Traditional Pre-tax vs Roth 401(k) Contributions
Making smart investment decisions is an important part of your retirement planning. Considering taxes is important as well.
It’s likely that your retirement plan offers contribution flexibility which allows you to make “Traditional” pre-tax and/or Roth after-tax contributions. Both provide certain tax benefits and, individually or together, can help you move closer to your long-term goals.
To take control of how you may be taxed, decide on one of these contribution options, or use a combination of both.
Please note that any matching contributions provided by your employer will always be contributed to your pre-tax “bucket” of your 401(k), regardless of how you decide to contribute to your 401(k) account.
“Traditional” Pre-tax Contributions
- These contributions reduce your current taxable income and, therefore, should reduce your current taxes.
- Your earnings will compound on a tax-deferred basis. No taxes are owed on your earnings until you withdraw money from your account.
- Withdrawals at retirement are taxable. Because you haven’t yet paid taxes on your contributions, you will be taxed when you take money from your account (unless you roll it to another tax-deferred account).
Roth After-tax Contributions
- Your contributions are from income that is taxed up front. Roth contributions come out of your paycheck after taxes have been calculated; therefore, your current taxable income is not reduced.
- Qualified withdrawals are tax-free. Your qualified withdrawals at retirement — including earnings — will be tax-free.
- You don’t have to worry about future tax rates. Since qualified distributions at retirement are tax-free, they won’t be negatively affected if tax rates increase in the future.
Here’s a handy calculator provided by American Funds that can help you make a decision on whether to make traditional pre-tax or Roth after-tax contributions.
Visit the American Funds Calculator Here
Please Note: Speak to your tax, legal or financial advisor for specific advice about your particular plans and situation.
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John R. Bubello is an investment advisor representative of and offers investment advisory services through Compass Retirement, LLC, a registered investment adviser offering advisory services in the State of Connecticut, State of Florida, State of North Carolina and other jurisdictions where registered or exempted.