Breaking down the difference between a Traditional and Roth 401(k)
When it comes to planning for your retirement, there’s a lot to look forward to — travel, relaxation, developing new hobbies, sharing time with loved ones. While retirement can be an incredibly rewarding experience, getting to that destination can be a bit confusing, especially if you’re signing up for your first 401(k) or your employer’s plan provides options you’ve never heard of before.
One of those options might be deciding between traditional or Roth 401(k) elective deferral contributions. Roth 401(k) elective deferrals have become more popular over the past few years. In fact, 93% of employer-sponsored plans offered Roth as an option in 2023, rising from 89% in 2022.1 While having the option to choose is an added benefit for employees, many are still unclear of the actual differences between these two choices and, more importantly, how they can benefit from them.
Below, we’ve spelled out the important differences between traditional 401(k) and Roth 401(k) elective deferrals made to a 401(k) plan and considerations to keep in mind when creating your retirement savings strategy. In this post, we’ll cover:
- What a tax-advantaged account is and why it matters to you
- The differences between traditional and Roth contributions
- Questions to consider when deciding if traditional, Roth, or perhaps a mix of both could be a good fit for you
Tax-advantaged accounts
Retirement plans like your 401(k) or an IRA are what are known as tax-advantaged accounts.
What's a tax-advantaged account?
A tax-advantaged account is any type of account or savings plan that offers tax savings by:
- Lowering your taxable income (which is how much of your income is subject to income taxes at the state and federal levels)
- Exempting your account from taxation, or
- Allowing your contributions and earnings to grow tax-deferred.
Other tax-advantaged accounts you might be familiar with include health savings accounts (HSAs) and flexible savings spending accounts (FSAs), which can be used to help manage your healthcare costs.
What’s the catch?
There are limitations to just how much one can take advantage of these types of accounts. Typically, these limitations come in the form of how much you can contribute to different account types each year.
The IRS refers to employee contributions to a 401(k) plan as "elective deferrals" (because you’re voluntarily tax-deferring a portion of your paycheck) and the limit is reviewed and updated based on cost of living adjustments (COLAs) annually.
- In 2025, individuals can contribute up to $23,500 to their 401(k) accounts. This limit does not include what your employer may contribute on your behalf.
- If you’re 50 years or older, you’re eligible to make catch-up contributions of $7,500, making the total amount you can contribute $31,000.
- Starting in 2025, the SECURE 2.0 Act of 2022 allows a special extended catch-up provision for folks 60-63; they can contribute an additional $11,250 for a total of $34,750 annually.
- These limits are the same for traditional and Roth 401(k) elective deferrals and reflect the total amount you can contribute across the two. For example: If you’re 35 years old, you can contribute up to $23,500 as a traditional pre-tax deferral, as a Roth 401(k) deferral, or a mix of both. Please note: If you are eligible to participate in more than one 401(k) plan in a given year (like when you start with a new employer), the cap on your elective deferral contributions does not reset as this is an individual taxpayer limit.
- The same applies to catch-up contributions, so if you’re 50 or older, you can contribute up to $31,000 — or $34,750 depending on your age — across all 401(k) accounts in a given year.
So, what exactly am I deciding between?
When it comes to your tax-advantaged retirement accounts, the individual can decide whether they want to get the tax advantage today (traditional) or if they want to enjoy that benefit in retirement (Roth).
Takeaways:
- Tax-advantaged accounts are a type of account or plan that have tax benefits such as tax deductible contributions, tax-free growth and/or tax free withdrawals.
- 'Traditional' and 'Roth' refer to the contribution methods and different tax treatments of those contributions that individuals can choose from when making contributions to a retirement account. They are available in both IRAs and 401(k) plans.
Traditional 401(k) vs. Roth 401(k) Elective Deferrals:
You have questions, we have answers. Let’s break it down together:
What is a traditional 401(k) elective deferral contribution?
