Roth or 401k Calculator

Roth vs. Traditional 401(k) Calculator

Understanding the Roth vs. Traditional 401(k) Decision

Deciding between a Roth 401(k) (or Roth IRA) and a Traditional 401(k) (or Traditional IRA) is one of the most crucial financial planning choices you'll make. Both are excellent vehicles for retirement savings, offering significant tax advantages, but they differ fundamentally in when those tax benefits are realized.

Traditional 401(k) / IRA: Pay Taxes Later

With a Traditional 401(k) or IRA, your contributions are typically made with pre-tax dollars. This means the money you contribute reduces your taxable income in the year you contribute it, leading to an immediate tax deduction and lower current tax bill. Your investments grow tax-deferred, meaning you don't pay taxes on the gains until you withdraw the money in retirement. At retirement, all withdrawals (both contributions and earnings) are taxed as ordinary income at your then-current marginal tax rate.

• Immediate Tax Benefit: Lower taxable income now.
• Tax-Deferred Growth: No taxes on gains until withdrawal.
• Taxed in Retirement: Withdrawals are taxed as ordinary income.

Roth 401(k) / IRA: Pay Taxes Now

A Roth 401(k) or IRA works in the opposite way. Your contributions are made with after-tax dollars, meaning you don't get an immediate tax deduction. However, the significant advantage is that your investments grow completely tax-free, and qualified withdrawals in retirement are also entirely tax-free. This means you'll never pay taxes on the earnings, provided you meet certain conditions (e.g., account open for 5 years and you're over 59½).

• No Immediate Tax Benefit: Contributions are made with after-tax dollars.
• Tax-Free Growth & Withdrawals: Qualified withdrawals in retirement are completely tax-free.
• Predictable Retirement Income: You know exactly how much you'll have without worrying about future tax rates.

Key Factors Influencing Your Decision

The primary factor in choosing between Roth and Traditional is your expectation of your marginal income tax rate now versus in retirement:

• If you expect your tax rate to be HIGHER in retirement: A Roth account is generally more advantageous. You pay taxes now at a lower rate, and then enjoy tax-free withdrawals when your rate would otherwise be higher.
• If you expect your tax rate to be LOWER in retirement: A Traditional account is generally more advantageous. You get a tax deduction now when your rate is higher, and then pay taxes on withdrawals later when your rate is lower.
• Current Income Level: High earners might find the immediate tax deduction of a Traditional 401(k) more appealing. However, Roth IRAs have income limits, while Roth 401(k)s do not.
• Future Financial Needs: If you anticipate needing a mix of taxable and tax-free income streams in retirement, contributing to both types of accounts can offer greater flexibility.

How to Use the Calculator

1. Annual Contribution: Enter the amount you plan to save annually in your retirement account.
2. Years Until Retirement: Input the number of years you have left until you plan to retire.
3. Expected Annual Investment Growth Rate (%): Estimate the average annual return you expect on your investments. A common historical average for diversified portfolios is 6-8%.
4. Current Marginal Income Tax Rate (%): Enter your current marginal federal income tax rate. This is the rate applied to your last dollar of income.
5. Expected Retirement Marginal Income Tax Rate (%): Estimate what you believe your marginal tax rate will be in retirement. Consider your anticipated retirement income and future tax laws.

The calculator will then project the estimated after-tax value of your retirement savings for both Roth and Traditional options, helping you visualize the long-term impact of your choice. It will also show the immediate annual tax savings you'd receive with a Traditional 401(k).

Important Considerations

This calculator provides an estimate based on your inputs. Real-world scenarios can be more complex due to changing tax laws, varying investment returns, and individual financial situations. It's always wise to consult with a qualified financial advisor to discuss your specific circumstances and make the best decision for your retirement planning.