Pre-tax vs. Roth 401(k)? How to decide which option is best

If you have a 401(k), one of the big questions is whether to make pretax or Roth contributions — and the answer may be complicated, experts say.

While pretax 401(k) contributions reduce your adjusted gross income, you’ll owe levies on growth upon withdrawal. By comparison, Roth 401(k) deposits won’t provide an upfront tax break, but the money can grow tax-free.

Some 80% of employer retirement plans offered Roth contributions in 2022, compared with 71% in 2018, according to a recent Vanguard report based on roughly 1,700 retirement plans.  

While your current and future tax brackets are part of the puzzle, experts say there are other factors to consider.

“It’s hard speaking in broad terms, because there are so many things that go into making that decision,” said certified financial planner Ashton Lawrence at Mariner Wealth Advisors in Greenville, South Carolina.

Here’s how to decide what’s right for your 401(k) plan.

One of the big questions to consider is whether you expect to be in a higher or lower tax bracket in retirement, experts say.

Generally speaking, pretax contributions are better for higher earners because of the upfront tax break, Lawrence said. But if your tax bracket is lower, paying levies now with Roth deposits may make sense.

Roth 401(k) contributions are typically good for younger workers who expect to earn more later in their careers, explained Lawrence Pon, a CFP and certified public accountant at Pon & Associates in Redwood City, California.

“If you’re in the 22% or 24% bracket or lower, I think the Roth contribution makes sense, assuming you’ll be in a higher bracket upon retirement,” he said. 

Although it’s unclear how Congress may change tax policy, several provisions from the Tax Cuts and Jobs Act of 2017 are scheduled to sunset in 2026, including lower tax brackets and a higher standard deduction.

Experts say these expected changes may also factor into the pretax versus Roth contributions analysis.

“We’re in this low-tax sweet spot,” said Catherine Valega, a CFP and founder of Green Bee Advisory in Boston, referring to the period before tax brackets may get higher. “I say taxes are on sale.” 

While Roth contributions are a “no-brainer” for young, lower earners, she said the current tax environment has made these deposits more attractive for higher-income clients, as well. 

“I have clients who can get in $22,500 for three years,” Valega said. “That’s a pretty nice chunk of change that will grow tax-free.”

Plus, recent changes from Secure 2.0 have made Roth 401(k) contributions more appealing for some investors, she said. Plans may now offer Roth employer matches and Roth 401(k)s no longer have required minimum distributions. Of course, plans may vary based on which features employers choose to adopt.

“Legacy goals” are also a factor when deciding between pretax and Roth contributions, said Lawrence from Mariner Wealth Advisors.

“Estate planning is becoming a larger piece of what people are actually thinking about,” he said.

Since the Secure Act of 2019, tax planning has become trickier for inherited individual retirement accounts. Previously, nonspouse beneficiaries could “stretch” withdrawals across their lifetime. But now, they must deplete inherited IRAs within 10 years, known as the “10-year rule.”

The withdrawal timeline is now “much more compact, which can impact the beneficiary, especially if they’re in their peak earning years,” Lawrence said.

However, Roth IRAs can be a “better estate planning tool” than traditional pretax accounts because nonspouse beneficiaries won’t owe taxes on withdrawals, he said.

“Everyone has their own preferences,” Lawrence added. “We just try to provide the best options for what they’re trying to achieve.”