While we often focus on tax-efficient withdrawals, it’s just as important to consider the tax implications of your savings plan throughout your lifetime. The question we all face at some point is whether we should prioritize tax savings today or in the future.
In this video we walk through how to analyze the trade-offs and figure out which savings bucket can give you the most tax-efficient outcome. We’ll focus on the decision between contributing to a pretax 401(k) or a Roth 401(k) and break down the pros and cons of each. By the end of this video, you’ll have a better understanding of how to make the right choice for your unique financial situation and goals.
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Pretax 401k vs. Roth 401k: Which is Right for You?
When it comes to planning for retirement, one of the most important decisions you’ll have to make is whether to contribute to a pretax 401k or a Roth 401k. Both options offer unique advantages and it’s crucial to understand the differences in order to make an informed choice that suits your financial goals and circumstances.
To begin with, let’s explore what pretax and Roth 401k plans actually mean. A pretax 401k allows you to contribute funds directly from your paycheck before any income taxes have been deducted. This means that the money you contribute is not included as taxable income, providing an immediate tax benefit. However, you will have to pay taxes on your withdrawals during retirement.
On the other hand, a Roth 401k involves contributing funds with after-tax dollars but offers tax-free withdrawals during retirement. This means that while you do not receive an immediate tax benefit, you can withdraw both your contributions as well as the earnings they generate tax-free in retirement.
So, which option is right for you? The answer largely depends on your current financial situation, tax bracket, and future retirement plans. Let’s delve into the key factors to consider when making this decision.
Income and Tax Bracket: If you are currently earning a high income and expect to be in a lower tax bracket during retirement, it might be advantageous to contribute to a pretax 401k. This allows you to reduce your taxable income in the present, potentially lowering your overall tax liability. On the other hand, if you anticipate being in a higher tax bracket in retirement, a Roth 401k could be more beneficial since you would pay taxes on the contributions now rather than at a potentially higher rate later.
Future Tax Rates: Predicting future tax rates can be challenging, but it’s worth considering when deciding between pretax and Roth contributions. If you believe that tax rates will rise in the future, contributing to a Roth 401k might be a smarter move. This way, you lock in the present tax rate while shielding your retirement savings from potential tax increases in the future.
Desired Retirement Lifestyle: Another important aspect to consider is the lifestyle you envision for your retirement. If you anticipate needing a significant amount of income during retirement, perhaps due to higher expenses or ambitious travel plans, contributing to a Roth 401k might be beneficial. Since withdrawals are tax-free, you won’t need to worry about potentially depleting your savings with unexpected tax burdens. However, if you plan to lower your expenses during retirement and can comfortably live on a smaller income, a pretax 401k might be more suitable.
Diversification of Tax Advantages: It’s also worth noting that you are not limited to choosing just one type of 401k plan. Some employers offer the option of contributing to both a pretax and Roth 401k, allowing for diversification of tax advantages. This can provide you with additional flexibility and control over your retirement savings, enabling you to adjust contributions based on your specific financial and tax circumstances.
Ultimately, the decision to contribute to a pretax or Roth 401k will depend on several factors unique to your situation. Consulting a financial advisor or retirement planner can help you navigate the complexities of each option and create a plan that maximizes your long-term goals. Remember, whatever option you choose, regularly reviewing and adjusting your contributions will be crucial to ensure you are on track to achieve a comfortable retirement.
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if you have 1million in roth..will you still qualify for medicaid???
Are you trying to build your income and prepare for retirement? It’s important to choose stocks that are expected to hold up in inflationary environments. To combat the negative effect of inflation, it’s a good idea to diversify your portfolio across different asset classes, such as stocks, bonds, and real estate. I've been using the services of a verifiable financial advisor Robin Brezik . I started with $140k, with her assistance I've have made more than $700k. You too can do same.
What I love about the Roth 401(k) is it can help you save on taxes in retirement. Not only are withdrawals tax-free at 59 1/2 , it won't impact the taxation of your Social Security benefit and Medicare premiums.This is an important aspect of a Roth account that most people are not aware of.
