Pre Tax Vs. Roth 401(k)

Taking potential taxes into account can make retirement planning much more difficult. With a Roth 401(k), you can eliminate concerns about your retirement tax rates, but it's not a free ride. For some folks, traditional 401(k)s are still the way to go.

However, if you're champing at the bit to make after-tax contributions, but your employer doesn't offer a Roth 401(k), talk to your HR department. The more interest there is, the more likely a company will shell out the extra cash to establish a plan.

How Contributions Differ

Salary deferred into a traditional 401(k) plan doesn't count as income in the year of the contribution, which makes it a great choice if you're raking in the dough and expect to pay less in the future. However, if you're just getting started, or doing well but still expect a higher tax rate in your retirement years, a Roth 401(k) plan allows you to make after-tax contributions, meaning the contributions do not reduce your taxable income for the year.

The contribution limits for the two types of plans are cumulative, meaning every dollar that you defer into a Roth 401(k) plan reduces your maximum deferral into a traditional 401(k) plan, and vice versa. However, the contribution limits are much higher than for IRAs.

Taxes and Penalties on Distributions

Qualified distributions from traditional and Roth 401(k) plans are the reverse: Traditional 401(k) distributions are taxable, but Roth 401(k) distributions are tax-free. To take a qualified distribution from a traditional 401(k), you just need to be 59 1/2. For a Roth 401(k), you have to have made your first contribution at least five years ago and must either be 59 1/2, permanently disabled or dead. If you're dead, you can rest peacefully knowing your beneficiaries can take tax-free distributions.

If you take an early withdrawal from a traditional 401(k) plan, the entire amount is taxable and – barring an exception – is subject to a 10 percent additional tax on early withdrawals. With Roth 401(k)s, your early distribution is divided proportionally between your after-tax deferrals, which come out tax-free and penalty-free, and your earnings, which receive the same treatment as traditional 401(k) early distributions.

Matching Employer Contributions

Many employers match your contributions to a traditional 401(k) plan by adding an employer contribution to the same account. On the other hand, Roth 401(k) plans can't accept matching funds from your employer. However, all is not lost because employers can use contributions to a Roth 401(k) to justify making a matching contribution to your traditional 401(k).

If you only put money in a Roth 401(k), your employer is required to put the matching contributions in a traditional 401(k) account. To do this, your employer might need you to sign a few extra forms to set up the traditional 401(k), if you don't already have one set up. For example, if your employer matches up to $5,000 of your 401(k) plan contributions and you put $5,000 in a Roth 401(k) plan, your employer will add $5,000 to a traditional 401(k) plan in your name.

Required Minimum Distributions

All 401(k) plans have required minimum distributions starting in the later of the year you turn 70 1/2 or the year you retire. You probably expected that bad news about traditional 401(k) plans but might have been hoping that Roth 401(k) plans were treated like Roth IRAs. Unfortunately, a Roth 401(k) is treated like a traditional 401(k) when it comes to required minimum distributions, meaning after age 70 1/2, you'll have to begin taking your RMDs.

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