Not all 401(k) plans or other employer qualified employer retirement plans allow for participants to make Roth contributions to them, but it seems that this option is becoming more widely available. Lately, I have been getting more and more questions from clients regarding whether it makes more sense for them to make traditional, pre-tax, contributions to their employers’ 401(k) plans or if they would be better off making Roth, or after-tax, contributions. The easy answer is that it ultimately comes down to personal preference, and while most people like the idea of reducing their current tax liability by making pre-tax contributions, it’s important to think ahead about your future tax liability in retirement.

There are a number of things to consider when deciding between making pre-tax contributions and Roth contributions, and while this is by no means an all-inclusive list, here are three things I find that people tend to overlook.

  1. It does not necessarily have to be one or the other. After weighing out the benefits of pre-tax versus after-tax contributions, and if you simply cannot decide one way or the other, don’t get too caught up on whether or not you are making the right or wrong decision. You actually have the option of making a portion of your contribution on a pre-tax basis and the remainder on an after-tax basis. Just because you decide to go with one option over the other doesn’t mean that you can’t make changes or adjustments in the future.
  2. Employer contributions are made with pre-tax dollars. Keep in mind that, whether you choose to make contributions on a pre-tax or after-tax basis, any employer contributions that are made on your behalf are going to be made before taxes. You will be responsible for paying taxes on those amounts when you take distributions regardless of which type of contributions you are making.
  3. No one knows exactly what tax rates will look like in the future. After factoring in the number of available deductions and credits written into the U.S. tax code, effective federal tax rates are currently near historic lows. Theoretically, you could assume that you would be in a lower tax bracket in retirement, but it is impossible to know this with absolute certainty.

Overall, when it comes to deciding between making pre-tax contributions or Roth contributions (or both!) to an employer’s retirement plan, there is not a single answer that is right for everyone. This is certainly something worth talking through with your advisor as you weigh the different benefits of each. Regardless of which route you decide to take, remember that actively deciding to contribute to your plan and save for retirement is what is really important at the end of the day.

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