How do I Choose the Best 401k Plan?

There are many factors to consider when you are trying to choose the best 401K plan. You can start by considering your unique goals for saving for retirement and handling taxes when comparing options. For example, you may prefer a traditional 401K plan if you are most interested in saving on taxes in the present while also saving for retirement. If you prefer the ability to make tax-free, penalty-free withdrawals once you reach 59.5 years old, however, a ROTH 401K is typically a better choice.

Both traditional and Roth 401K plans allow you to put aside money for retirement. Likewise, you will typically contribute to either of these retirement plans via payroll deductions. A major difference, however, is how the money is considered in terms of your pay. With a traditional 401K plan, your contributions are considered pretax contributions and work to reduce your taxable income. The change in taxable income may reduce the amount of tax money for which you are liable in a given year.

A Roth 401K plan is considered an after-tax contribution, despite the fact that the money is deducted from your pay. As such, the amount you contribute does nothing to reduce your taxable income or your tax liability for an applicable tax year. On the other hand, it does offer a benefit that a traditional 401K plan does not: withdrawals without penalties and taxes when you reach the age of 59.5. With a traditional 401K, you essentially enjoy tax breaks now and pay later when you may be in a lower tax-liability bracket. A Roth 401K, on the other hand, involves paying taxes now and enjoying tax-free retirement money later.

In some cases, the decision to choose a traditional 401K plan instead of a Roth 401K depends on the current state of your finances. If you will enjoy greater financial stability by paying taxes later, this may be the best option for you. On the other hand, it is important to consider the tax bracket you may be in when you want to start making withdrawals. If you think you may be in a higher bracket at that point, you may be better served by a Roth 401K.

You may also consider your age when deciding whether a traditional 401K or a Roth 401K is best for you. At a younger age and when you are unsure how much your income might increase, you may prefer a Roth 401K plan. If you are middle aged, however, and it is unlikely that your income will increase dramatically, you may prefer the current tax breaks.