How to choose between pre-tax contributions and Roth 401(k) contributions

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

While pre-tax 401(k) deposits offer upfront tax credits, funds grow with tax deferral, meaning you have to pay fees when you withdraw funds. In contrast, Roth 401(k) contributions occur after taxes, but your future earnings grow without taxes.

Most plans have both options. Approximately 88% of 401(k) plans offered Roth accounts in 2021, almost double the number from ten years ago. Council of America plan sponsorduring which more than 550 employers were interviewed.

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

“It’s hard to speak in general terms because there are so many things that go into making 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 current and future tax brackets

Experts say one important question to consider is whether you expect to be in a higher or lower tax bracket when you retire.

In general, according to Lawrence, pre-tax contributions are better suited to higher-earning individuals due to upfront tax credits. But if your tax bracket is lower, paying fees now with Roth deposits might make sense.

If you’re in the 22% or 24% group or below, I think Roth’s contribution makes sense, assuming you’ll be in the higher group when you retire.

Lawrence Pont

CPA at Pon & Associates

Lawrence Pon, CFP and Pon & Associates Certified Public Accountant in Redwood City, Calif., said Roth 401(k) contributions are generally good for younger workers who expect to earn more later in their careers.

“If you’re in the 22% or 24% or below group, I think Roth’s contribution makes sense, assuming you’re in the higher category when you retire,” he said.

“Taxes are sold” until 2025

We are in this sweet place with low taxes.

Ekaterina Valega

Founder of Green Bee Advisory

While Roth’s deposits are no problem for low-income young people, she said the current tax environment has made these deposits more attractive to higher-income clients as well.

“I have clients who can get $22,500 over three years,” Valega said. “That’s a pretty good part of the change that will grow without taxes.”

In addition, recent changes to Secure 2.0 have made Roth 401(k) deposits more attractive to some investors, she said. Plans can now offer Roth employer matches, and Roth 401(k) no longer requires a minimum allocation. Of course, plans can vary depending on what features employers decide to accept.

Many investors also consider “obsolete targets”.

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