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Employers often force employees to choose between investing in two employer-sponsored retirement accounts: the traditional 401(k) and the Roth 401(k). Sound familiar? If so, you’ve probably debated which is the better investment.
Both have their merits. On her Woman & Money podcast, financial guru Suze Orman says that 401(k)s are a fabulous place to put your money.
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Traditional vs. Roth 401(k)s
Traditional 401(k)s are pre-tax retirement accounts. You are taxed when you pull your money out of the account. Here is what makes traditional 401(k)s so appealing:
- You typically pay taxes in retirement. That’s great for folks who anticipate moving to a lower tax bracket in retirement.
- Large enough contributions may knock you into a lower tax bracket right away.
Roth 401(k)s are after-tax retirement accounts. You are taxed when you put money into the account. Here’s what makes Roth 401(k)s so appealing:
- You pay taxes upfront. That’s great for folks anticipating moving to a higher tax bracket in retirement.
- Roth 401(k)s offer greater flexibility to retirees than traditional counterparts.
Employers often match a percentage of employee investments regardless of which account you choose. That’s more savings on top of whatever you feel comfortable contributing.
Author’s note: However, this percent match often comes with strings attached — employers sometimes revoke the match if employees quit too soon. Stay informed. Read the fine print and check whether the company has a vesting schedule.
Here’s why Suze Orman prefers Roth 401(k)s
Orman loves Roth 401(k)s for two reasons: Unlike traditional 401(k)s, Roth accounts no longer require retirees to make annual withdrawals. And folks can contribute more to a Roth 401(k) than they can a Roth IRA (individual retirement account).
Zero annual withdrawal requirements
Orman says, “You’re better off doing a Roth 401(k) versus a traditional 401(k)… because you can just leave it in there for the rest of your life.”
Traditional 401(k)s come with a condition called RMD, which stands for required minimum distribution. If you have money in a 401(k) during retirement, you must withdraw a minimum amount of money from that account each year or pay a stiff fine.
In 2024, Roth 401(k)s will no longer require RMDs thanks to the Secure Act 2.0. Investors can leave money in their accounts for as long as they want, regardless of age or retirement status. Roth 401(k)s give retirees greater flexibility when making withdrawals.
Higher contribution limits than IRA
Orman adds, “You can put larger amounts of money in there than you can in a Roth IRA. And anytime you want, you can always convert it to a Roth IRA.”
In 2023, the Roth 401(k) contribution limit is $22,500. The Roth IRA contribution limit is $6,500. (Folks over 50 have higher contribution limits.) You can contribute more long-term savings to a Roth 401(k).
Employees who switch jobs or retire can convert their accounts into a Roth IRA. Like the Roth 401(k), the Roth IRA doesn’t require you to withdraw money in retirement.
Best Roth IRA accounts
You have options if you choose to roll over your Roth 401(k) into a Roth IRA. Make sure to shop around. The best Roth IRA accounts offer powerful features like simple setup and low fees.
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