{"id":512,"date":"2020-08-10T13:00:00","date_gmt":"2020-08-10T13:00:00","guid":{"rendered":"https:\/\/moneywithkatie.com\/traditional-vs-roth-explained\/"},"modified":"2025-09-05T19:50:16","modified_gmt":"2025-09-05T19:50:16","slug":"traditional-vs-roth-explained","status":"publish","type":"post","link":"https:\/\/moneywithkatie.com\/traditional-vs-roth-explained\/","title":{"rendered":"Traditional vs. Roth, Explained"},"content":{"rendered":"
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August 2020<\/h4>\n<\/div>\n
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Me, my mans, and my beret in retirement, looking out at the vast expanse of my Roth contributions.<\/p><\/div>\n

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EDIT FROM MARCH 2021<\/em><\/strong>: When I wrote this post, I had not yet figured out a way to get money out<\/em> of a pre-tax (traditional) 401(k) without paying taxes on it. Now that I\u2019ve figured it out, I no longer believe the Roth 401(k) is the best option, but I\u2019ve left this article intact as it was originally published so you can see my original thought process. Here\u2019s the more recent follow-up about why I switched my 401(k) from Roth to Traditional<\/a>. <\/p>\n<\/div>\n

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I almost included this breakdown within a larger post about investing, but decided the sexy and salacious world of investment taxes deserved its own standalone post \u2013 mostly because I don\u2019t trust the attention spans of people my age and I became increasingly wary as the length of the article grew longer.<\/p>\n

Without further ado, let\u2019s address the IRS-sized elephant in the room.<\/p>\n

One fundamental distinction that\u2019s crucial to understand when you\u2019re investing is the difference between Traditional and Roth retirement plans. I\u2019ve found it to be one of those things that people ask in hushed tones, eyes darting around the room to ensure secrecy, \u201cSo\u2026 what\u2019s Roth mean anyway?\u201d <\/em>Much like references to classic movies we\u2019ve never seen and words we should\u2019ve learned studying for the SAT, \u201cRoth\u201d is one of those financial terms that elicits nods and smiles while Googling under the table.<\/p>\n

Why do I care about taxes on my retirement plan? Isn\u2019t everything I do taxed anyway?<\/h4>\n

Yes, despite the fact that the government taxes you coming, going, and getting the T-shirt, this is still worth the 5 minutes to learn. (For some reason it feels appropriate right now to mention that I almost flew to Portland once to make an expensive purchase because Oregon has no sales tax. I will stop at nothing to save, even while splurging.)<\/p>\n

But the taxes that will impact your retirement accounts either happen right now or when you\u2019re old and decrepit (I apologize in advance to my retired parents for the #old jokes to follow). <\/p>\n

For our purposes today, the accounts that this decision will apply to (for most) are probably the 401(k) and IRA, but you may have a 403(b), 457, or any number of other more obscure accounts as well, depending on your employer.<\/p>\n

Let\u2019s use 401(k) as our primary example<\/h4>\n

If you have a Traditional<\/strong> 401(k), you\u2019re contributing pre-tax income to the account.<\/p>\n

This means if you make $2,500 per paycheck and you contribute 10% to a Traditional plan, the IRS has not yet taken its cut of your $250 contribution. Instead, they\u2019re biding their time on the promise that, at 59.5 when you\u2019re able to withdraw, you\u2019ll pay taxes on your withdrawals in your 59.5-year-old self\u2019s income tax bracket.<\/p>\n

That\u2019s really all there is to it. <\/p>\n

Why I doodle Roth + KG 4ever in my notebooks<\/h4>\n

Which brings me to the Roth. Man, I love Roth plans. I have a crush on Roth plans. If I were a senior in high school, I\u2019d ask my Roth 401(k) to prom and shyly stand in the corner all night, feeling self-conscious.<\/p>\n

Here\u2019s why:<\/p>\n

Remember our 10% paycheck contribution? Well, in a Roth plan, you\u2019d be contributing 10% of already-taxed<\/em> paycheck dollars. Which means you bite the bullet and pay Uncle Sam now, in your current income tax bracket, and invest the money. It grows and grows and grows over the next 35 years, facing no taxes on the growth, and then, at 59.5 when you start withdrawing, it\u2019s just\u2026 yours. No taxes to speak of. <\/p>\n

I know. But I\u2019ve already asked Roth to prom, so get your own date.<\/p>\n

You might be wondering why anyone would use a Traditional given the absolute tax-free #payday that a Roth retirement account provides later in life, but the main advantage to a Traditional account is that it lowers your tax burden now<\/strong>. In other words, if you contribute the limit of $19,500 to a Traditional plan now, the government basically subtracts $19,500 from your salary and you only owe income tax on what\u2019s left.<\/p>\n

