A 401(k) can be either pre-tax or post-tax, and most plans offer both

A traditional 401(k) is pre-tax: money comes out of your paycheck before income tax is calculated, which lowers your taxable income for the year. A Roth 401(k) is post-tax: you pay income tax on the money now, but withdrawals in retirement are tax-free. Many employers offer both options in the same plan, so you can split your contributions between them or choose one.

The choice between pre-tax and post-tax affects how much you pay in taxes today versus in retirement. Pre-tax contributions reduce your current tax bill. Post-tax contributions cost more now but give you tax-information programs later. Neither is universally better — it depends on whether you expect to be in a higher or lower tax bracket when you retire.

Key Takeaways

  • Traditional 401(k) contributions are pre-tax and lower your income tax this year, but you pay income tax on withdrawals in retirement.
  • Roth 401(k) contributions are post-tax and cost you more now, but may have access to withdrawals in retirement are completely tax-free.
  • Most employers allow you to contribute to both types in the same plan, splitting your money between them however you choose.
  • Your choice should depend on whether you expect to be in a higher tax bracket now or in retirement, not on market performance.

How pre-tax traditional 401(k) contributions work

When you contribute to a traditional 401(k), the money is deducted from your gross pay before federal income tax is withheld. If you earn $50,000 a year and contribute $7,000 to a traditional 401(k), your taxable income for the year becomes $43,000. You pay income tax only on the $43,000, not the full $50,000.

This means your paycheck is smaller by the contribution amount, but your tax bill is also smaller. The tax savings happen when ready. However, when you withdraw money from a traditional 401(k) in retirement, every dollar you take out is taxed as ordinary income at whatever your tax rate is then.

The account itself grows tax-deferred: you do not pay taxes on the investment gains, dividends, or interest while the money sits in the account. You only pay taxes when you withdraw.

How post-tax Roth 401(k) contributions work

A Roth 401(k) contribution comes out of your paycheck after income tax has already been withheld. If you earn $50,000 and contribute $7,000 to a Roth 401(k), you still pay income tax on the full $50,000. Your take-home pay is reduced by the $7,000 contribution plus the taxes on your full income.

The benefit arrives in retirement. Once you reach age 59½ and have held the account for at least five years, you can withdraw your contributions and earnings completely tax-free. The account grows tax-free, and you owe nothing to the IRS when you take the money out.

This makes Roth 401(k)s useful if you expect to be in a higher tax bracket in retirement or if you want to lock in today's tax rates before they potentially rise.

Comparing the tax impact: which saves you more money

The math depends on your tax bracket now versus your expected tax bracket in retirement. If you are in a 24% tax bracket now and expect to be in a 22% bracket in retirement, a traditional 401(k) saves you money: you avoid 24% tax now and pay only 22% later. If you expect to be in a 32% bracket in retirement, a Roth 401(k) is better: you pay 24% now instead of 32% later.

The problem is that nobody knows their future tax bracket with certainty. Tax laws change. Your income in retirement might be higher or lower than you expect. For this reason, many people split contributions between both types: some money goes into a traditional 401(k) for the when ready tax break, and some goes into a Roth 401(k) for tax-free growth and withdrawals.

Your employer's plan documents will show the current tax brackets and any historical changes, which can help you estimate. A tax professional can also model both scenarios using your specific situation.

Contribution limits and employer matching

The IRS sets an annual contribution limit for 401(k)s — currently $23,000 for people under 50 and $30,500 for people 50 and older. This limit applies to your combined contributions to both traditional and Roth 401(k)s. If you contribute $10,000 to a traditional 401(k) and $10,000 to a Roth 401(k), you have used $20,000 of your limit.

Employer matching contributions are always made to a traditional 401(k), even if you contribute to a Roth. The match is pre-tax money. This does not reduce your personal contribution limit, but it does count toward the total plan limit of $69,000 per year (for 2024).

Required minimum distributions and withdrawal rules

Traditional 401(k)s require you to start taking withdrawals at age 73 (as of 2023, under the find 2.0 Act). These are called required minimum distributions, or RMDs. You must withdraw a certain amount each year, calculated by the IRS based on your age and account balance, and you pay income tax on every dollar withdrawn.

Roth 401(k)s also have RMDs during your lifetime, but you can avoid them by rolling the Roth 401(k) into a Roth IRA after you retire. Roth IRAs have no RMDs, so your money can keep growing tax-free for as long as you live. This makes Roth accounts useful if you do not need the money in retirement and want to leave a larger tax-free inheritance.

When you might choose one over the other

Choose a traditional 401(k) if you want to lower your taxable income this year, you are in a high tax bracket now, or you expect to be in a lower bracket in retirement. It is also the right choice if you need the when ready tax savings to reduce your current tax bill or increase your take-home pay.

Choose a Roth 401(k) if you are early in your career and expect your income to rise significantly, if you think tax rates will be higher in the future, or if you want the flexibility of tax-free withdrawals in retirement. It is also useful if you want to avoid RMDs or plan to leave money to heirs.

Many people benefit from splitting contributions. You might put 70% into a traditional 401(k) for the tax break now and 30% into a Roth 401(k) to hedge against higher future tax rates. Your employer's plan documents and a tax professional can help you decide the split that makes sense for your situation.

Frequently Asked Questions

Can I change from traditional to Roth or vice versa?

You can change your contribution type at any time during the year, usually through your employer's benefits portal or HR department. The change applies to future contributions only — money already in a traditional 401(k) stays there unless you do a conversion, which is a separate taxable event.

Do I have to choose one or the other, or can I do both?

Most employer plans let you split your contributions however you want between traditional and Roth. You might contribute $5,000 to traditional and $5,000 to Roth in the same year. The combined total cannot exceed the annual limit.

What happens to my Roth 401(k) if I leave my job?

You can roll it into a Roth IRA at your new employer's plan or at a bank or brokerage. Rolling it into a Roth IRA is often better because Roth IRAs have no required minimum distributions and usually offer more investment choices.

If I am in a low tax bracket this year, should I always choose Roth?

Not necessarily. A low bracket this year might be temporary — a bonus, a spouse's job loss, or a career change. If you expect your income to rise next year, a traditional 401(k) now locks in the low rate for this year only. A tax professional can help you model both scenarios.

Can my employer force me to use one type over the other?

No. If your employer offers both, you choose which one to use. Some smaller employers offer only traditional 401(k)s, in which case you have no choice. You can always open a Roth IRA separately if you want post-tax retirement savings.