401k Plan Guide | Traditional 401k vs Roth 401k Overview & Benefits
What is a 401(k) plan?

A 401(k) is a savings and investing plan for retirement offered by employers, that gives employees a tax break on money they contribute. It works by automatically withdrawing contributions from employee paychecks each month and investing the funds wherever the employee chooses. 

There are two types: traditional and Roth 401(k).

What are the key differences between Traditional and Roth 401(k) plans?

The most notable difference between a traditional 401(k) and Roth 401(k) is how the money contributed is taxed. We will outline the key differences below:

1.  Traditional 401(k)

A traditional 401(k) plan is a pre-tax savings account. This means that when you invest in one, your contributions go in before they’re taxed which ultimately makes your taxable income lower.

2. Roth 401(k)

A Roth 401(k) plan is a post-tax retirement savings account, which differs from traditional plans as contributions are taxed before they enter your account.

The Pros & Cons of Traditional and Roth 401k) plans

To understand the potential advantages and disadvantages, we first need to look at the key differences between the two types of 401(k) plans.

Traditional 401(k)

Roth 401(k)

Contributions

Contributions are done using pre-tax dollars. This ultimately lowers your taxable income now but will mean you need to pay taxes later in retirement.

Contributions are done using after-tax dollars. This means that you pay taxes on your contributions now, instead of later in retirement.

Withdrawals

Withdrawals are usually taxed at the ordinary income tax rate, but most state income taxes may also apply depending on where you are located.

You may incur additional tax penalties if you make an unqualified withdrawal prior to age 59 ½.

The money and its growth may not be taxed. However, your employer match may be subject to taxes.

Please note that withdrawing earnings may incur penalties and taxes if you haven’t had the account for five years or are under 59 ½.

Access To Distributions

You have access to your distributions at age 59 ½ and above. This does not change, even based on how long you’ve had your 401(k) for. If disability or death occurs, you or your beneficiaries can also receive distributions earlier.

You can start taking money out once you are age 59 ½ if you’ve held the account for at least 5 years. You or your beneficiaries can also receive distributions due to disability or death.

Contribution Limits

There are a few limits on the contributions that can be made by an employee or employer, and the maximum amounts are adjusted periodically to account for inflation.

For example – in 2021, the annual limit on employee contributions is $19.5k per year for workers aged 49 and below. But in 2022, the limit rose to $20.5k per year. It’s worth noting that anyone aged 50 and above can make a catch-up contribution of $6.5k in 2021 and 2022.

Employee and Employer Contribution Amounts

If an employer wants to also contribute, or the employee wants to make additional after-tax contributions to their traditional 401(k) plans, there is a total employee-and-employer contribution amount for the year.

a) 2021

For employees under 50, the total employee-and-employer contribution amount stops at $58k, or 100% of employee compensation (whichever is the lower amount). However, if the catch-up contribution is included for those who are 50 and over, the limit is capped at $64.5k.

b) 2022

For workers who are under 50 years old, the total employee-employer contributions cannot exceed $61k per year. If you include the catch-up contribution for those 50 and over, the limit is capped at $67.5k.

Rolling Over Your 401(k) Plan 

Do you have a 401(k) with a former employer? Our team of dedicated advisors are here to help guide you through the complex transfer process. You can read more about transferring your 401(k) into an IRA here.

If you are interested in learning more about 401(k) rollovers, then please contact us directly at [email protected] or call us directly:

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New York NY,
10017,
USA
Tel: +1 646 891 5990

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Houston TX,
77024,
USA
Tel: +1 347 471 7519

Where to find us

12 East 49th Street, 11th Floor, New York NY 10017, United States of America.
Tel: +1 646 891 5990.

800 Town & Country Blvd, Office 552, Houston, TX 77024, USA.
Tel: +1 347 471 7519

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