Now before we go too far down the rabbit hole, I should point out that each of these accounts has pros & cons. Don't make a decision on which account to use without fully understanding what they do and how they work. Or better yet, get the opinion of a professional.
With that said, here we go. In recent years, I have started to notice that more employers are starting to offer Roth 401ks as part of their retirement benefits package. The vast majority of people that I sit down with, however, are not using this type of account when they should be. The reason behind this is that most simply don't understand the difference between the two, nor the pros & cons associated with each. So let's clear up some gray areas here.
First of all, 401ks & Roth 401ks are not investments. They are simply a container that you place investments inside of. If your 401k is doing better or worse than someone else's, it's because the investments inside the 401ks are different. Let's start with a traditional, Pre-Tax 401k. The differences between a 401k & a Roth 401k are simple. With a 401k, the money you contribute to it has not yet been taxed. It remains un-taxed until you withdraw money from the account. Once you take money out, Uncle Sam gets his cut. With this type of account, once you reach the age of 70 1/2, you must take an RMD (Required Minimum Distribution). Even if you don't need to make a withdrawal, the government will require you to start taking money out because you have avoided the taxes long enough. For everyone under 50 with access to this type of account, you are allowed to contribute up to $19k per year to this account. If you are over 50 years of age, you can contribute up to 25k per year. It's important that you keep an eye on these contribution amounts as they do
often change.
With a Roth 401k, the contribution limits are the same. However, in this account, the money you contribute will be taxed upfront and then placed into the Roth 401k. There is no tax due upon a withdrawal (provided you meet certain requirements) and there is no RMD (Required Minimum Distribution) for a Roth account because the taxes have already been paid. The government has already taken their cut and therefore, has no interest in what happens to the account from there on.
So which is best to use? Well, like anything, it depends on your situation. Generally speaking, If you are close to retirement, and trying to "catch up", you may need the upfront tax break from the Pre-Tax 401k. Most however would benefit greatly by taking advantage of the Roth 401k. Ask yourself this question: Would I rather pay tax on the seed, or the fully-grown tree?
Some questions to ask yourself before you decide on which is right for you. Do you have student loans? If you do, you would be doing yourself a great service by having a loan analysis done. I don't mean consolidating the loans to a lower interest rate. I'm talking about a professional student loan analysis! In many cases, the Pre-Tax 401k is a clear-cut winner for those with certain student loans. Call me if you want to know why. Also, make sure your employer will match inside a Roth 401k. Not all will. If your employer offers a match, you certainly want to take advantage of it. That's a 100% return on your money and you won't get that in the market!