For example:<\/p>\n

Say you make $80,000.<\/p>\n

Subtract the standard deduction of $12,400 for a taxable income of $67,600. <\/p>\n

Now pretend you\u2019ve somehow finessed a scenario in which you can afford to contribute all $19,500. <\/p>\n

Subtract another $19,500 and \u2013 bada bing, bada boom \u2013 your taxable income is $48,100.<\/p>\n

That\u2019s a pretty substantial amount lower than your base salary of $80,000! <\/p>\n

So that\u2019s why some people choose Traditional. Honestly, my theory is that most people who opt for Traditional just didn\u2019t know the difference and picked the one that was set as the default, but hey \u2013 I remember feverishly texting my roommate-at-the-time Rob and going, \u201cShit, should I pick Traditional or Roth?\u201d and he told me Roth, so\u2026 thanks, Rob. I owe you one.<\/p>\n

Limitations<\/h4>\n

I feel like anyone who makes too much to qualify for a Roth retirement account probably doesn\u2019t read my blog, but maybe I\u2019m selling myself short. If your modified adjusted gross income is more than $139,000 for the 2020 tax year, you can\u2019t contribute to a Roth. Boo-hoo. We\u2019re sad for you and your monstrous income. Something tells me you\u2019ll be all right, though.<\/p>\n

At that point, though, you probably wouldn\u2019t want to anyway \u2013 since you\u2019re paying the taxes upfront in a Roth scenario, you\u2019d be paying them in accordance to that Mack Daddy income. At $140,000+ per year, it\u2019s probably a safe-ish bet that your tax rate in retirement will be lower (unless you have grand Wolf of Wall Street plans for your 70-year-old self, in which case, rage on).<\/p>\n

Retirement accounts in general<\/h4>\n

So I guess now you know that I make under $139,000\/year. Surprise! The girl who\u2019s obsessed with budgeting and almost flew across the country to evade sales tax doesn\u2019t make six figures. I understand \u2013 it\u2019s shocking.<\/p>\n

But alas, we\u2019re all on different paths to wealth, and my PR degree and I unintentionally chose the \u201cslow and steady\u201d path. Until I become a full-stack developer or invent something that \u201cdisrupts\u201d an industry that didn\u2019t need to be disrupted, I\u2019ll be here. Join me!<\/p>\n

To my knowledge, you can opt Traditional or Roth for almost all retirement plans (of course, some odd-ball employer plans may not allow it; I\u2019m not clairvoyant so I can\u2019t say for sure but 99% of the people I\u2019ve worked with have no trouble). <\/p>\n

More broadly, \u201c401(k)\u201d and \u201cIRA\u201d are both alphanumeric soup names you should know. They\u2019re both able to be Traditional or Roth, and in my upcoming \u201cHow to Prioritize Your Investments\u201d post, I\u2019ll explain more. <\/p>\n

But in the meantime, you can think about it like this:<\/p>\n

The account (401k, IRA, 403b, etc.) is the car. Your 401(k) is a minivan \u2013 dependable and ready for the long haul. Your IRA is the hybrid SUV. A 403(b) is\u2026 honestly, I can\u2019t even think of an analogy. A Camry?<\/p>\n

Traditional and Roth are just the colors of the car. You can imagine Traditional as blue and Roth as red. Your minivan and SUV can both be blue or red \u2013 you could have both blue, both red, or a mix.<\/p>\n

Does this make it more or less confusing? <\/p>\n

Regardless of Traditional or Roth, retirement accounts are baller<\/h4>\n

And here\u2019s why: You aren\u2019t paying taxes year-over-year on the growth in a retirement account<\/strong>.<\/p>\n

That might not seem like that big of a deal, but taxes really eat into the compound interest of your returns over time. This is to say that regardless of whether you opt to pay the taxes on your income now or on the withdrawals later, you don\u2019t have to pay taxes on the growth every tax season like you do with \u201cregular\u201d investment accounts that aren\u2019t for retirement. <\/p>\n

This is why there are limits \u2013 the IRS doesn\u2019t want someone who\u2019s bringing home $250,000 per year to stick $200,000 of it in an investment account for retirement that they can\u2019t take their cut of every year. <\/p>\n

Next time<\/h4>\n

Now that we\u2019ve covered our tax basics, we can dig into the priority order of accounts. See you same time next week.<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

August 2020 EDIT FROM MARCH 2021: When I wrote this post, I had not yet figured out a way to get money out of a pre-tax (traditional) 401(k) without paying taxes on it. 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