Choosing between Roth and pre-tax contributions for retirement savings depends on how each impacts your taxes now and in retirement. Roth contributions are made with after-tax dollars, so both contributions and earnings can be withdrawn tax-free in retirement if done correctly. Pre-tax contributions, on the other hand, reduce taxable income now but are taxed upon withdrawal, including both contributions and earnings. Factors like your income, current tax bracket, future tax expectations, and retirement goals influence the best choice. A financial advisor can help evaluate these factors to determine which option aligns with your plan.
Understanding Roth Contributions
Roth contributions are made using after-tax dollars, meaning the money you contribute has already been taxed.
The biggest advantage of Roth accounts is that qualified withdrawals in retirement are tax-free, provided you meet certain criteria, such as holding the account for at least five years and being at least age 59½ at the time of distribution. This makes Roth contributions particularly appealing if you expect to be in a higher tax bracket during retirement than you are now.
Types of Roth Accounts to Consider
There are two main types of Roth accounts: Roth IRAs and Roth 401(k)s. Both account types allow you to grow your retirement savings tax-free. But you should note that you can only create a Roth 401(k) if you have access to a workplace plan. Here’s how they compare:
Roth IRA
A Roth IRA is an individual retirement account that you can open through a financial institution. These accounts allow for more flexible withdrawal rules and no required minimum distributions (RMDs), but contributions may be limited based on your income. For 2024 and 2025, the contribution limit for a Roth IRA is $7,000 for individuals under 50, and $8,000 for those 50 and older.
However, eligibility to contribute directly to a Roth IRA is subject to income limits. In 2024, single filers with a modified adjusted gross income (MAGI) of $161,000 or more are ineligible to contribute directly. For a married couple filing jointly, the limit is $240,000. Single filers who make less than that but more than $146,000 (more than $230,000 for joint filers) can only make a partial contribution.
Roth 401(k)
A Roth 401(k), only offered by employers, doesn’t have income restrictions. As of 2024, Roth 401(k) plans are also no longer subject to RMDs. Previously, RMDs started at age 73 or when you stopped working at that job (after age 73). In 2024, you can contribute up to $23,000, or $30,500 if you’re over 50 ($23,500 or $31,000 over 50 in 2025). Take note: Beginning in 2025, employees aged 60 to 63 will be allowed to make catch-up contributions of $10,000 or 150% of the 2024 limit, whichever amount is higher.
Understanding Pre-Tax Contributions
Pre-tax contributions are made using income that hasn't yet been taxed, allowing you to reduce your taxable income in the year in which you contribute. This can be especially beneficial if you expect to be in a lower tax bracket in retirement than you are now, as you’ll defer paying taxes until you begin withdrawing funds.
With pre-tax accounts, such as traditional IRAs and 401(k)s, you’ll pay taxes on both the contributions and any earnings when you make withdrawals in retirement.
Types of Pre-Tax Accounts to Consider
The most common types of pre-tax accounts are traditional IRAs and traditional 401(k)s. Here’s a look at these two account types and how they stack up:
Traditional IRA
A traditional IRA is an individual account that you can set up through a financial institution. This account is appealing if you're looking to reduce your taxable income now, though your contributions may not be tax-deductible if you or your spouse are covered by a retirement plan at work. For a traditional IRA, you can contribute up to $7,000 in 2024 ($8,000 if you're 50 or older).
Traditional 401(k)
Offered only through employers, traditional 401(k) plans have higher contribution limits and may also include employer matching contributions, adding a significant boost to your retirement savings. For 401(k) plans, the contribution limit for 2024 is $23,000 for those under 50, and $30,500 for those 50 or older. It’s also important to note that pre-tax accounts have RMDs starting at age 73, meaning you must start withdrawing from your 401(k) a certain amount each year, which can affect your tax situation during retirement.
Roth vs. Pre-Tax Contributions: Key Differences
When deciding between Roth or pre-tax contributions, several factors come into play. Here are the key differences to consider:
- Tax treatment: Roth contributions are made after taxes, so withdrawals in retirement are tax-free. Pre-tax contributions reduce your taxable income now, but you’ll pay taxes on withdrawals later.
- Contribution limits: Roth IRAs have income limits, while Roth 401(k)s do not. Both traditional and Roth 401(k) plans allow higher contribution limits compared to IRAs.
- Required minimum distributions (RMDs): Roth IRAs don’t have RMDs and starting in 2024, neither do Roth 401(k) plans, giving you more flexibility in retirement. Pre-tax accounts require RMDs starting at age 73.
- Future tax considerations: If you expect to be in a higher tax bracket in retirement, Roth contributions may be more beneficial. If you believe you’ll be in a lower tax bracket later on, then pre-tax contributions could make more sense.
- Eligibility: Eligibility for Roth IRAs is based on your income, while pre-tax accounts and Roth 401(k) plans are open to all income levels.
Frequently Asked Questions
Can I Contribute to Both Roth and Pre-Tax Accounts?
Yes, you can contribute to both a pre-tax traditional account and a Roth account, but the total amount you contribute must stay within the IRS contribution limits for each account type. For example, for 2024, you can split the $23,000 contribution limit for a 401(k) between a traditional 401(k) and a Roth 401(k).
Are Employer Matches in a Roth 401(k) Treated as Roth Contributions?
Employers can offer after-tax Roth matching contributions. They get added to current taxable income.
Bottom Line
When considering Roth vs. pre-tax contributions, it's important to evaluate your current tax situation and your expectations for retirement. If you expect your tax rate to be higher in the future, a Roth account may offer the most long-term benefits. On the other hand, pre-tax contributions can reduce your taxable income now and provide more savings flexibility. Whichever option you choose, make sure you understand the tax implications and rules of each type of account, so you can make the most of your retirement savings.
Retirement Planning Tips
- Taxes can take a bite out of your nest egg in retirement. A financial advisor can help you create a retirement plan strategy that aims to minimize your tax liability. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to know how much your retirement savings could grow over time, SmartAsset's retirement calculator could help you get an estimate.
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