When it comes to making decisions on your 401(k) contributions, there can be a lot of different factors that make it difficult to ensure you are making the right choices. One of those choices can be deciding whether to make pre-tax contributions into a traditional 401(k) or after-tax contributions to a Roth 401(k).
Pre-tax contributions into a traditional 401(k)
These reduce your taxable income for the year and can potentially give you large tax savings now and will begin earning interest tax free. However, these contributions and earnings will be taxed when they are distributed to you in the future. Pre-tax contributions into a traditional 401(k) would be ideal if you expect to be earning a lower wage around the time of your retirement as opposed to right now.
After-tax contributions to a Roth 401(k)
Now, what about those starting off their careers who aren’t making the level of income they plan to be making in future years? That’s when a Roth 401(k) can be a smart move and end up giving you more cash when it comes time for retirement. Contributions to a Roth account are made with after-tax dollars. They begin earning interest tax free and there is also no tax due at the time of distribution. In this case, you do not benefit from tax savings at the time of contributions, rather at the time of retirement.
Lastly there is a third option which consists of splitting your contributions between the two. This would be a conservative approach as it lowers the importance of properly estimating future earnings. In this situation, your tax savings would be divided between now and the time of retirement.
Look to the future
The big thing to keep in mind is taking your future into account when making decisions today. It can be worrisome to think about whether you’ll be making more now or then but planning now can help avoid poor consequences later. Knowing where you are and where you are going will help you make the right choice.