In a recent Reddit post, an important question came up. The Reddit user said they make $135,000 annually and work at a job that offers both a traditional 401(k) and a Roth 401(k). Their company matches contributions, but those matching funds don’t vest for five years and they lose them if they leave before then — which they most likely will. 

Their question was whether to invest in either of their workplace plans or opt for a Roth IRA instead. While the best person to offer advice on this would be a financial advisor that knows the ins-and-outs of their financial life and future goals, some general advice can also be helpful in making this choice.

Roth 401(k) or traditional 401(k)

If you have a choice of workplace plans and you’re deciding between a traditional and a Roth 401(k), it’s important to know how each one works:

• A traditional 401(k) allows contributions with pre-tax dollars so you aren’t taxed on money going in — but you do pay taxes when money comes out. You’re taxed on withdrawals in retirement at your ordinary income tax rate and you must begin taking money out at age 73 as you’re subject to Required Minimum Distribution rules. 
• A Roth 401(k) does not offer upfront tax savings and you invest with after-tax dollars. You get to make tax-free withdrawals, though. You also do not have to take RMDs and any money you take out of your Roth 401(k) will not count in determining if you hit the income threshold at which Social Security benefits become taxable. 

So, how should you decide which to use? Consider your tax bracket now and likely tax bracket later. If you expect to be taxed at a higher rate in retirement — because you think your income will be higher or tax rates will increase in general — then you’d want a Roth 401(k). If you think you’re paying higher taxes now, you want the tax savings now so should choose the traditional 401(k).

By considering when the tax breaks are likely to save you the most, you can choose the account that minimizes the money you’ll send to the IRS over your lifetime. 

Workplace or independent plan?

The Reddit poster was also skeptical of contributing to a plan at work because they didn’t think they’d be at their job long enough to actually have their matching funds vest. As a result, they were considering opening their own Roth IRA outside of work instead of investing on-the-job. 

There are undoubtedly benefits to just picking your own plan. You can choose a brokerage firm that you’re interested in, won’t have to worry about moving the money if you leave your job, and can gain access to a broader pool of investment options than a 401(k) makes available. 

However, passing up an employer match isn’t a good idea because it is free money. The general rule of thumb is to invest at least enough to get your match before switching to other accounts. While the Redditor doesn’t think they’ll be at the company long enough to earn it, life may turn out differently and they may decide to stick around — which could lead to big regrets if they passed up free 401(k) funds for no reason. 

The downsides of investing enough to earn the match are not big enough disadvantages to give up the chance at this free money. It’s likely worth contributing the necessary sum to earn the full 4%. The worst that happens in this case is they roll their contributions over into a Roth IRA, leaving the unvested matching funds behind if they leave their job early. But, in a best-case scenario, they end up getting this money and it makes them richer. 

Ultimately, the right choice will depend on their goals and a financial advisor can help define those — but, investing in the workplace plan and picking the one offering the biggest tax breaks is a good, simple solution that should help set them on the path to future financial security. 

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