Types

• There are two types of 401(k) plan. The traditional 401(k) plan is a retirement account that allows you to make pre-tax (tax deductible) contributions to the account. The Roth 401(k) plan is the other type of 401(k) plan available for employers to offer employees. Roth 401(k) plans only allow non-deductible contributions. In both cases, taxes are eliminated on investments inside of the 401(k) account as long as money remains in the account.
  
  

Significance

• The significance of the tax deductible contributions allowed on a traditional 401(k) plan is that your adjusted gross income that is subject to taxation is lowered. You also pay income taxes when you withdraw money from the account during retirement. Taxes are assessed on all of the money withdrawn. The significance of a Roth 401(k) plan is that your adjusted gross income is higher than with a traditional 401(k) plan, but all withdrawals from the 401(k) plan are tax-free.
  
  

Benefit

• The benefit of a traditional 401(k) plan is that you get to invest more money that you otherwise would be able to invest if you did not receive a tax deduction. This may result in a higher total retirement savings. The benefit of a Roth 401(k) plan is that, since withdrawals are tax-free during retirement, you may end up with more net income from your retirement account even if your total retirement savings is lower than with a traditional 401(k) plan.
  
  

Disadvantage

• The disadvantage with a traditional 401(k) plan is that you must pay income tax when you withdraw money from your account. This income tax may be higher than what you would have paid if you had invested money outside of the 401(k) plan and paid capital gains tax on your retirement savings. Consequently, even though you get to invest pretax dollars in your 401(k) plan, you may end up with less net income in retirement than if you had not used the 401(k) plan. The disadvantage to Roth 401k plans is that you get less money to invest initially, since all contributions to the account are taxed.