Roth vs Pre-Tax: Which One Is Best for You

401(k)s allow you to contribute money in different ways: pre-tax, Roth, or after-tax. Pre-tax contributions (sometimes called “Traditional”) reduce your taxes now, but you’ll eventually need to pay taxes on them later when you take the funds out of the 401(k). Roth contributions give no tax break now, but everything you put in can grow tax free for the rest of your life if you follow certain rules. The after-tax bucket gives no tax break now but may allow you to put more money into your Roth bucket if your 401(k) plan has certain features (the “mega backdoor Roth” strategy”).
 

Should You Make Pre-Tax Contributions or Roth? And When Should You Make After-Tax Contributions? 6 Things to Consider:

How do you know which one to use? Here are some of the relevant factors:

• What will your tax bracket be in retirement? 
  If your tax bracket will be lower in retirement, pre-tax contributions may be better. If your retirement tax bracket will be the same, Roth may be favorable.
• How much money do you make? 
  If your income is $100K+ and you want to save more than the annual 401(k) deferral limit, the after-tax bucket may be useful.
• How much money have you saved already? 
  If your pre-tax 401(k) and traditional IRAs are large or will be large by the time you retire (approaching $1M or more), you may want to shift more contributions to Roth, even if it may cost you more in taxes now.
  If you don’t have much in your pre-tax 401(k), it could make sense to put some there.
• How close are you to retirement? 
  If you haven’t saved much for retirement, you want to start saving a lot, and if you’re 5 years from retiring, it can sometimes make sense to put all the contributions into pre-tax and slowly convert the balance to Roth in the 3 to 10 years after you retire when your tax bracket is lower.
• Where are you in your career?
  If you’re 25 and hoping to get a promotion by the time you’re 30, you may want to put all your money into Roth while you’re in a lower tax bracket.
  If you’re 58 and earning the highest salary you ever will, you might want to lean towards pre-tax.
• Do you expect to get a large inheritance?
  If you think you may receive a large inheritance of pre-tax 401(k) or Traditional IRA funds at some point, you might want to put more into Roth to leave yourself flexibility in how you will handle the taxation of the inheritance.

One Size Does Not Fit All Investment Strategies.

You have to weigh these factors together to decide what is right for your situation. For example, you may be a high earner in the peak of your career, close to retirement, and you plan to be in a lower tax bracket when you retire, but you may still want to consider more Roth if you have a very large balance in your pre-tax 401(k). 

If you'd like help thinking through what makes sense for you, feel free to reach out.

This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.