Roth 401(k)s work best for young workers

Highway sign with the words Rewards-Next Exit

If you're in your 20s or 30s, a Roth 401(k) is the smartest way to save for retirement.

Traditional 401(k)s can be a better bet for older, high-income taxpayers because contributions can be deducted from their current income. (That's because 401(k) accounts were originally created as a tax shelter for corporate executives with extra money to invest.)

But if you're young and just starting out, you aren't making as much as you will later in your career, and your taxes should be pretty low.

Getting a deduction for contributing to your retirement account isn't going to make much of a difference in how much you owe the government.

Roths also offer you a big advantage over traditional 401(k) accounts: When you retire, none of your withdrawals are taxed. (All withdrawals from traditional 401(k)s are taxed.)

You have a considerable number of years before retirement, so that will give your earnings time to grow and become a far more valuable part of your account than your contributions.

With a Roth 401(k), you'll never pay taxes on any of those earnings, including interest, dividends and capital gains (the increased value of your mutual fund holdings).

Let's say you contribute $500 a month and earn an average annual return of 7% over 30 years. Your balance would grow to $616,000, and contributions would make up only $180,000 of that. The remaining $436,000, or more than two-thirds of the account's value, would be totally untaxed earnings.

Follow on Twitter.

Leave a Reply

Your email address will not be published. Required fields are marked *