Ask a Planner: Should I Contribute to a Pre-Tax or Roth 401(k)?
The beginning of the year is a good time to check-in on your benefits and make sure you have accounted for the increased limits for 2023 (i.e. 401(k) plan limits have increased from $20,500 in 2022 to $22,500 in 2023) and to consider incrementally increasing the amount you put into your annual retirement accounts. Even a 1% annual increase can produce large benefits during retirement. Did you know that over 80% of employer-sponsored retirement plans now offer 401(k) Roth options? Take this time to consider whether contributing to a pre-tax or Roth 401(k) in an employer-sponsored retirement plan is the right option for you.
The basic difference between a traditional and a Roth 401(k) is when you pay the taxes. With a traditional 401(k), you make pre-tax contributions, so you get a tax break up front, helping to lower your current income tax bill. Both your contributions and earnings grow tax-deferred until you withdraw the money. At that time, withdrawals are considered ordinary income and you will have to pay tax at your current tax rate; there may be state taxes as well. (With certain exceptions, you’ll also pay a 10 percent penalty if you’re under 59½.) With a traditional pre-tax 401(K) you will also be required to take minimum distributions in your 70s (just as you would with a traditional IRA) so your money cannot continue to grow tax-deferred indefinitely.
With a Roth 401(k), it’s basically the reverse. You pay tax on your contributions now, at your current tax rate, meaning there is no upfront tax deduction. However, withdrawals of both contributions and earnings are tax-free at age 59½, as long as you’ve held the account for five years. There are also no required minimum distributions on Roth accounts during one’s lifetime 1 so money in a Roth account continues compounding and growing tax-free until you decide to withdraw from the account. This is a complicated and highly personal decision that depends on an individual’s specific circumstances and timeline.
Reach out if you have any questions or want to discuss how to think through making this decision personally: firstname.lastname@example.org.
Written by Dana R. Cahan, CPWA
Have a Question for Dana? Submit it Here.
Zuckerman Investment Group, LLC (“ZIG”) is registered with the United States Securities and Exchange Commission (“SEC”) as an investment adviser. Such registration with the SEC does not imply any certain level of skill or training. It also does not imply that the Firm is recommended or approved by the United States government or any regulatory agency. The information contained in this email has not been filed with, reviewed by or approved by the SEC or any other United States regulatory or self-regulatory authority.
The information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including, but not limited to, warranties of performance, merchantability, and fitness for a particular purpose.
Zuckerman Investment Group, LLC may only transact business or render personalized investment advice in those states and international jurisdictions where it is registered, has notice filed, or is otherwise excluded or exempted from registration requirements. This is for information distribution only and should not be construed as an offer to buy or sell securities or to offer investment advice. Please refer to Zuckerman Investment Group, LLC’s ADV Part 2 (brochure) and Form CRS for additional information.
We have no responsibility for any information or policies of any other websites that may be accessible from this email via hyperlink. Zuckerman Investment Group does not endorse, sponsor, or promote any products or services offered by any website that may be linked to this email. If you access any other website through this email, you do so at your own risk. Parties may not reproduce this email in any form, nor reference it in any publication, without the express written consent of Zuckerman Investment Group, LLC.
Secure Act 2.0 eliminates required minimum distributions for Roth 401(k) accounts starting in 2024↩