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Recent graduate with new job: Choose Roth 401(k), or traditional 401(k)?

I'm just a few years out of college, and am starting to put aside some retirement savings. My employer offers both traditional and roth 401(k) options, but I'm having a hard time deciding which would be more beneficial for me.

I see that the benefit of the Roth plan is tax-free withdrawals, so any money earned would essentially be tax-free. Also, since tax rates are relatively low compared to history and my income is presumably less now than it will be in the future (currently 25% tax bracket), I may pay a lower rate now than I would in the future. On the other hand, I'd be contributing less than with a traditional plan since it is taxed before being invested. Is there a general sentiment about which is preferable, or some way I can make an objective assessment?

The plans are identical save for the pre-tax/post-tax contribution difference (in both cases the employer has a 100% match up to 6%). Assume I will not hit the annual contribution cap.

marked as duplicate by Chris W. Rea Aug 24 '12 at 3:09

This question has been asked before and already has an answer. If those answers do not fully address your question, please ask a new question.

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    Did you see this similar question? money.stackexchange.com/questions/1598/… – Chris W. Rea Aug 23 '12 at 20:57
  • @ChrisW.Rea : Thanks, I missed that one. It didn't show up in the possible duplicates as I was posting. This can be closed as a duplicate if a mod sees fit, that question is very, very similar – goric Aug 23 '12 at 21:06
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    No problem. So did that other question address your concerns adequately? If so then I'll close yours as duplicate, if not you can elaborate above by editing your question. – Chris W. Rea Aug 23 '12 at 21:14
  • The other advantage of having the money in a Roth IRA is that, once in retirement, you can withdraw large sums all at once without incurring unfavorable tax treatment, whereas with a traditional IRA you might wish to limit your yearly withdrawals in order to stay within a certain tax bracket. This flexibility may be useful if you have a large one-time expense. – user296 Aug 24 '12 at 0:41
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    @ChrisW.Rea: yes, the answers over there are good. You can close this one. – goric Aug 24 '12 at 2:31

On the other hand, I'd be contributing less than with a traditional plan since it is taxed before being invested.

You got it backwards. The effective limit is higher for a Roth 401k than a Traditional 401k. The nominal limit is the same -- $17000. But an amount of money in a Roth plan is equivalent to a greater amount of money in a Traditional plan, because money in a Traditional plan is pre-tax that will need to be taxed when taken out, resulting in less post-tax money. Conversely, for a Roth plan, that is post-tax money, which came from a greater amount of pre-tax money; and it won't be taxed again. So it is more money, tax-neutral comparison wise.

Of course, since you say that you won't hit the limit, this consideration doesn't matter anyway.

  • You suggest the Roth is "denser" and it does matter, nice answer. – JTP - Apologise to Monica Aug 24 '12 at 2:07
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    This is a good point, but like you say it's only applicable in a slightly different situation – goric Aug 24 '12 at 2:34

It would be quite the miracle if you found that you know, now, just graduating college, what your tax rate would be at retirement. But, it's fair to say that chances are that you'll be in a higher tax bracket in years to come due to promotions,better job, etc. So, I'd suggest Roth for now, with an eye towards pretax savings as your income and bracket rises. Ideally, a retiree finds himself in a bracket no higher than while working, but also not lower. You see, saving in Roth 100% and missing the ability to withdraw at 0, 10, and 15%, is as bad as saving 100% in pretax, and fining you retire in a higher bracket. No one can tell you the best path, but at any given moment, the highest probability outcome may be visible.

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