Understanding the Traditional 401(k) vs. Roth IRA: Which One Makes Sense for You?

When it comes to planning for retirement, one of the most fundamental questions investors face is: Should I contribute to a traditional 401(k) or a Roth IRA? While both vehicles are powerful tools for building long-term wealth, they come with different tax treatments, and choosing the right one can depend on a few key personal and financial considerations.

This is part one of a two-part series on retirement planning, where we’ll break down important factors to consider when building your long-term financial strategy.

At its heart, the decision between a traditional 401(k) and a Roth IRA boils down to when you pay taxes.

• Traditional 401(k): Contributions are made with pre-tax dollars, which lowers your taxable income today. However, you’ll pay taxes on withdrawals in retirement.
• Roth IRA: Contributions are made with after-tax dollars, meaning you pay taxes upfront. But the payoff is substantial — qualified withdrawals in retirement are tax-free.

This raises a crucial question: do you expect your tax rate in retirement to be higher or lower than it is today?

Trying to predict your future marginal tax rate isn’t easy. It depends on several unknowns:

• Your future income and career trajectory
• Potential changes in federal tax policy
• The long-term outlook for U.S. debt and deficits, which could push rates higher

Given these uncertainties, many investors find value in diversifying their tax exposure — essentially, hedging their bets by contributing to both a traditional 401(k) and a Roth IRA. This blended approach can help provide flexibility down the road, especially when it comes time to draw down assets in retirement.

When weighing these options, here are a few additional points to consider:

• Required Minimum Distributions (RMDs): Traditional 401(k)s are subject to RMDs starting at age 73, which can impact your income planning and tax situation. Roth IRAs, however, are not subject to RMDs during the original owner’s lifetime.
• Investment Flexibility: Roth IRAs often offer more freedom when it comes to choosing individual investments. Traditional 401(k) plans typically limit you to the menu of options your employer provides.
• Early Withdrawals: While Roth IRA contributions (not earnings) can be withdrawn without penalty at any time, accessing funds before age 59½ from a traditional 401(k) can come with taxes and penalties — unless certain exceptions apply.
• Employer Matching Contributions: Don’t overlook this. If your employer offers a match on your 401(k), it’s often worth prioritizing contributions to capture the full match — it’s essentially free money.

One of the most compelling aspects of the Roth IRA is the long-term power of tax-free compounding. Not only can you enjoy decades of tax-free growth, but Roth IRAs can also be passed on to heirs, who can continue to benefit from tax-free growth for another 10 years. In many ways, it’s one of the last true “tax havens” still available to investors.

Because future tax rates are so difficult to predict, many clients find it prudent to split contributions between traditional and Roth accounts. For example, allocating 50% of retirement savings to a traditional 401(k) and 50% to a Roth IRA provides a mix of tax-deferred and tax-free growth, helping you manage future income more strategically.

Our team can help you evaluate your options and develop a customized financial plan. Visit our Wealth Management page or contact us to get started.