How to Decide Between Pre-Tax and Roth 401(k) Contributions

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Whether you’re starting a new job or updating retirement savings goals, you may need to choose between pre-tax or Roth 401(k) contributions — and the choice can be more complicated than you think.

While pre-tax 401(k) deposits offer an upfront tax break, the funds grow tax-deferred, meaning you’ll pay a levy upon withdrawals. In contrast, Roth 401(k) contributions are made after taxes, but your future earnings are tax-free.

Most plans have both options. tentative 88% of 401(k) plans offered Roth accounts in 2021, nearly double from a decade ago, according to Plan Sponsors Council of AmericaWhich surveyed more than 550 employers.

while your current and future tax brackets While those are part of the puzzle, experts say there are other factors to consider.

“Broadly speaking it’s hard because there are so many things that go into this decision,” said certified financial planner Ashton Lawrence, partner at Goldfinch Wealth Management in Greenville, South Carolina.

Here’s how to decide what’s right for your 401(k).

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Compare your current and future tax brackets

Experts say one of the big questions to consider is whether you expect to be in a higher or lower tax bracket in retirement.

Generally speaking, pre-tax contributions are better for high earners, Lawrence said, because of the upfront tax break. But if your tax bracket is lower, it may make sense to pay the levy now with a Roth deposit.

If you’re in the 22% or 24% bracket or lower, I think Roth contributions make sense, assuming you’ll be in a higher bracket at retirement.

Lawrence Pawn

CPA at Pone & Associates

Lawrence Pon, a CFP and certified public accountant at Pon & Associates in Redwood City, California, said Roth 401(k) contributions are generally a good fit for younger workers who expect to earn more later in their careers.

“If you’re in the 22% or 24% bracket or lower, I think Roth contributions make sense, assuming you’ll be in a higher bracket at retirement,” he said.

‘Taxes are on sale’ by 2025

While it’s unclear how Congress might change tax policy, several provisions of the Tax Cuts and Jobs Act of 2017 set for sunset in 2026Including lower tax brackets and higher standard deductions.

Experts say these expected changes may also factor into the pre-tax versus Roth contribution analysis.

“We’re in this low-tax sweet spot,” said Catherine Velega, CFP and founder of Green Bee Advisory in Boston, referring to the three-year period before the tax brackets were higher. “I say the taxes are on the sale.”

We’re in this low-tax sweet spot.

Catherine Velega

Founder of Green Bee Advisory

While Roth contributions are a “no-brainer” for younger, lower earners, she said the current tax environment has made these deposits more attractive to high-income clients.

“I have clients who can get by for $22,500 for three years,” Vallega said. “That’s a pretty decent chunk of change that will go tax-free.”

plus, Recent Changes from Secure 2.0 That has made Roth 401(k) contributions more attractive to some investors, she said. Plans can now offer Roth employer matches and Roth 401(k)s no longer require minimum distributions. Of course, plans can vary depending on which features employers choose to adopt.

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Many investors also consider ‘legacy goals’

Lawrence of Goldfinch Wealth Management said ‘inheritance goal’ is also a factor in deciding between pre-tax and Roth contributions. “Estate planning is really becoming a big part of what people are thinking about,” he said.

Since the SECURE Act of 2019, tax planning for inherited individual retirement accounts has become trickier. Previously, non-spouse beneficiaries could “stretch” the withdrawals over their lifetimes. But now they need Eliminate inherited IRAs within 10 yearsKnown as the “10-year rule”.

Withdrawal timelines are now “much more compact, which can impact the beneficiary, especially if they are in their peak earning years,” Lawrence said.

However, Roth IRAs can be a “better estate planning tool” than traditional pre-tax accounts because non-spouse beneficiaries won’t owe taxes on withdrawals, he said.

“Everyone has their preferences,” Lawrence said. “We try to provide only the best options for what we are trying to accomplish.”

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