Traditionally, elective deferral contributions have come from individuals’ paycheck on a pre-tax basis. This type of contribution is commonly known as a traditional or pre-tax elective deferral. Your Guideline participant dashboard refers to this method as "pre-tax."
What does 'pre-tax basis' mean?
When you contribute pre-tax funds from your paycheck to your 401(k), that money is deducted from your gross pay before your federal income tax is calculated. This means that the IRS will tax these funds, including earnings, when the individual receives a distribution (or withdraws funds in retirement) from the plan. The federal and state taxes, if any, incurred are based on the retiree’s tax bracket in the year they receive their distribution.
What does that mean for me?
Traditional contributions lower your taxable income today by the amount you contribute. When you take your distribution in retirement, you will owe taxes on the amount you withdraw, based on your tax bracket in the year of the withdrawal.
When do I get that tax advantage?
When you make elective deferral contributions to a traditional 401(k) account, you receive that benefit 'today' via a tax deduction on the amount contributed. Those amounts continue to grow tax-deferred, and when you withdraw in retirement, that’s when you’ll pay taxes on 100% of your withdrawal.
What is a Roth 401(k) elective deferral contribution?
Roth elective deferral contributions, introduced in 2006, allow employees to contribute their compensation on an after-tax basis.
What does 'after-tax basis' mean?
This means that you pay federal and state income taxes on your compensation before you contribute it to the 401(k) plan, instead of when you withdraw from the plan in retirement. The elective deferral amount that is deducted from your paycheck will be taken after taxes have been paid, and therefore does not lower your taxable income today.
What does that mean for me?
While you won’t be taxed on qualified withdrawals of Roth elective deferrals in the future, it does mean your contributions will take a bigger bite out of your paycheck today. When you receive a qualified distribution1 (or, withdraw funds in retirement), you will not owe any additional taxes — on what you contributed or on any earnings from interest.2 Roth contributions are popular with individuals who believe they are in a lower tax bracket now than they will be in retirement.
Am I eligible to make Roth 401(k) elective deferral contributions?
As long as your employer offers Roth 401(k) elective deferrals as an option, you can elect to make Roth 401(k) elective deferral contributions to your 401(k) account. Unlike a Roth IRA, there are no income limitations in place that may exclude you from choosing that contribution type. Guideline 401(k) plans accommodate both Roth and traditional contributions. If you’re not able to benefit from the tax savings associated with a Roth IRA because of your income, making Roth elective deferral contributions to your 401(k) account is another way to diversify your tax strategy.
When do I get that tax advantage?
When you make contributions to a Roth elective deferral account, you receive the tax benefit at retirement.
| Traditional 401(k) | Roth 401(k) | |
|---|---|---|
| Contributions | Pre-tax | Post-tax |
| Tax-break | Today | Retirement |
| Distributions at Retirement | Owe income taxes on funds withdrawn from your retirement accounts | Tax-free. You don't owe taxes when taking a qualified distribution. For a non-qualified distribution, taxes only apply to the earnings portion. |
Takeaways:
- Both traditional 401(k) and Roth 401(k) elective deferral contributions are tax-deferred. Either way, you are not paying taxes on your earnings each year as you would with a general investment account. Rather, all of those earnings get reinvested (tax-free) and power the compounding interest.
- Traditional 401(k) elective deferral contributions provide you with a tax benefit today by lowering the amount of income subject to federal income taxes in the year they are made. This is also commonly referred to as a 'tax deduction.' So, for example, if your annual income is $75,000 and you contribute $10,000 in traditional 401(k) elective deferrals this year, your income subject to federal income tax for this year is lowered to $65,000. When you withdraw funds during retirement, you will owe income taxes on the entirety of your withdrawal (including all earnings) based on your income and tax bracket at that time.
