This 401(k) Mistake Could Hurt You Before -- and After -- Retirement
Key Points
A lot of savers choose traditional 401(k)s for the up-front tax break.
With a traditional 401(k), you may run into issues with early withdrawal penalties and RMDs.
A Roth 401(k) could offer more flexibility.
- The $23,760 Social Security bonus most retirees completely overlook ›
A 401(k) is one of the most effective tools for building long-term wealth. And these days, employers tend to offer two types of 401(k) plan -- traditional and Roth.
Many savers favor the traditional 401(k) because it offers an immediate tax break on contributions, whereas a Roth 401(k) doesn't. But that doesn't mean a traditional 401(k) is your best bet. And sticking to one could mean having to alter your retirement plans and/or give up control over how you manage your savings.
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Why a traditional 401(k) might hurt you
The money you put into a traditional 401(k) can lower your tax bill each year you make contributions. But there's a flipside -- withdrawals are taxed in retirement, which isn't the case for a Roth 401(k).
That's not all, though. You may end up wanting to retire early. But if you take a withdrawal from a traditional 401(k) before turning 59 and 1/2, you could easily get hit with a 10% early withdrawal penalty.
With a Roth account, you can access your principal contributions before age 59 and 1/2 without a penalty, since that account was funded on an after-tax basis. You just can't touch the gains portion.
Furthermore, once you turn 73 or 75, depending on your age, the IRS will force you to take required minimum distributions (RMDs) from a traditional 401(k). Those could drive up your taxes and have other consequences, too, such as leading to taxes on Social Security benefits and Medicare premium surcharges.
Roth 401(k)s don't force savers to take RMDs, though. That means you get complete control over your money. If you retire with a $1 million Roth 401(k) and don't want to touch it, you can let that money grow tax-free for as long as you've alive.
Giving up an immediate tax break could be worth it
You may be loath to forgo the up-front tax break that comes with funding a traditional 401(k). But sticking to a traditional 401(k) is a mistake that might haunt you before retirement and after.
It could be worth giving up that tax break for the promise of tax-free withdrawals that come with a Roth 401(k). But on top of tax-free withdrawals, you get flexibility, whether it relates to tapping your savings early or not raiding your savings down the line.
That flexibility could be extremely valuable to your overall retirement plan. So it's worth considering a Roth 401(k) over a traditional one if your workplace offers that option. Not taking advantage of a Roth 401(k) is a move you might sorely regret.
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