It’s common to get a call from clients expressing confusion over the different ways to save for retirement. But the most common question these days is, what is a Roth 401(k) anyway?

Vanguard estimates that 71% of the traditional 401(k) plans it administered in 2018 included a Roth 401(k) option. However, fewer than 15% of workers who have access to Roth 401(k) plans take advantage of this option. Part of the reason is confusion or questions about the available choices, so let’s examine the differences between these options.

One of the questions you need to ask yourself is, do you want to pay taxes, Now or Later?

In a traditional 401(k) you make pre tax contributions and pay taxes when you withdraw. If you withdraw before age 59 1/2 , there’s a 10% early withdrawal penalty over and above paying any ordinary tax due on the withdrawal. Any contribution to a Roth 401(k) is taxed, so the money withdrawn is tax free, as long as you’re 59 1/2 and you’ve had the Roth account for at least 5 years.

Next, how much can you afford to save?

The maximum annual contribution for 2019 is $19,000 for those who are under the age of 50 while an additional $6,000 as catch up contribution for those who are 50 years or older. This contribution limit is for both accounts.

If you noticed I did not ask how much your contributions your employer would match. Regardless of the size of the match, I suggest you try to save the maximum. If that’s not possible, you need to put in at least 10% of your annual pay.

Let’s say, you can afford to save the maximum and are willing to pay some taxes now and some later. You could split it however you want according to your willingness to pay taxes now. You could split your 401(k) contributions 60% traditional & 40% Roth.

This gives you latitude to take money out tax-free during big spending years (like travelling, etc.) in retirement. This could turn out to be a huge benefit as you now have a controlling mechanism when it comes to your marginal tax bracket. You may pull money from your deferred taxable account and anything beyond the certain normal amount you’ll pull out from the Roth account to avoid moving up to the next higher tax bracket.

Also, because you already paid taxes on the Roth Account, the money would be tax free to your heirs.

How about if you can save beyond the $19,000 or $25,000 for those older than 49 years ?

A Traditional 401(k) & a Roth IRA, might be a perfect combination.

If you can afford more than the maximum, then, contribute the maximum amount to your traditional 401(k) then open a Roth IRA outside your employer plan. That way you can contribute an additional $7,000 provided your income is within the limits. If you’re a single filer, phase out starts at $122,000; ineligible at $137,000. For married filing jointly and qualifying widow/er, phase out starts at $193,000; ineligible at $203,000.

It’s never too early or too late to create a plan that takes into consideration the the most effective retirement investment choices available to you through your employer with your long term goals in mind, and considering future taxes, other income sources and retirement distribution strategies. Consult a Financial Advisor who is a fiduciary, who puts your best interest first.