Roth vs Traditional 401k Calculator: Which One is Best? A 401(k) plan is an employer-sponsored retirement savings account that allows employees to contribute a portion of their paycheck before taxes are taken out. The contributed funds can grow tax-deferred and employees generally have options on how these accounts are taxed – either paying taxes on contributions now with a Roth 401(k) or taking distributions as income later with a traditional 401(k).
Choosing between these two account types can have a significant impact on your take-home amount at retirement. In this article, we provide a detailed Roth vs traditional 401k calculator to help you determine which option may work better in your financial situation.
How Do Roth and Traditional 401(k)s Work?
Roth 401(k)
A Roth 401(k) allows you to contribute after-tax dollars, meaning the contributions are subject to income tax in the current year. However, qualified Roth distributions in retirement are tax-free. Some key points:
- Contributions are made with after-tax dollars
- All qualified distributions are tax-free
- Offers tax-free growth potential
- No required minimum distributions (RMDs) at age 72
Traditional 401(k)
With a traditional 401(k), contributions are made pre-tax, reducing your current year taxable income. However, withdrawals in retirement are taxed as ordinary income. Some key points:
- Contributions are made with pre-tax dollars, lowering current income taxes
- Distributions are taxed as ordinary income when withdrawn
- Funds grow tax-deferred
- Subject to required minimum distributions (RMDs) at age 72
The best option depends on your financial situation now and expected income needs in retirement. Our calculator helps make this determination.
Roth vs Traditional 401(k) Calculator
Our calculator allows you to input your details like current income, expected retirement income, account balances, contribution amounts, tax rates and more. It then projects out your 401(k) savings and estimated balance at retirement for both Roth and traditional options. Finally, it calculates the amount of taxes owed on withdrawals so you can effectively compare which leaves you with more money on an after-tax basis during your retirement years.
Specifically, our calculator takes into account factors like:
- Current income and income tax rates
- Retirement income and expected tax rates
- Current 401(k) balances and projected annual returns
- Annual contributions and employer match
- Rate of inflation on living expenses
- Life expectancy / total years in retirement
Based on all these inputs, we project your 401(k) balance at retirement. Then, taxes are calculated on qualified withdrawals each year to determine your total after-tax retirement cash flow over your lifetime. This lifetime, after-tax cash flow number with both Roth and traditional 401(k) options is calculated and compared.
The higher this after-tax lifetime cash flow value, the better option for your situation. The key benefit of this analysis is identifying which 401(k) type leads to paying the least amount in taxes over your full retirement.
Scenarios Where Roth 401(k) Is Better
When You Expect to Be in a Higher Tax Bracket in Retirement
If you expect your income and tax rates to increase in retirement, contributing to a Roth 401(k) can save you money in the long run. For example, if you currently fall within the 22% tax bracket but expect to be at least within the 24% tax bracket or higher in retirement, then paying taxes now with a Roth at that lower rate can be very advantageous. As retirement withdrawals would be tax-free in retirement, you essentially locked in taxation of those dollars at the lower bracket early on.
When You Have Many Years to Benefit from Tax-Free Growth
The earlier you start saving into a Roth 401(k) option, the more you benefit from decades of tax-free growth on contributions and earnings. Say you start contributing $5,000 annually at age 30 into a Roth 401(k). That gives over 30 years for compounding returns to grow your account balance exponentially without any tax drag. Delaying would reduce years of tax-free earnings.
When You Want to Avoid Required Minimum Distributions
Once you turn 72, the IRS requires you to take minimum distributions from retirement accounts like 401(k)s and traditional IRAs each year based on your projected life expectancy and account balance. However, Roth 401(k)s do not have RMDs. This allows your savings to continue growing tax-free if you don’t need distributions. This retirement flexibility can be invaluable from both cash flow and tax planning perspectives.
If You Prioritize Leaving an Income Tax-Free Inheritance
Another benefit of Roth accounts is that they are income tax-free when inherited by your beneficiaries. Because taxes were already paid upfront, any growth over your lifetime passes to heirs without reduction for income taxes due. This can enable you to maximize wealth transfer to loved ones or charities.
