When considering how you want to save for retirement, one decision you may face is whether you’d like to delay paying taxes on your contributions until you withdraw them or pay taxes now in order to enjoy tax-free income later. Your decision will help you choose between contributing to a traditional retirement plan or a Roth plan, if your employer offers both.
To make that choice, you should compare your current tax status with what you think it may be in retirement. That is, if you’re in a higher tax bracket now than you could be in retirement, going the traditional route might make more sense. On the other hand, if you’re in a lower tax bracket now than you expect to be in retirement, going the Roth route might make more sense.
Here are more differences and similarities to consider before you decide.
How they're similar
- The IRS imposes an annual maximum contribution limit
- Individuals age 50 or older can make additional contributions up to the catch-up limit
- For IRAs, individuals must have earned income; this can come from being paid by someone else or through your own business or farm
- For 401(k), 403(b) and 457(b) plans, individuals must be employed by the plan sponsor or have employment compensation, depending on plan type
- For IRAs, by the annual income tax filing deadline
- For 401(k), 403(b) and 457(b) plans, by the end of the day on December 31
How they differ
|How they are taxed
||How they are taxed
|Required minimum distributions
||Required minimum distributions
Consider getting the benefits of both
If predicting your future tax status seems like a complete shot in the dark, you might contribute to a traditional and a Roth account in the same year, assuming your employer offers a Roth option. This would allow you to take advantage of tax benefits both now and later. As long as you do not contribute more than the IRS and plan limits, this approach can be a smart way to prepare for your retirement income needs.