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To Roth or Not to Roth, That is the Question

We often get the question:  “I have the option of making Roth (post tax) contributions to my 401k – should I do that?  How should I decide?”

Without getting into all the minutiae of current tax rates vs. future tax rates, tax inclusive vs. tax exclusive and marginal rates vs. effective rates, the easy answer is: do some of each.

You can use the tax savings generated by the pre tax contribution to pay the taxes on the post tax contribution – and, you can arrange the mix of each so that it is tax neutral.

If tax neutrality is your objective, then the actual mix of pre and post tax contributions varies a little depending on your tax bracket.  To keep it simple, we’ll show one example using the 28% tax bracket:

Maximum 401k contribution       $17,000

Pre tax                                        $  9,884 saves $2,768 in taxes

Post tax                                       $  7,116 costs  $2,768 in taxes

Total contribution                        $17,000

Net tax cost                                 $-0-

Net contribution cost                   $17,000

What if you don’t have a Roth option in your 401k?  You can use this same logic to fund a Roth IRA – the pre-tax contribution to the 401k can offset the taxes you pay to make the Roth IRA contribution.  The math is the same.

At retirement when you withdraw your funds:

·        the pre tax funds plus related earnings will be taxable

·        the post tax funds plus related earnings will be tax free

·        ALL employer matching contributions plus related earnings will be taxable (regardless if the match is to pre tax or post tax contributions)


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Comment   |  7 years, 8 months ago from Redmond, WA