Traditional vs. Roth 401(k

People frequently ask our team whether they should contribute to a Roth 401(k) or a traditional 401(k). The answer to this question depends on your personal situation. There are several factors you should consider.

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Traditional 401(k) vs. Roth 401(k) Similarities

A Roth 401(k) and a traditional 401(k) are both qualified retirement accounts offered by employers. Your contributions to both types of accounts come out of your paycheck. Both types of 401(k)s may be eligible for a company match if offered by your company. The company plan specifies the rules for the company match.

Contribution Limits, Including Catch-ups and Super Catch-ups

The employee contribution limit is the same for both types of 401(k)s. For 2025, the contribution limit is $23,500. Additionally, some individuals can make catch-up contributions and possibly super catch-up contributions in 2025.

Individuals who are age 50 or older can make a catch-up contribution of $7,500 for 2025. And if you turn 60, 61, 62, or 63 in 2025, there’s a new opportunity to contribute even more than that. A new SECURE Act 2.0 provision will allow you to contribute up to $11,250 in 2025.

RMD Rules

The Required Minimum Distribution rules are the same for both types of 401(k) accounts. This is a big difference between Roth 401(k) accounts and Roth IRA accounts, as Roth 401(k) requires participants to take an RMD. In contrast, there is no RMD for a Roth IRA. Roth 401(k) participants may want to roll the funds over to a Roth IRA upon retirement to avoid having to take a distribution.

Traditional 401(k) vs. Roth 401(k) Differences

The most significant difference between the two types of 401(k) plans is the timing of taxes. When you contribute money to a traditional 401(k), you receive a tax deduction. The amount in the 401(k) grows tax-deferred. This means that tax on the original contribution and growth in the 401(k) is paid when you take a distribution from the account.

On the other hand, you do not receive a tax deduction when you contribute money to a Roth 401(k). No tax is due on the original contribution or the growth in the Roth 401(k) when you take a distribution from the account if you meet the qualified distribution rules. To be a qualified distribution, the Roth 401(k) account must be open for at least five years, and you need to be age 59½ or older.

The decision between which type of account to contribute to comes down to when it is best to pay the taxes. You should consider your age at contribution and how long until you will need to use the funds. Careful 401(k) contribution planning can potentially minimize your tax liability over your lifetime.

It may allow for additional tax planning opportunities in retirement.

Three major issues that need consideration regarding 401(k) contribution planning are:

The tax rates now versus the tax rates in the future
The IRA distribution’s effect on other types of retirement income
The IRA distribution’s effect on other aspects of retirement

Tax Rates

There are three rules of thumb regarding the decision to contribute to a traditional 401(k) or a Roth 401(k):

If your tax bracket is the same when you are making contributions and taking distributions, then it does not matter which type of 401(k) you use.
If you are in a lower tax bracket now than you expect to be in the future, you should contribute to a Roth 401(k).
And if you are in a higher tax bracket now than you expect to be when taking distributions in the future, then you should contribute to a traditional 401(k).

The one certainty with tax law is that it is always changing. The decision of whether to contribute to a traditional 401(k) or Roth 401(k) would be easier if we knew what the future holds for tax rates. Based on current tax law, the rates are scheduled to increase on January 1, 2026.

Even with the uncertainty of future tax rates, there is a common misconception that most people are in a lower tax bracket when they retire. Due to IRA distribution’s effect on other types of income, our experience is that many people are in higher tax brackets when they retire versus working full-time.

Effects of IRA Distributions on Other Types of Retirement Income

Taxation of Social Security

Originally, Social Security was intended to be a tax-free source of income, but the laws were changed so that Social Security became taxable for higher-income individuals.

Provisional income is the IRS measurement to calculate if you need to pay taxes on your Social Security benefits. To compute this number, add your adjusted gross income, tax-exempt interest, and 50% of your Social Security benefits. Depending upon your tax filing status and your other income, 50% to 85% of your Social Security benefits could be taxable.

When you take a 401(k) distribution, this increases your provisional income and thus may cause your Social Security benefits to be taxed. In contrast, distributions from a Roth 401(k) are not included in provisional income. This is one factor that needs consideration when deciding whether to contribute to a traditional 401(k) or a Roth 401(k).

Taxation of Qualified Dividends and Long-Term Capital Gains

Another factor to consider is what impact 401(k) distributions will have on the taxation of qualified dividends and long-term capital gains. Three tax brackets currently apply to this type of income – 0%, 15%, and 20%. The income from a traditional 401(k) distribution may cause qualified dividends or long-term capital gains to move from a 0% tax bracket to a 15% or 20% tax bracket. When deciding where to save, it is important to consider what other types of income you will have in retirement and what effect the 401(k) distributions will have on the taxation of that income.

IRA Distribution’s Effect on Other Aspects of Retirement

State Taxation of Retirement Distributions

State taxation should be another consideration when deciding between a traditional 401(k) and a Roth 401(k). If you are currently in a high tax state and plan to move to a lower tax state upon retirement, the tax deduction for contributing to a traditional 401(k) now may be more beneficial.

Some states also provide adjustments for certain types of retirement income. This may mean that a portion of your traditional 401(k) will not be subject to state taxation. On the other hand, having a Roth 401(k) distribution may make it so your income is low enough that your Social Security income is not subject to state taxation. It really just depends upon the state tax laws in the state you live in when you retire.

Medicare Premiums and How to Calculate IRMAA

Have you heard of Medicare IRMAA? IRMAA stands for income-related monthly adjustment amount, which is a surcharge on Medicare Part B and Medicare Part D premiums. Calculating IRMAA can be rather confusing. It isn’t calculated based on your current taxable income or income from the prior tax year. It’s based on your Modified Adjusted Gross Income on your tax return from two years prior. For example, if you want to know if you’ll be subject to the IRMAA surcharge in 2025, it will be based on your Modified Adjusted Gross Income from 2023.

Income from a traditional 401(k) is included in modified adjusted gross income, whereas income from a Roth 401(k) is not. When deciding where to save, the 401(k) distributions effect on how much you will pay for Medicare is another aspect to consider. These additional premiums can be significant in retirement.

Putting It All Together

Many factors need consideration in determining whether to contribute to a traditional 401(k) or Roth 401(k). The best way to make this decision is by looking at this decision as part of a comprehensive financial plan. This plan will include a multi-year tax projection. You should consider working with a CPA and financial advisor to develop a forward-looking tax plan to help you determine the optimal place for you to save today. We also have a company retirement plan team at Modern Wealth that can walk individuals through different decisions pertaining to their 401(k).

If you have any questions about the nuances of traditional vs. Roth 401(k)s and which makes the most sense for you to save to, start a conversation with our team below.

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The bottom line is that the answer of whether to save to a traditional or Roth 401(k) depends on your unique situation. We look forward to learning more about your situation and how our team can help you make informed decisions about your money.

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The views expressed represent the opinion of Modern Wealth Management a Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.