Is it better to contribute to both (if I can afford it) since one is pre-tax and one is post?
One consideration that is often ignored by advisors: annual contribution limits are nominal and not tax-adjusted. If your savings rate exceeds your 401k and IRA contribution limits and you have a long-term time horizon, then a ROTH could save you a considerable amount of money in future taxes.
I have found it helpful to position the issue as follows: the current contribution limit for 401k plans is $17,000 for 2012. If the IRS raised the contribution limit to $23,000 (roughly the pre-tax equivalent of the nominal ROTH limit for many people), would you take advantage of it? Unless you expect your marginal tax rate to decline, and even if it does decline somewhat, the nominal contribution limit makes the ROTH a superior vehicle for maximizing long-term total return.
Take a look at the online calculator at http://roth.northcapital.com, which you can use to estimate the benefits under different scenarios.
Hi Farrah...great question. This is really a question that varies on a case by case basis. You should consult with a tax professional to determine the best situation for you. Both have benefits in that the 401k is tax deferred, while the Roth 401k allows tax free distributions. Another benefit of the Roth 401k is when you leave your employer and you roll to a Roth IRA you are exempt the the required minimum distributions after age 70 1/2. Some requirments to the Roth are you must not distribute until 5 years after you establish the plan. In my opinion if you believe tax rates will increase in the future, at least a portion of your retirement savings should go to the Roth 401k. Of course, I have not touched on all the differences, so again, I recommend you consult with a tax professional. Hope this helps.
Hi Farrah, we all know diversification in our retirement portfolios makes sense. But tax diversification also makes sense, which I think is the heart of your question. When you retire, your traditional 401k money will be taxed as ordinary income when withdrawn. Your Roth 401k money, on the other hand, will come out income tax free. By having the ability to draw on either taxable or tax-free income in any given year in retirement, you gain the ability to have more direct control over your income taxes as a retiree. So I think having both now (or contributing to the traditional 401k in a year when you expect to be in a high income tax bracket, and then contributing to the Roth 401k when you might be in a low tax bracket for a year) is a good long-term retirement strategy.
Regardless of which 401k version you use, the important message is to regularly save/contribute. Keep up the good work!
Hi Farrah, while I don't know your age or other details, these days legislative risk may be as big as market risk. I like tax diversification; I like the idea of contributing to both.
I think the last part of Mike's answer is what's most important. Begin contributions as soon as possible and as much as you can handle. The traditional/Roth decision is a tricky one as it depends on unknowable variables - as pointed out by Tont and Michael. If this issue is delaying your contributions I would just split it 50/50 (Roth/Traditionsl). Get it started and re-evaluate in a few years. Good luck!