Which should I prefer, traditional or Roth 401k?

Question

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Recent graduate with new job: Choose Roth 401(k), or traditional 401(k)?

I'm just a few years out of college, and am starting to put aside some retirement savings. My employer offers both traditional and roth 401(k) options, but I'm having a hard time deciding which would be more beneficial for me.

I see that the benefit of the Roth plan is tax-free withdrawals, so any money earned would essentially be tax-free. Also, since tax rates are relatively low compared to history and my income is presumably less now than it will be in the future (currently 25% tax bracket), I may pay a lower rate now than I would in the future. On the other hand, I'd be contributing less than with a traditional plan since it is taxed before being invested. Is there a general sentiment about which is preferable, or some way I can make an objective assessment?

The plans are identical save for the pre-tax/post-tax contribution difference (in both cases the employer has a 100% match up to 6%). Assume I will not hit the annual contribution cap.

Answer 1

On the other hand, I'd be contributing less than with a traditional plan since it is taxed before being invested.

You got it backwards. The effective limit is higher for a Roth 401k than a Traditional 401k. The nominal limit is the same -- $17000. But an amount of money in a Roth plan is equivalent to a greater amount of money in a Traditional plan, because money in a Traditional plan is pre-tax that will need to be taxed when taken out, resulting in less post-tax money. Conversely, for a Roth plan, that is post-tax money, which came from a greater amount of pre-tax money; and it won't be taxed again. So it is more money, tax-neutral comparison wise.

Of course, since you say that you won't hit the limit, this consideration doesn't matter anyway.

Answer 2

It would be quite the miracle if you found that you know, now, just graduating college, what your tax rate would be at retirement. But, it's fair to say that chances are that you'll be in a higher tax bracket in years to come due to promotions,better job, etc. So, I'd suggest Roth for now, with an eye towards pretax savings as your income and bracket rises. Ideally, a retiree finds himself in a bracket no higher than while working, but also not lower. You see, saving in Roth 100% and missing the ability to withdraw at 0, 10, and 15%, is as bad as saving 100% in pretax, and fining you retire in a higher bracket. No one can tell you the best path, but at any given moment, the highest probability outcome may be visible.