The only constants in life are death and taxes
Have you ever wondered how to make the most of your employer's benefits? Sure, maybe you monitor your funds, but have you considered the best "vehicle" for them? The funds you choose will have a large effect on your retirement income. How that income is taxed is the reason.
What's the difference?
The first time I heard about 401k's and IRA's I thought they were in themselves an investment. I really had no idea. A 401k (or 403b for some) is just a rule about how taxes are handled around retirement investing. Essentially, you get to contribute to any number of investments such as mutual funds with PRE-TAX money. That is, you can put money directly from your paycheck into it before any gets snagged by the government. The money isn't taxed until you withdraw it. The biggest advantage is that you will likely be in a lower tax bracket when you retire. The only catch is that you can't withdraw until retirement.
A Roth, on the other hand, is an investment you make after taxes. How is this different from just investing your money in stocks on Robinhood? If you keep your money invested until retirement, you won't have to pay taxes on the earnings. You will have paid taxes at the rate when you earned it instead of at retirement.
Everything else being equal, you earn the same
If you have the same tax rate at earning time and at retirement, you will have the same outcome at the end. That is, if you go through the compound interest formula from high school, you'll get the same answer.
Roth is better for those whose incomes stay about the same or go up in retirement
Individuals are being taxed at historically low rates now, so paying taxes on your investments now would be the same or better than at retirement. This is making the assumption that taxes can't really get lower than they already are.
Tax rates are tied to income levels, so if your income stays the same, your tax rate will probably increase over time (or at least stay the same).
Traditional is better if you will be dropping tax brackets in retirement
For those who plan to live on a lower income in retirement, you can probably plan on a lower tax bracket than at the time of earning. Yes, the rate of that bracket might go up over time, but probably not higher than the next bracket at the time of earning.
Your best method may shift over time
When you start your work life, you are probably at about the lowest tax bracket you will have for your career. In other words, it's unlikely that your tax bracket will be lower in retirement. In the beginning of your career, Roth will almost always be the best idea.
Some people may go on to earn a large salary later in their careers. This bumps them into higher tax brackets. In fact, they may be making a lot more than they expect to earn in retirement. If this is you, you should consider traditional for your contributions while you are earning a lot.
Is it usually easy to switch back and forth?
Yep.
How much should I contribute?
Many experts say 10 percent will keep you on track for a comfortable retirement. At a minimum, contribute enough to maximize any employer match. I know it's hard to give up even a small part of your salary at first, but it's worth it!
My strategy has been to increase my contribution by one percentage point every time I get a significant raise. This way, I still get an increase in my paycheck and "future me" is happy too.
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