What is the difference between a traditional and Roth account? Are there advantages to using one versus the other?
Saving for retirement is important, and there are plenty of account options available to assist in this goal. Traditional and Roth individual retirement accounts as well as traditional and Roth 401(k)s are among the more commonly used retirement savings vehicles. However, due to IRS income phase-out limits, many physicians are not eligible to contribute to a Roth IRA and cannot take advantage of the tax benefits associated with contributing to a traditional IRA.
Viable alternatives for physicians are traditional and Roth 401(k) and 403(b) plans. These accounts are often available to physicians through their employers and are not subject to the same income limits.
Unbeknownst to many investors, 401(k)s and 403(b)s are nearly identical retirement savings vehicles. Both have the same contribution limits and the same tax-deferred or tax-free benefits. The primary difference is that a 401(k) plan is only offered through a for-profit company whereas a 403(b) plan is offered through a non-profit organization.
Also by Jeff Witz, CFP, and David Zemon: How do active and passive fund management differ?
The mechanics of traditional 401(k) and 403(b) plans are fairly straightforward. You can usually make a pre-tax contribution of up to $18,000 each year ($24,000 if you are over age 50), and your employer may contribute additional money through either a fixed percentage or a match. Contributions are typically invested in mutual funds and/or exchange-traded funds, and grow tax-deferred (meaning you do not pay capital gains tax on any sales made that generate a gain). Once you reach age 59½ , you can take qualified distributions from the account. But since contributions were made pre-tax, you must pay ordinary income tax on any amount withdrawn from the plan.
There are no income limits that prohibit contributing to these plans, nor are there income limits that reduce the tax benefits. However, be aware that for high-income individuals earning over $270,000 per year, the maximum amount your employer can contribute is limited.
Roth 401(k)s and 403(b)s work in similar fashion to traditional plans; however, instead of contributing pre-tax dollars, you contribute post-tax dollars. This means federal and state taxes have already been withheld. Since you have already paid taxes on the contribution side, the funds grow tax-free, and withdrawals made during retirement are tax-free as well.