Author: Paul A. Carl, CHSA, CPFA™Vice President, Retirement Plan Consulting, Registered Representative
Years ago, I listened to a retirement plan participant summarize a retirement educator’s lengthy explanation of the differences between pre-tax and Roth employee deferrals. They explained, “If I retire with a $100,000 account balance that is Roth, I get the whole $100,000. If I retire with $100,000 that I contributed pre-tax, I only get to keep a portion of the $100,000 because I still need to pay federal and state income taxes.” It was a simple statement with basic truths.
So why wouldn’t every participant contribute Roth if you receive your entire account balance?
Prior to EGTRRA , 401(k) plan participants had pretty much one choice for deferring contributions: pre-tax that grew tax deferred. Contributions were withheld from a participant’s pay prior to applying any federal (and state, as applicable) income tax withholding.
In 2001, EGTRRA1 introduced the very popular Roth IRA concept to 401(k) plans whereby, if permitted by the plan provisions, an employee could defer contributions on an after-tax basis from the paycheck; these contributions would then grow tax-free provided certain criteria was met.
The decision to make pre-tax or Roth deferrals is based on the individual’s personal situation. Both are tax-advantaged. Some of the basic questions that a retirement participant should consider:
- Does my 401(k) plan allow for Roth deferrals?
- Do I need a higher net take-home-pay currently?
- Do I want to pay taxes now or later?
- Will I be contributing the same amount regardless of the pre-tax or Roth strategy?
- What tools and calculators have I utilized and what do the projected results indicate?
Regardless of your stance on the pre-tax versus Roth contribution debate, the most important step towards a successful retirement is to save.
Which method of deferring do you think is best for you?
1EGTRRA is the acronym for the Economic Growth and Tax Relief Reconciliation Act of 2001.
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