Traditional vs. Roth 401(k) Calculator
Use this calculator to compare the potential long-term value of contributing to a Traditional 401(k) versus a Roth 401(k) based on your current and expected future tax rates.
Results:
Traditional 401(k)
Annual Tax Savings (Current):
Total Contributions (Pre-Tax):
Future Value at Retirement (Pre-Tax):
Net Value After Retirement Taxes:
Roth 401(k)
Total Contributions (After-Tax):
Future Value at Retirement (Tax-Free):
Summary
Understanding Traditional vs. Roth 401(k)
Choosing between a Traditional 401(k) and a Roth 401(k) is a significant financial decision that impacts your tax situation both today and in retirement. Both offer excellent ways to save for retirement, but they differ fundamentally in how your contributions and withdrawals are taxed.
Traditional 401(k)
With a Traditional 401(k), your contributions are made with pre-tax dollars. This means the money you contribute is deducted from your taxable income in the year you contribute, potentially lowering your 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 (contributions and earnings) are taxed as ordinary income at your then-current marginal tax rate.
Key Features:
- Contributions are tax-deductible in the year they are made.
- Investments grow tax-deferred.
- Withdrawals in retirement are taxed as ordinary income.
- Ideal if you expect to be in a lower tax bracket in retirement than you are now.
Roth 401(k)
A Roth 401(k) operates on an "after-tax" basis. You contribute money that has already been taxed, meaning your contributions do not reduce your current taxable income. The significant advantage of a Roth 401(k) is that your qualified withdrawals in retirement are completely tax-free. This includes both your contributions and all the investment earnings.
Key Features:
- Contributions are made with after-tax dollars (not tax-deductible).
- Investments grow tax-free.
- Qualified withdrawals in retirement are completely tax-free.
- Ideal if you expect to be in a higher tax bracket in retirement than you are now.
How to Use the Calculator
To get the most out of this calculator, input the following information:
- Annual Contribution Amount: The amount you plan to contribute to your 401(k) each year.
- Years Until Retirement: The number of years you plan to continue contributing and for your investments to grow.
- Annual Investment Growth Rate (%): Your estimated average annual return on investment. A common historical average for diversified portfolios is 7-10%.
- Pre-Retirement Marginal Tax Rate (%): Your current marginal tax bracket. This helps determine the immediate tax savings of a Traditional 401(k).
- Post-Retirement Marginal Tax Rate (%): Your estimated marginal tax bracket in retirement. This is crucial for comparing the tax implications of withdrawals.
The calculator will then show you the estimated net value of your retirement savings for both Traditional and Roth options, allowing you to see which strategy might be more beneficial for your specific situation.
Example Scenario
Let's consider an individual who contributes $10,000 annually for 30 years, with an average annual growth rate of 7%. Their current marginal tax rate is 24%, and they anticipate their retirement tax rate to be 15%.
- Traditional 401(k):
- Annual Tax Savings: $10,000 * 24% = $2,400
- Total Contributions: $10,000 * 30 = $300,000
- Future Value (Pre-Tax): Approximately $944,607
- Net Value After Retirement Taxes (15%): $944,607 * (1 – 0.15) = $802,916
- Roth 401(k):
- Total Contributions: $10,000 * 30 = $300,000
- Future Value (Tax-Free): Approximately $944,607
In this scenario, the Roth 401(k) would result in a higher net value at retirement because the post-retirement tax rate (15%) is lower than the pre-retirement tax rate (24%). If the post-retirement tax rate were higher, the Traditional 401(k) might be more advantageous.