Pre-tax vs. Roth: Factors to consider when contributing to your Guideline 401(k) | Guideline Help Center (2024)

FAQs

Pre-tax vs. Roth: Factors to consider when contributing to your Guideline 401(k) | Guideline Help Center? ›

Taxable income and tax bracket

Contributions are made pre-tax, which reduces your current adjusted gross income. Roth contributions are made with after-tax dollars. You'll pay more taxes today, but that could mean more money in retirement. Distributions in retirement are taxed as ordinary income.

Contributions to a 401(k) are tax-deductible and reduce your taxable income before taxes are withheld from your paycheck. There is no tax deduction for contributions to a Roth IRA, but contributions and earnings can be withdrawn tax-free in retirement.

The Bottom Line

With a traditional 401(k), you defer paying taxes on those savings until you withdraw them. With a Roth 401(k), you pay taxes on the money you deposit in your account as you go. Qualified withdrawals are completely tax-free.

Contributions to a traditional 401(k) are made with pre-tax dollars—meaning the money goes into your retirement account before it gets taxed. With pre-tax contributions, every dollar you save will reduce your current taxable income by an equal amount, which means you'll owe less in income taxes for the year.

If you think your tax rate will be lower when you begin taking withdrawals in retirement, traditional contributions may make sense. If your tax rate will be about the same (or higher), Roth contributions might be preferable.

Converting a 401(k) to a Roth IRA may make sense if you believe that you'll be in a higher tax bracket in the future, as withdrawals are tax-free. But you'll owe taxes in the year when the conversion takes place. You'll need to crunch the numbers to make a prudent decision.

If you are a new employee and have a lengthy career ahead of you, consider starting with pre-tax contributions. Your contributions can grow tax-deferred, and your paycheck will see less of an impact. After you've been in the DCP for a few years, consider adding Roth (after-tax) contributions.

What is the difference between a traditional IRA and a Roth IRA? The main difference between traditional 401(k) and Roth 401(k) is whether the income tax is fully paid when opening the account.

A big difference between Roth IRAs and 401(k)s lies in their tax treatment. You fund Roth IRAs with after-tax income, meaning your withdrawals are not taxable retirement income. Conversely, you fund 401(k)s with pre-tax income.

How to choose between 401k and Roth 401 K? ›

To make an educated choice between traditional and Roth deferrals, you want to consider your current tax situation and your anticipated situation in retirement. In general, you want to choose traditional deferrals if you expect your tax rate to decrease in retirement and Roth deferrals if you expect it to increase.

The list of cons may be short for Roth 401(k)s, but missing tax deferral is a big one. When faced with a choice of paying more tax now or later, most people choose to pay later, hence the low participation rates for Roth 401(k)s.

Both plans offer tax advantages, either now or in the future. With a traditional 401(k), you defer income taxes on contributions and earnings. With a Roth 401(k), your contributions are made after taxes and the tax benefit comes later: your earnings may be withdrawn tax-free in retirement.

In a traditional 401(k) plan, pre-tax contributions could offer an immediate tax break, but you'll pay taxes when withdrawing in retirement. Contributions to a Roth 401(k) plan come out of after-tax income, but the money grows tax free.

Maxing out your 401(k) contributions might not make financial sense if you don't earn a high salary. For example, if you make $50,000 per year, contributing over 40% of your pay to retirement savings could leave you cash-strapped to pay current bills and expenses.

If your employer matches your Roth 401(k) contribution, the contributions will be made before the employer pays taxes on it. This means you will have to pay income taxes on the match and any growth associated with the match when you take distributions.

Key Takeaways. Given the chance, should you contribute on a pretax basis to a traditional 401(k) or steer after-tax dollars into a Roth 401(k). In general, Roth dollars tend to be worth more because those assets can be withdrawn tax free, whereas the traditional 401(k) dollars have yet to account for taxes.

A Roth 401(k) is an employer-sponsored after tax retirement account that has features of both a Roth IRA and a 401(k). Like a Roth IRA, contributions to a Roth 401(k) are made with income that's already been taxed, allowing investments to grow and be withdrawn in retirement without being taxed.

Pros of Pretax Investing

Contributions are generally tax-deductible. That can reduce your taxable income during your working years, when you're likely to pay more in taxes. Employer-sponsored accounts like 401(k)s may offer an employer match.

Contributions to a Roth IRA aren't deductible (and you don't report the contributions on your tax return), but qualified distributions or distributions that are a return of contributions aren't subject to tax. To be a Roth IRA, the account or annuity must be designated as a Roth IRA when it's set up.