Saveday 401(k) plans offer both Pre-Tax (Traditional) and Roth contribution options for participants. The major difference between these contribution types is when you are taxed.
With a Traditional 401(k), your employer deducts your contribution before it even shows up in your paycheck. This lowers your gross income on paper, and therefore, the amount of taxes you pay week-to-week goes down a bit too. When you retire and begin withdrawing money from your Traditional 401(k), you’ll pay ordinary income tax on the amount you withdraw - both your contributions and their investment earnings.
With a Roth 401(k), your employer deducts your contribution from your net after-tax income. This means there are no reductions in your gross income or resulting deductions in your current taxes or tax bracket. However, when it comes time to retire, you’ll have already paid taxes on your contributions and investment earnings! In general, this means you’ll be able to withdraw money without owing taxes or penalties.
Overall, people who expect to be in a lower tax bracket when they retire would benefit from selecting a Traditional 401(k) plan. Employees who expect to be in a higher bracket after retiring might opt for a Roth plan so that they can avoid paying taxes on their savings later. However, since no one knows what tax rates will be decades from now, neither type of 401(k) plan can be 100% the right answer. Many financial advisors recommend splitting contributions into both types of accounts.