How to choose between a traditional 401(k) and a Roth 401(k) for retirement

ANCHORAGE, Alaska (KTUU) - Many dream of retirement, but saving for it can be complicated. One of the critical choices is between a traditional 401(k) and a Roth 401(k) plan.

A 401(k) lets future retirees save part of their income before taxes, lowering the current year’s tax bill. A Roth 401(k) enables people to save money after taxes but not pay taxes when they withdraw in retirement.

Financial adviser James Miller, owner of Baobab Wealth Management and author of a book called “Divorce the IRS,” explains the difference.

“So, for example, if you make $100,000, and you put $5,000 into your traditional 401(k) or your IRA, then you’re only taxed that you’re on $95,000. That $5,000 goes in before taxes. On a Roth, it goes in after taxes,” Miller said. “So if you make that same $100,000, you pay taxes on the $100,000 you make, then you take some of your own money out of the bank that’s already been taxed, and you put it in a Roth or a Roth 401(k) account. And so that money goes in after tax.”

Deciding which retirement plan is right boils down to wanting to pay taxes now or later. For example, a person in a high tax bracket now who may expect to be in a low one later might prefer a traditional 401(k). For people who think taxes will go up in the future, a Roth 401(k) may be the right choice. Miller says people should start saving for retirement as soon as possible.

“Wherever you’re at in life, it’s best to start and start saving,” Miller said. “Young people have to save a lot less because they have more time than older people. But young people should plan on putting away 15 to 20% of their income annually towards their long-term goals like retirement, which will generally get them to their goals.”

Another thing Miller says is essential when it comes to retirement, outside of picking a plan, is a person’s health. He warns about the high cost of this valuable expense.

“Health care is the biggest expense any retiree in America has,” Miller said. “You know, most people may be asking, ‘What’s going to be your biggest expense in retirement?’ And most people will tell you, ‘Travel, I’m going to travel the world.’ It’s not travel by far. The average American spends a little over $250,000 — $253,000 as of the last study — on health care during retirement. It’s the single biggest expense that Americans have in retirement for sure.”

According to Medicare.gov, Medicare is for people 65 or older, unless a person is diagnosed with a disability, in which they may be able to get Medicare early. Nevertheless, the retirement age is 59 and a half. In that case, a person wanting to retire is left paying for health care out of their retirement for more than five years.

“The government health care for retirees doesn’t start until age 65. ... Medicare is charged as a monthly premium that comes right out of your Social Security check, plus there’s co-pays, deductibles, and all that kind of stuff on top of it,” Miller said. “You even can start Social Security as early as 62. But you can’t start the government health insurance until 65. And so when people want to retire early, they need to buy their own insurance unless it’s provided by like their old employer because they worked there for 30 or 50 years.”

The bottom line is that there is a lot to think about when it comes to retirement, and it starts with maintaining a healthy lifestyle on top of a person’s choice of where to put their money.

Furthermore, the misconception that Medicare is free because a person pays for it out of taxes is far from the case. So, consider this when preparing for retirement: a reliable health care plan for early retirement, income status, tax benefits and breaks, and if needed, a financial adviser.

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