Contributed by: Iris Hayes and Josh Golden
Edited by: Kelsey Arvai, CFP®, MBA
The Emerging Wealth Series
Iris Hayes and Josh Golden join The Center for the summer. This series is a summer intern-led exploration of the values, behaviors, and trends shaping the future of wealth.
Congratulations, graduate! The hard work paid off, and you secured that full-time offer. As you start your new role, you will be introduced to different types of employer benefits, most commonly 401(k) plans and 403(b) plans. While these options may feel overwhelming at first, they serve as valuable resources to help you achieve your financial goals. Throughout this blog, we will break down the basics of these plans so that you can make informed decisions and optimize your benefit package.
A 401(k) is an employer-sponsored retirement plan that allows employees to contribute a portion of their paycheck toward the employer-defined contribution plan. 403(b) plans are offered for non-profit and government employees, while 401(k)s are exclusively for the private sector. Contributions can be made with either pre-tax or after-tax dollars, depending on whether you choose a Traditional or Roth 401(k), AND if your plan allows for Roth 401(k) contributions. The contribution limits for employee deferrals to 401(k) plans in 2025 are $23,500, with an additional catch-up contribution of $7,500 for those aged 50 and above. Now, we will discuss the differences between Traditional and Roth accounts – specifically the tax treatment of employee and employer contributions for 401(k) and 403(b) plans.
One of the main benefits of a Traditional 401(k)/403(b) plan is the pre-tax contribution style. Contributing with pre-tax dollars is an effective way to reduce your taxable income. Employers may offer a match feature, meaning they match your contribution up to a certain percentage – often referred to as ‘free money’. For example, if you make $100,000 and you contribute $20,000 to your Traditional 401(k), your taxable income will be $80,000. The money in this account grows tax deferred. In other words, you pay taxes when you withdraw money from the plan. This strategy helps you save for retirement and gives you an immediate tax benefit. Another way to say this is that you pay ordinary income tax on the amount you withdraw after age 59 ½. If you are in the 22% bracket and you’d like to withdraw $20,000, you will have to withdraw the gross amount to account for Federal and State taxes. Assuming you live in Michigan, at 4.25% the gross distribution would be $25,250 ($20,000 NET + $4,400 Federal Taxes + $850 State Taxes).
With Roth 401(k) or 403(b), contribution limits are identical to those of a Traditional 401(k)/403(b). The main difference lies in their tax treatment. Roth 401(k) contributions are made with after-tax dollars, meaning you’ve already paid taxes on the money that you are contributing. A key distinction between Traditional and Roth 401(k) is the employer match. The money in the plan can grow significantly and be tax-free, as are the withdrawals. With the magic of compounding interest, the gains on your investments grow tax-free. This is a good way to pay less tax later in life, especially if you anticipate retiring in a higher tax bracket. An employer match in a Roth 401(k) is deposited into a separate pre-tax account. Therefore, taxes would need to be paid when withdrawals are made from the employer-matched plan.
It may be challenging to absorb all the new information, but taking advantage of these offers will ultimately set you up for financial wellness and stability in the long run. Taking responsibility to educate yourself by asking HR questions and reviewing your benefits package is a proactive way to plan for your future! Consider establishing a relationship with an advisor as soon as possible to help ensure you are optimizing your plan.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the authors and not necessarily those of Raymond James.
Examples are hypothetical and are not representative of every employer's retirement plan. Not all employers offer matching 401(k) contributions. Please contact your employer's benefits department or retirement plan provider for terms on potential matching contributions.
Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Roth 401(k) plans are long-term retirement savings vehicles. Contributions to a Roth 401(k) are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. Unlike Roth IRAs, Roth 401(k) participants are subject to required minimum distributions at age 72 (70 ½ if you reach 70 ½ before January 1, 2020).
