Roth vs Traditional 401k | 4-Facts to make the right choice

The difference between the traditional 401k and the Roth 401k

It’s all about the taxes. Yes, that’s right. The main difference between the Traditional 401k plan and the Roth 401k is at what specific time are you going to pay your taxes.

If you are selecting the Traditional 401k Plan your invested money will be taxed when you’ll retire. That means your contribution will be before tax. And if you are adding money into the Roth 401k – your contribution is after tax. 

The question is: What’s better? Does it make sense to pay your taxes when you’ll retire, or is it better to pay your taxes now? This question can’t be answered as easy.

But I guess an easy example should help us to make better choices. Let’s get started.

Bob is 35 years old. What would happen, if he decides to invest all his contributions into the Traditional 401k plan? $3000 is his own contribution, and another $3000 is the match from his employer. He calculates to retire at the age of 65.

Calculation Example Roth vs. Traditional

The calculation shows, that in this particular case the Roth 401k contribution would be the better choice if Bob does not consider to invest any tax-savings generated by traditional contributions.

Usually people who pay into the Traditional 401k do not really invest any tax-savings. Most of the time the majority of people is happy if the tax year is over – and perhaps you’ll get some money back from the IRS.

Think about your own situation. If you pay into a 401k – are you going to invest any additional money that you are going to save on taxes? I know myself. I don’t, I won’t. The reason is clear. It’s really complicated to figure out how much tax money you will really save.

Tax Brackets do matter

Your tax-savings are depending on the tax brackets 

Are your earnings always the same? And if so, what additional percentage are you going to save? I guess, it can be just a ballpark number. And if you consider that, depending on your income, your number can be anywhere between 10 – 37%. 

The next speculation are the tax rates itself. We don’t know if taxes will be higher in future. However, if I am going to consider the development of the economy, it’s very likely that taxes will rise from year to year.

If that’s the case, the traditional 401k choice would feel like a kick in your butt. Because at the end, you might be much higher taxes. I made a lot of research and I was reading a lot of different opinions on that very specific topic.

The result of my investigations are clear. It depends on your own situation and the tax brackets you are facing. But general speaking. It’s all a speculation, because we can’t predict the future.

Also, you can’t predict your own personal future. You simple can’t tell if you are going to earn more as you get older. All you can do is making assumptions.

401k taxes & living abroad 

Are there any tax benefits if you are planing to retire abroad?

When doing my research, I was asking myself one critical question: What happens, if you’ll retire in a different country than the US? And what’s happening to the traditional 401k funds?

I was reaching out to multiple Finance Experts and Tax Accountants. I like to use Twitter a lot. It’s super fast to reach people and asking them critical questions.

And when doing my research I got also my answers within a couple of hours. Carlos Dias Jr. tweeted back to me. I guess his answer and response clarified my question.

My question:
If you plan to retire overseas, are you going to be taxed from the US or from the country overseas? I was not able to find any rules that could answer that question for traditional 401k funds. I would like to know for US-citizens and non-US-citizens. Thanks a lot!

  1. Bernhard Rieder‏ if you plan to retire overseas, are you going to be taxed from the US or from the country overseas? I was not able to find any rules that could answer that question for traditional 401k funds. I would like to know for US-citizens and non-US-citizens. Thanks a lot!
  2. Carlos Dias Jr.‏ If you’re a U.S. citizen or resident alien, your worldwide income is subject to U.S. income tax, regardless of where you live. https://www.irs.gov/individuals/international-taxpayers/taxpayers-living-abroad …
  3. Bernhard Rieder‏ Right. But if you leave the US when you’ll retire, and you are non-US-resident and not US-Citizen, what happens then with the 401k funds?
  4. Carlos Dias Jr.‏ @CarlosADiasJr Even as a nonresident alien, you will still pay U.S. income tax on the money withdrawn from a 401(k). If you’re under age 59 1/2, you will be also subject to a 10% early withdrawal penalty. Withdrawals from 401(k)s are taxed the same way for residents and nonresidents.

Now we know how it rolls. As soon as you contribute money to the traditional 401k plan, it doesn’t matter where you will retire or live. As soon as the money will be put into the 401k – you’ll have to pay US-based income tax. no matter where you live, no matter if you are US-Citizen or non-US-citizen or an Alien US resident. Capiche?

That being said, it’s really important to have this clarified. In the next chapter. I am going to disclose all my results starting a 401k plan. Yes, that’s right. At this point, you should know all the mandatory facts about the 401k plan. Now it’s time to jump into the next chapter: How to start a 401k plan!

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