Some plans allow participants to make Traditional (pre-tax) contributions and also Roth (after-tax) contributions. Making a decision on which contributions are right for you can be a difficult choice, as there are current and future tax consequences that you should consider.
With a Roth 401(k), you can eliminate concerns about your retirement tax rates, but for some people, traditional 401(k)’s are still the way to go. For example, contributions deferred into a traditional 401(k) plan don’t count as income in the year of the contribution, which makes it a great choice if your gross income is more than you expect it to be in the future. However, if you’re just getting started, or expect a higher tax rate in your retirement years, a Roth 401(k) plan allows you to make after-tax contributions, meaning the contributions do not reduce your taxable income for the year.
Ultimately, a good approach in making your decision is to compare your current tax bracket with which bracket you think you will be in when you retire. If you expect your future tax rate to be lower, then it might be a good idea to go with pre-tax contributions. If you expect your future tax rate to be higher, then Roth might be your best bet. If you are unsure, but the plan allows you to do both, then that would be an option as well.
Looking at your current and future tax rates isn’t the only factor that you should be considering in making your decision; however, it is a good place to start.
By Ryan Wojdacz