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)