Roth 401(k) account combines the features of both Roth IRA account and Traditional 401(k) account. At the time of withdrawing the money Roth 401(k) accounts are exempted from penalties after the age of 59½.
When the employer gives an option to choose any one of the account, it is necessary to know the basics of both the 401(k) accounts. Below mentioned is a tabular format featuring basic comparisons and differences between Roth 401k account and Traditional 401k account:
| Traditional 401k account | Roth 401k account | |
| Contributions and Tax Status | The contribution in the account is pretax money and current taxes are applied while withdrawing the amount | The contribution is after-tax money and no taxes will be applied while withdrawing the amount |
| Status of tax distributions after the age of 59½ | Amount is taxable as current income | Amount is tax free and penalty free for the accounts exceeding 5 years |
| Rollovers to IRA’s | This account must be rolled over to a Traditional IRA account initially, and then and only then it can be converted to Roth IRA account, which will require paying taxes | Can be rolled over to Roth IRA directly, without paying any taxes |
Before choosing a Retirement Plan:
- Confirm with the employer whether Roth 401(k) or Traditional 401(k) account is offered by them.
- Ask for the paperwork and information on each plan before participating.
- Review the present household spending and the annual budget, and then determine how much money can be set aside for the retirement plan on a regular basis.
