Show The most expensive thing you’ll probably buy during your lifetime is retirement. Perhaps you’ve never thought of “buying” retirement, but that’s exactly what you do when you participate in a 401(k) plan – you are saving now to buy retirement income later. When you consider that income may need to last 10, 20, even 30 years, it’s easy to understand why retirement is so expensive. However, by following a simple 4-step plan during your working years - save early, contribute regularly, invest appropriately, minimize account fees - you can reduce the out-of-pocket cost of your retirement by a lot! You may be able to reduce your retirement's cost even further by contributing Roth deferrals to your 401(k) account instead of traditional deferrals. While traditional deferrals are contributed pre-tax and then taxed upon withdrawal, Roth deferrals are the opposite - contributed after-tax and then tax-free upon withdrawal. Taking the tax hit on Roth deferrals now could save you a lot in taxes in the long-run. Not all 401(k) plans permit Roth deferrals, but if your plan does, making an informed decision about the best deferral option for your 401(k) account can be well worth your time. Not sure how to choose? Below is a comparison and factors to consider. Roth vs. Pre-Tax 401(k) Deferrals - Major DifferencesIn general, Roth and traditional deferrals are subject to similar contribution and distribution rules. Their primary difference is when they’re taxed – Roth on the front-end (at contribution), traditional on the back-end (at distribution).
Roth vs. Pre-Tax 401(k) Deferrals - How to ChooseTo 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.
Roth vs Pre-Tax 401(k) Deferrals - Tax ExamplesBelow are examples that demonstrate how taxes would affect the value of Roth and traditional deferrals over a 10-year period assuming a 5% annual rate of return.
Some tax planning now can pay off big-time later!It can be tough to pass up a tax break by choosing Roth over traditional deferrals, but you need to think ahead when saving for retirement. Paying taxes now might help you save thousands – or even tens of thousands – in net taxes. That additional money can come in handy in retirement. That said, nobody has a crystal ball about their future earnings and tax rates. If the right choice for you is not clear, you can always split your deferrals between Roth and traditional. Is it better to contribute to Roth or preYou pay less in taxes now when you make pretax contributions, while Roth contributions lower your paycheck even more after taxes are paid.
Should I convert my preConverting all or part of a traditional 401(k) to a Roth 401(k) can be a savvy move for some, especially younger people or those on an upward trajectory in their career. If you believe you will be in a higher tax bracket during retirement than you are now, a conversion will likely save you money.
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