Is a Roth 401(k) Right for You?

If you expect to be in a lower tax bracket when you retire, you might be better off with a traditional 401(k) that lets you put off taxes until then. But if you expect your income to be higher in retirement, you could go the Roth route and pay taxes on your contributions at your current, lower rate.

That’s why younger workers tend to be more likely to have a Roth 401(k), says Kirsten Hunter Peterson, vice president of thought leadership at Fidelity: “Right now, they probably have a lower tax rate, so it just makes sense for them to potentially pay that tax on their retirement contributions now.”

Where and how you choose to live in retirement can also come into play. For example, “if you live in a state now that has a lower income tax than the state you plan to move to, then you might want to consider contributing after-tax or on a Roth basis,” Hunter Peterson says.

Do you need more take-home pay?

When you save a portion of your salary in a Roth 401(k) plan, you pay the taxes up front. But with more of your money going to taxes, your take-home pay will be less than what you’d pocket if you saved the same amount of money in a traditional 401(k).

“For folks who might feel like they need every dollar in that paycheck right now, or don’t have that wiggle room in their budget to be able to pay the tax up front, that’s an important consideration,” Hunter Peterson says.

When will you need the money?

Are you counting down the days before you can tap your retirement account, or is enough coming in from other income streams, such as Social Security or a pension? If the latter, recent changes in retirement-saving rules could make a Roth 401(k) more attractive.

Most retirement plan owners must take a set amount out of their accounts each year, starting at age 73. As part of the SECURE 2.0 Act of 2022, a federal law aimed at expanding savings opportunities, Congress exempted Roth 401(k) plans from these required minimum distributions (RMDs), effective with the 2024 tax year.

Now, if you don’t need much money (or any money) from your Roth 401(k) in a particular year, you don’t have to take it — you can leave it where it is, earning investment returns or interest. That could provide a hedge against rising costs as you age (for health care, for example) or let you pass on more to heirs, if you intend to leave an inheritance.

Does your plan allow Roth conversions?

What if you’ve saved a sizable amount in a traditional 401(k) account and now want to move that money into a Roth 401(k)? A majority of workplace plans allow employees to convert from a traditional 401(k) to a Roth, but about 43 percent do not, according to an industry survey of plan sponsors. Check with your HR department or plan manager to see about your options.

Can you afford to convert?

If you can and do choose to make the switch, be sure to consider all costs involved. “Converting a traditional 401(k) to a Roth 401(k) means you’ll have to pay taxes on the converted amount,” says Derek Miser, a financial adviser and founder of Miser Wealth Partners in Knoxville, Tennessee. “You want to ensure you have enough cash on hand to cover any tax liability from the conversion.”

Keep in mind, too, that you must own a Roth account for five years before you can make qualified withdrawals (unqualified withdrawals carry a 10 percent tax penalty). If, say, you plan to retire in two years and will need to tap your account at that time, a Roth conversion might not make sense.

Indeed, when it comes to choosing between a traditional or a Roth 401(k), there’s no right or wrong answer — it all depends on which account type works best for your personal situation.

And you don’t necessarily have to choose one or the other. Suppose you have a traditional 401(k) and you change jobs. If your new employer offers a Roth 401(k), “you can do both, and you can diversify your tax strategy now and in retirement by doing so,” Hunter Peterson says. “That’s a third option.”