Roth vs. Traditional 401(k) Plans

Roth vs. Traditional 401(k) Plans: A Comprehensive Comparison by 401k Auditors

When saving for retirement in a 401(k), employees can choose between Traditional and Roth contributions. Both offer significant advantages but differ in tax timing, contribution rules, and retirement strategy. Understanding these differences is essential for making informed decisions.

1. Tax Treatment: Pay Now vs. Pay Later

  • Traditional 401(k): Contributions are made pre-tax, reducing taxable income today, but all withdrawals in retirement are taxed as ordinary income.
  • Roth 401(k): Contributions are made with after-tax dollars, with tax-free qualified withdrawals in retirement.

Qualified withdrawals from a Roth account require the participant to be at least 59½ and the account to be held for five years. Early withdrawals may trigger penalties and taxes depending on the type of account and distribution.

2. Contribution Limits & Income Rules 

For 2025, employees can contribute up to $23,500 to either or both types combined, with an additional $7,500 catch-up if aged 50 or older. There are no income limits for Roth 401(k)s (unlike Roth IRAs), making them accessible to high earners.

Employers may match contributions, but even if you contribute to a Roth, the match typically goes into a Traditional (pre-tax) account. However, under the SECURE 2.0 Act, employers now have the option to match into Roth accounts directly, which would be taxable to the employee in the year of the match.

3. Contribution Mechanics & Payroll

 Traditional contributions reduce taxable wages, while Roth contributions do not. This affects take-home pay. Employers must ensure payroll and recordkeeping systems accurately track Roth vs. Traditional deferrals to avoid errors.

Over-contributions must be corrected to avoid penalties. Starting in 2026, catch-up contributions for high earners (income above $145,000) must be Roth.

4. Investment Options and Management

Effective investment options and prudent management are at the heart of a successful employee benefit plan. For plan sponsors, conducting thorough due diligence when selecting and monitoring investment options is essential—not only to maximize plan assets for eligible participants but also to align with the company’s broader business administration strategy.

Our audit specialists bring deep expertise to the audit process, reviewing the full spectrum of investment options and management practices within your 401(k) plan. This includes a detailed examination of bank statements, plan assets, and supporting documents to determine whether investments are managed in accordance with both the IRS and ERISA regulations, as well as industry best practices. By scrutinizing these elements, we help ensure compliance and identify opportunities to enhance plan performance.

CPA firms like ours invest in specialized training for auditors, equipping them to spot potential errors and risks associated with investment management. Our team leverages insights from the American Institute of Certified Public Accountants’ (AICPA) Employee Benefit Plan Audit Quality Center, adhering to the highest standards for benefit plan audits. This commitment to quality ensures that every plan audit is conducted with the utmost diligence and professionalism.

With advanced credentials, such as a master’s degree in business administration and extensive experience across various industries, our auditors are uniquely qualified to provide comprehensive audit services tailored to your plan’s specifics. Our audit services include a thorough review of investment options and management practices, offering actionable guidance to help plan sponsors comply with ERISA and IRS requirements, reduce risk, and improve overall plan performance.

For plan sponsors, ensuring that investment options and management practices are in sync with your company’s business goals is vital. By partnering with our firm, you gain the assurance that your employee benefit plan is being audited by professionals with the expertise to identify risks, provide strategic guidance, and help you achieve both compliance and long-term plan success.

4. Withdrawals & Required Minimum Distributions (RMDs)

  • Traditional 401(k): RMDs begin at age 73 (age 75 for those born in 1960 or later).
  • Roth 401(k): As of 2024, no RMDs are required during the original account holder’s lifetime.

Roth 401(k) withdrawals don’t count toward taxable income, which may help manage taxes on Social Security and avoid Medicare surcharges in retirement.

5. Strategic Suitability by Income & Goals

  • Traditional 401(k) may benefit those expecting lower tax rates in retirement, needing tax relief now, or planning a relocation to a lower-tax state.
  • Roth 401(k) suits younger workers, those in lower tax brackets, or those wanting tax-free growth and no RMDs.

Many financial advisors recommend contributing to both types for tax diversification, offering flexibility during retirement to manage tax liabilities.

6. Employer Considerations & 401k Auditors for Employee Benefit Plans

Employers offering Roth must update plan documents and coordinate with payroll to ensure proper administration. Both types of contributions are subject to annual nondiscrimination testing (unless the plan qualifies as a safe harbor).

For businesses with over 100 eligible participants, a 401 k audit is a regulatory requirement. Audit requirements are set by the Department of Labor, and the department oversees compliance for employee benefit plans under labor regulations. Companies must conduct a 401 k audit annually to ensure compliance with labor regulations and to file the required report with the department.

401k auditors verify plan compliance, ensure correct treatment of Roth and Traditional contributions, and assess whether contributions are tracked and reported accurately. During the audit process, businesses may face challenges such as gathering the plan’s specifics, meeting audit requirements, and managing deadlines. Experienced auditors assist clients in navigating the audit process and addressing any issues promptly. Employee benefit plan audits and audit employee benefit plans are essential for ensuring the integrity of retirement plans and benefit plans. The audit process involves a thorough review of the plan year, plan’s specifics, and compliance with labor regulations. The audit is completed when the report is filed with the department, and any errors identified can be corrected. It is important to understand the unique needs of each company and tailor audit services to different clients and benefit plans. Errors can lead to penalties or plan disqualification.

Even for smaller plans, proactive internal reviews or voluntary audits can help employers catch discrepancies early, enhancing fiduciary compliance.

7. Fiduciary Duties and Compliance 

Plan sponsors must act in the best interest of participants, provide clear education on Roth vs. Traditional options, and ensure all processes comply with ERISA and IRS regulations. Offering a Roth option adds value to employees but increases the responsibility to administer it correctly.

Documentation, accurate tracking, and staying updated with legal changes (e.g., Roth matching and catch-up provisions) are essential to avoid fiduciary breaches. Many employers partner with 401k audit firms for independent reviews to meet these standards. These firms assist employers in understanding and fulfilling their fiduciary responsibilities.

Conclusion

 Choosing between Roth and Traditional 401(k) contributions is a strategic financial decision. Traditional offers tax deferral today; Roth offers tax-free income tomorrow. A combination of both can offer tax flexibility in retirement. Employers must ensure plan design, documentation, and audits are managed properly to support both options.

By understanding the key differences, engaging in proactive compliance, and leveraging expert oversight like 401k auditors, both employees and employers can maximize the benefits of their retirement plans while minimizing risk.