Choosing between a traditional 401(k) and a Roth 401(k) can be difficult, since you may not be sure what your tax rate will be in retirement relative to when you're working. Those who opt for the traditional, pre-tax variety implicitly believe their tax rate will fall in retirement; on the flip side, Roth 401(k) retirees get their tax bill out of the way up front and ultimately pay no tax on future portfolio withdrawals.
Still, there are many reasons one might choose a traditional 401(k).
1. You think you'll retire in a low- or no-tax state
The traditional 401(k) allows you to defer taxes now, accumulate investment value, and pay tax later on any withdrawals in retirement. This can make a lot of sense if you have your eyes set on a state like Texas or Florida (among others) that levies no state income tax. This is particularly true if you currently live and work in a state like New York -- which will also levy local taxes if you live in the city -- since you'll not only save state tax on any retirement contributions, but you may never have to pay it at all if you relocate to a no-income-tax state for retirement.
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2. You're a very high earner
If you make well into the six figures (alone or alongside a spouse), the traditional 401(k) can make more sense than the Roth. Tax rates for single people earning north of $230,000 and married people earning over $450,000 can be more than a combined 50% when considering federal, state, and local tax burdens. If this is you, the traditional 401(k) will allow you to defer a substantial amount of tax; when your 401(k) money becomes available to you penalty-free in retirement, you'll also likely face a lower tax rate.
3. You appreciate tax deferral
Instead of voluntarily paying taxes at a high rate today, consider the benefits of tax-deferred compounding in a traditional 401(k). Thanks to the magic of compounding and compound interest, the more you're able to defer now, the faster you can expect your retirement assets to grow. What's more, you'll face a lower current tax bill every year you contribute to your traditional plan.
The new SECURE 2.0 Act also increased the age for required minimum distributions (RMDs) to age 73 in 2023, and it will rise again to 75 in 2033. This means you won't be mandated to withdraw money until halfway through your eighth decade; for people in their early 20s, that's over 50 years for your retirement money to grow in a tax-advantaged manner.
Consider the traditional 401(k) for a secure retirement
The three situations above outline a perfect scenario for someone to contribute to a traditional 401(k), but that doesn't mean you shouldn't contribute if you don't perfectly align. There are instances in which the Roth 401(k) can make sense, and there are also borderline cases where splitting contributions is actually a smart idea. Regardless of the option you choose, be sure that you understand why you're selecting it, and how you stand to benefit when it comes time to tap the accounts in retirement.
