NEW YORK (TheStreet) -- A fresh graduate starting a first adult-world job can face a raft of unfamiliar issues, from buying a car or getting an apartment to starting the 40- or 50-year process of saving for retirement. Among them: Should you start a 401(k), and, if so, how should you set it up? What's best, a traditional 401(k) or a Roth?
An employer's 401(k) plan allows the employee to contribute a portion of income to a long-term retirement plan, often with a matching contribution from the boss. In a traditional 401(k), contributions are subtracted from taxable income, and there are no annual taxes on investment gains, reducing the employee's annual tax bill. But income tax must be paid on money withdrawn in retirement.
With a Roth, there is no tax deduction on contributions, but all withdrawals -- the original contributions and investment gains -- are tax free.
On paper, the pros and cons of each are simple. If your tax rate will be higher in retirement than when you make the contribution, the Roth may be the better choice. You will pay tax at a low rate, such as 15%, on the money used for the contribution to avoid tax at a higher rate, say 35%, when you make withdrawals.
The traditional 401(k) would be better in the opposite case -- with a high tax bracket when contributing and a low one when withdrawing. You could save a big tax bill upfront and pay only a small one later.