When Traditional 401(k) Is Typically the Better Option
If You Expect Lower Income and Tax Rates in Retirement
If your retirement lifestyle will likely put you in a lower tax bracket than your current earnings, then deferring taxation with a traditional 401(k) can save substantially on taxes over the long run. For example, contributing pre-tax today at a 32% bracket and withdrawing later at just a 22% effective rate saves 10% on total taxes paid over simply paying income taxes during working years.
If You Currently Have Low Income and Tax Bracket
Similarly, if you are just starting your career in a lower tax bracket, deferring taxes with a traditional 401(k) makes sense in anticipation of earnings and rates increasing over the course of your career. By saving taxes now when your bracket is low, you avoid losing 25%, 28% or even 33% or more to taxes on future distributions later in retirement.
If You Plan to Move to a Low or No Income Tax State
Some states like Florida and Texas do not levy any state income taxes on retirement account distributions. Moving to one of these states in retirement puts you in position for possibly tremendous state + federal tax savings later by contributing pre-tax dollars to a traditional 401(k) upfront from higher-tax states today.
If You Want Higher Current Cash Flow
Contributing to a traditional 401(k) lowers your current year taxable income and tax liability, especially if moving to a lower tax bracket threshold. The tax savings may enable more take-home pay for current lifestyle needs and expenses like housing, healthcare or amenities. Higher current disposable income can be invaluable for today’s costs.
Other Considerations Impacting Roth vs Traditional Decisions
Employer Retirement Plan Matching
Many companies offer matching contributions on 401(k) savings up to a percentage of salary. This essentially provides free money towards retirement. Make sure to contribute at least enough to receive full employer matching dollars before considering other accounts. That match will typically go into a traditional 401(k) regardless if you contribute to Roth, traditional or both.
401(k) Early Withdrawal Penalties
Taking distributions from any 401(k) plan before age 59.5 results in a 10% early withdrawal penalty by the IRS in most cases, on top of ordinary income taxes due. Roth IRAs allow earlier access to contributions without penalty, making that option potentially better for early semi-retirement income needs.
Income Limitations
Higher income earners may be prohibited from opening or contributing to Roth accounts based on modified adjusted gross income limits each year. Be aware that your eligibility to participate in Roth savings options could be impacted as income increases.
Potential Future Tax Law Changes
While tax rules are rather constant, significant reforms still occur periodically. It is impossible to predict if retirement tax rates and laws for 401(k) plans will be drastically different 30+ years from now. Maintaining both Roth and traditional savings provides flexibility to hedge unknown policy changes.
Conclusion
Knowing whether to prioritize Roth or traditional 401(k) savings is challenging. Each path offers unique tax advantages now versus later dependent on financial situation. Use our comprehensive calculator to run scenarios on your specific circumstances, projected retirement costs and potential tax rates.
That quantitative comparison will pinpoint which option is optimal to maximize after-tax retirement income and cash flow. Often the best approach is saving into both account types regularly when possible.
This balances getting retirement savings growing tax-deferred now while also locking in some income tax rates today. Consult a financial advisor if needing additional guidance on the split strategies to yield greatest after-tax withdrawals over your lifetime.
FAQs Related to Roth vs Traditional 401k Calculator
What are the key differences between Roth and Traditional 401(k) plans?
The main differences are when you pay taxes and how withdrawals are taxed. With a Roth 401(k), you contribute after-tax income and pay taxes upfront. Future qualified withdrawals are tax-free. With a traditional 401(k), taxable contributions lower your current income taxes owed. However, withdrawals in retirement will be subject to ordinary income tax rates at the time.
When might a Roth 401(k) be better than a Traditional 401(k)?
Scenarios where a Roth 401(k) might be better include if you expect to be in a higher tax bracket in retirement, have many years to let your account grow tax-free, want to avoid required minimum distributions (RMDs) in retirement, or seek to maximize wealth transfer to heirs.
When might a Traditional 401(k) be a better choice over a Roth 401(k)?
A traditional 401(k) likely makes more sense if you expect to be in a lower tax bracket in retirement, currently fall into a low tax bracket, plan to move to a state with no income tax in retirement, or want higher disposable income today rather than later.
How exactly does a Roth vs Traditional 401(k) calculator help me choose?
This retirement calculator runs your specific numbers on current and future expected tax rates, income, savings balances, returns, etc. to model out estimated after-tax cash flows in retirement under each account type. The output showing which leaves you with greater retirement income net of taxes is generally the better approach for your goals.
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