- Roth 401(k) elective deferral contributions provide you with a tax benefit in retirement, by contributing after-tax dollars today, but you get to take tax-free qualified withdrawals in retirement. To use the same example as before, if your annual income is $75,000, all $75,000 will be subject to federal income taxes today. When you withdraw funds during retirement, you won’t owe any taxes on whatever you take out (including all investment earnings) as long as it’s a qualified distribution. As a reminder, Roth 401(k) elective deferral contributions are not taxed if withdrawn as a non-qualified distribution, but the earnings will be subject to federal income taxes.
- So, when do you enjoy the tax advantage? Traditional 401(k) = today, Roth 401(k) = retirement.
This example is for illustrative purposes only. This is not investment or tax advice.
Which one is right for me?
There are benefits to both Roth and traditional methods of contributing elective deferrals, and there’s no 'one-size-fits-all' approach. Everyone has different needs and preferences when it comes to their personal finances, and you should consider what you are comfortable with when deciding what’s right for you. Here are some questions you should consider when creating a contribution strategy that’s right for you:
How long until you are planning to retire?
It’s helpful to think about what tax bracket you think you will be in upon retirement. As you continue to grow in your career and earn a higher salary, your tax bracket will inevitably increase.
Depending on the income you will be earning in retirement (whether from Social Security, withdrawals from your retirement accounts or other investments, or even continued income), it’s possible for your tax bracket to be higher in retirement than it is before retirement. While that may sound counterintuitive, remember that retirement can be your opportunity to reap the rewards of your hard work (and potentially those gains from compounding returns/interest).2
Individuals earlier in their careers often consider the benefits of Roth contributions given their (likely) lower tax-bracket today and the opportunity for the investments and compounding returns/interest to grow completely tax-free until distributions are taken.
When you contribute funds on a Roth (post-tax) basis from your paycheck to your 401(k), that money comes out after income taxes have been paid. This means that you’re paying income taxes on the amount you have contributed, and it does not lower your taxable income today. But the benefit comes when you retire because the earnings on your Roth contributions will be fully tax-free if it is a qualified distribution.1
As you near retirement and plan to withdraw, the benefit associated with Roth 401(k) elective deferrals begins to get smaller since you have more visibility into your income at retirement and the tax bracket you’ll likely be taxed at. Additionally, there could be less time for your earnings on interest to grow tax-free. Dependent on your financial situation and time horizon, it may make more sense to pay-as-you-go (i.e., pay taxes on what you withdraw) at this point.
What can your budget accommodate?
If you were to contribute the same amount (let’s say 5%) to your 401(k) account via Traditional or Roth 401(k) elective deferrals, your take-home pay would be higher if you opted for Traditional. Depending on your expenses and financial plans, that might be more important for you.
If you are not as reliant on that money today, and prefer that your retirement savings be 'out of sight, out of mind,' Roth contributions can be a way to save a bit more for tomorrow (remember: you will have already paid taxes). Your contributions and earnings can grow tax-free and you may not be tempted to spend that money you’ve 'earmarked for retirement' in your checking account. Moreover, when you make a qualified withdrawal from a Roth account, you won’t owe any taxes.
In contrast, when you withdraw from a traditional account when you retire, you will owe taxes on the full amount of the withdrawal, whether it’s contributions or earnings.
Did you know you can opt for both?
With any investment strategy, diversification can help you get where you want to go. There is no sure way to know whether your taxes will be higher or lower in retirement, so having a mix of traditional and Roth contributions is a great way to hedge against that unknown.
Does your employer contribute to your 401(k) account? The IRS historically required that any employer contribution (like a match) was made using the traditional contribution method, even if you chose to make Roth elective deferral contributions. The SECURE 2.0 Act changed this in 2022, making it possible for employers to permit an employee who is 100% vested to elect the employer contribution be made as a designated Roth contribution with the contribution amount being included in the participant’s gross income. It’s now even easier to diversify your retirement savings and have both tax-free and taxable savings to pull from in retirement.
Whether you’re just starting down the road to retirement or you’re well on your way and considering diversifying the path you take to get there, it may never be too early (or too late) to start setting your future self up for potential success.