With Roth IRA, the money you are contributing has already been taxed. At any time for any reason, you can withdraw your contributions tax-free and penalty-free. Additionally, any earnings on investments can also be withdrawn tax-free and penalty-free, Not sure how much to contribute, I'm still at a crossroads deciding if to liquidate my $338k stock portfolio.
The chart showing the total amount of taxes paid over the remaining life for pre-tax 401k vs Roth 401k is not the answer to the real question, which is: how do the different tax payments affect your investments? I crunched the numbers and found that in EVERY case (I ran a lot of cases), pre-tax 401k wins over Roth because the part of the pre-tax contributions that did not go to taxes was able to grow over time, resulting in more money in retirement, even after paying taxes on withdrawals! HOWEVER, this only works if you actually invest the pre-tax money. In other words, if you can only afford to contribute $500 to a Roth 401k but can contribute $600 to a pre-tax 401k because of the tax savings, then pre-tax 401k wins. But if you go pre-tax and stay at $500, you'll be shooting yourself in the foot (i.e., you'll just be spending the tax savings).
I'm retired and recently crunched numbers to see if it was worth it to convert my traditional IRA to a Roth IRA. It was not, due to the reason stated above: the savings from not having to pay taxes down the road does not offset the taxes that have to be paid up-front to do the conversion, because that money will no longer be growing (regardless of the average rate of return). This was a big surprise because all the experts say converting is the way to go.
My 401K is mixed, some Roth some pre-tax. When you take take distributions can you specify which? Do Roth distributions count as income for government programs like health insurance etc? I am considering funding a Roth IRA with a 401K loan so it comes out before I get paid. Is that a bad idea?
BEST time to contribute to a roth 401k is when you are helping pay for a child's college, and you are getting tax credits. This generally results in an extremely low effective tax rate.
What about keeping it simple – have both.
Kinda neat that whether you are looking at the benefits of Roth contributions/conversions or delaying social security the break even is always around age 80. Hope I live to then!
You need to add in time value of money to the conversation. Also charitable giving.
I'm almost 62 and eligible to retire with enough money to live comfortably. I have money in a Roth 401K (13%), a traditional 401K (50%), a brokerage account (24%), and a Roth IRA (13%). I want to convert the traditional and brokerage money to Roth but having a hard time figuring out when. I make a lot of money so it would drive my taxes very high to convert now. If I wait until 65, it would drive up my cost for medicare. I want to be done before I have to take RMDs. I could retire now and with a lower income, start large conversions. It seems no choice is a great one.
I am still working but I would like to start taking my Social Security at the age of 62. I also have a Roth 401(k) and a Roth IRA account. Will Social Security tax me on my 401(k) and Roth IRA account or will they even care? Are they going to want to know my total income even though it’s both Roth IRA accounts if I take S.S. at 62 ?
They can save $30,000 per year in Roth, then they could save maybe $35,000 in traditional
Please tell me your not comparing $30,000 in Roth to $30,000 in traditional
I'd like your opinion on the issue of comparing the contributions of pre-tax and post-tax money. To contribute $30,000 into a pre-tax (traditional IRA) account, I would have to earn $30,000 + 7.65% since I still have to pay Social Security and Medicare taxes. For the post-tax (Roth IRA) account, I would have to earn $30,000 + the income tax (fed & possibly state.) + 7.65% for SS & MC. If income tax is 20%, for example, I am spending about $38,754 of my income for a $30,000 Roth contribution. For the traditional contribution, I am spending $32,295 for a $30,000 contribution. It seems that the $30,000 contributions should not be compared apples to apples. If we contribute the money that we are paying in income taxes on the Roth into the traditional, (therefore spending equal amounts each year), the compound growth difference would be huge. That additional deposit each year + year over year growth would likely outweigh the taxation at withdrawal.
How much taxes on 45 thousand ?
I know it's sounds crazy but i take some out of my 401k because of the 4% match but stay under my 100,000 dollar mark incase of any credits given on a state or government level then i have been putting it into either a money market or CD that pays good intrest?