Personal Finance

I'm in my 20s and make $100k a year - is it better to stash money in a Roth 401(k) r over a Traditional 401(k)

Chris MacDonald

Published: January 8, 2025 9:30 am

Deciding between a Roth 401(k) and a Traditional 401(k) can be one of those financial decisions individuals struggle with. After all, for many individuals who may have contributed to their Roth IRA for years and maxed out that account, deciding between whether a Roth or Traditional 401(k) makes the most sense can be a decision that can feel daunting.

For one Reddit user, a 27-year-old earning $100,000 annually in Los Angeles, this is certainly the case. This particular individual is presented with a scenario that may not be that unique – many readers may have encountered a similar situation during their working lives. Does it make sense to continue maxing out a Traditional IRA account, or switch to focusing on a company’s Roth 401(k) program (which is also matched).

There’s a mathematically correct answer to this question, and plenty of nuance to go along with this decision. Various personal factors such as one’s personal income, lifestyle expectations and future goals should shape the discussion.

With that, let’s dive into what this individual may want to consider moving forward. 

Key Points About This Article:

• Deciding to switch one’s focus away from maxing out an individual IRA toward putting money away in a company’s 401(k) is a more nuanced decision than many think.
• Here are the factors investors may want to consider when thinking about where they choose to invest for retirement. 
• Retiring early is possible, and may be easier than you think. Click here now to see if you’re ahead, or behind. ^(Sponsor)

Understanding the Basics of the 401(k) Game

To choose between a Roth 401(k) and a Traditional 401(k), it’s essential to understand their core differences between the two products.

The most important difference to consider is the fact that money that is contributed to a traditional 401(k) are pre-tax dollars, which means that those contributing to such plans reap the tax benefits of having their taxable income reduced by the amount of their contributions. Thus, for an individual earning $100,000 per year, contributing the $23,000 maximum (as of 2024) would reduce that individual’s taxable income to $77,000 per year. This would effectively reduce that individual’s tax burden by 22% (assuming this individual is filing as an individual) for the $23,000 they invested. That would amount to a little over $5,000 in tax savings in a given year.

In other words, by maxing out a traditional 401(k), this individual is ensuring a tax refund of around $5,000 per year, assuming all appropriate elections were taken on this individual’s forms. 

On the other hand, contributions to a Roth 401(k) are made with after-tax dollars. This means that there’s no up-front tax break received as a result of contributing to such a fund, but no taxes will be paid on the gains in this account at the time of retirement. For this reason, contribution limit for most Roth IRA accounts is substantially lower than that of a Traditional 401(k).

Another notable difference is in the treatment of required minimum distributions (RMDs). Traditional 401(k) account holders must begin taking RMDs at age 73, while starting in 2024, Roth 401(k) holders will no longer be subject to RMDs during their lifetime, allowing for greater flexibility in managing retirement funds.

The Right Answer Won’t Be the Same For Everyone 

The Reddit user’s situation provides valuable context for making this decision. At 27 years old, someone earning $100,000 annually and expecting future income growth may certainly be in a higher tax bracket than most of their peers. However, if one expects to be in an even higher income bracket in later years, it could make sense to maximize a Roth IRA in one’s younger years, to benefit from a longer compounding timeframe over one’s working life (with tax-free withdrawals in retirement), and take an even larger tax break in the future.

Indeed, the key variable many investors will need to grapple with, particularly those who are just starting out in their careers, is how much one expects to earn over the course of various decades. If an individual is in a position where they think they’ll be earning substantially more over time, it can make sense to delay maximizing a Traditional 401(k), and focus on a Roth account first.

That said, a guaranteed 22% rate of return (this person’s assumed marginal tax rate) is pretty great. And when combined with last year’s market return of around 23% for the S&P 500, assuming this individual simply bought index funds tracking the S&P 500, they’d be up roughly 50%. That’s a pretty good investment by all measures. 

That said, with various personal goals such as getting married and having a family likely on the horizon for this individual, having greater financial flexibility with a Roth retirement account may be something to consider. Thus, this decision really depends on where one sees their future self in 10 or 20 years time. 

Tax Considerations and Future Goals

Taxes play a pivotal role in deciding between which of these accounts make most sense for the type of higher-income earner looking to the future. We all hope the future will be much brighter, and it’s that optimism that creates markets (or even the ability to have financial markets). We all expect growth, and that innovation and new technologies will drive a brighter future. Investing for the future requires that one has this view.

However, forecasting with any degree of precision where one’s salary will be in 10 or 20 years is a very difficult task. Taking the tax break now and re-investing the tax refund may be the best option. For others, it may be better to put after-tax dollars away and wait to take tax breaks down the line.