Many employees have choices when it comes to retirement planning. Here are three common retirement-planning choices:

  • A Roth 401(k)
  • A traditional 401(k)
  • A Roth IRA

How do you decide which is best for you?

Retirement Planning: Eligibility Requirements
First, determine if either of the Roth options is available to you. Not all 401(k) plans have a Roth 401(k) option. Check to see if yours does.
Roth IRAs are not available to everyone. If your adjusted gross income exceeds certain limits, you are not eligible. For single filers, contribution is phased out starting at $105,000. For joint filers, contribution is phased out starting at $167,000. These limitations do not apply to Roth 401(k) plans.
Retirement Planning: Tax Differences
If you are lucky enough to be eligible for a Roth option, you need to understand the differences between a Roth and a traditional contribution.
Your contributions to a Roth 401(k) and a Roth IRA are made with after-tax funds, meaning you have already paid taxes on the funds you contribute to these accounts. You get no tax deduction on your current tax return for making this contribution.
The flip side of the tax picture is the contribution to a traditional 401(k). You can take a deduction and reduce your tax liability for the year in which the contribution is made.
There is no free lunch provided by Uncle Sam. Withdrawals from Roth plans are tax-free. Withdrawals from non-Roth plans are fully taxable at your marginal tax rate when you make
them.
Retirement Planning: Contribution Limits
You can contribute up to $16,500 to a Roth or traditional 401(k) (you can add $5,500 if you are over age 50). Your total 401(k) contributions cannot exceed these limits. For example, if you have both a Roth 401(k) and a traditional 401(k) and are under 50 years of age, you could put a maximum of $8,250 into each account.
Contributions to Roth or traditional IRAs are limited to $5,000 ($6,000 if you turn 50 or older this year). Your total IRA contributions cannot exceed these limits. For example, if you have both a Roth and a traditional IRA and are under 50 years of age, you could put a maximum of $2,500 into each account.
You can contribute the maximum to your 401(k) account and do the same with your IRA account. If you elect to take the Roth 401(k) route and your employer matches your contributions, its contributions are kept in a separate, traditional 401(k) account.
Retirement Planning: Practical Considerations
It’s the unknowables that make the “Roth vs. traditional” decision so difficult. If you knew your tax rate is lower today than it will be when you start withdrawals, you would be better off in a Roth account. Unfortunately, no one can predict future tax rates.
I have a more practical approach for retirement planning. If you can afford to pay the tax now, you should seriously consider the Roth option. There is a big difference between tax-deferred income and tax-free income. If the issue is a close one, opt for the Roth 401(k) or the Roth IRA, or both.
Roths have other benefits. They have no required minimum distributions, unlike traditional 401(k)s and IRAs, which require distributions once you reach age 70½.
You don’t have to take an “all or nothing” approach to retirement planning. Many experts recommend a combination of tax-deferred and tax-free accounts, which can act as a hedge against tax uncertainty. It can also protect you from the potential disaster of retroactive tax legislation.
Don’t be paralyzed by your choices. You can’t start planning too early for your retirement.