Experts state that deciding on how to make contributions to a pretax or Roth 401(k) plan can be more intricate than one would anticipate. With pretax 401(k) deposits, you can get a tax break at the outset, yet when you remove the money, you will have to pay taxes. On the other hand, Roth 401(k) investments are made with funds that have already been taxed, yet your returns can accumulate tax-free. Still, selecting the right option is dependent on more than just your current and potential tax brackets.
If you possess a 401(k), a significant inquiry is whether to make pretax or Roth contributions — and professionals declare the answer may be intricate. Pretax 401(k) contributions may lessen your adjusted gross income, even though taxes may be imposed on growth when you take the money out. On the other hand, Roth 401(k) deposits do not grant a tax advantage upfront, but the funds can grow without any tax burden. Data from a Vanguard report indicates that around 80% of employer retirement plans had Roth contributions in 2022, compared to 71% in 2018, which based on roughly 1,700 retirement plans.
Life Changes brings you a selection of articles featuring a financial angle on crucial lifetime experiences. We explore the adjustments to be made when returning to the workplace after the pandemic, take a look at the percentage of gig drivers receiving unemployment benefits at the height of the virus, and suggest some smart money strategies for new parents.
Here's an overview of other stories that provide an economic perspective on major life moments. How to adapt to going back to the workplace after the pandemic One out of five gig workers got unemployment benefits at its height in the pandemic. Here some clever financial steps for new moms and dads.
Experts note that although your current and future tax brackets are important considerations, there are other elements to weigh in when making decisions about your 401(k) plan. According to Ashton Lawrence, a certified financial planner at Mariner Wealth Advisors in Greenville, South Carolina, “It's hard to make generalized statements because there are numerous factors that come into play when determining what's best for your 401(k) plan.”
It is a critical point to ponder if you expect your tax bracket to go up or down in retirement, experts state. In general, one would benefit more from pretax contributions if they are a higher wage earner due to the initial tax break, Lawrence said. Otherwise, if you are in a lower tax bracket, making Roth deposits while paying taxes may be the better option.
According to Lawrence Pon, a CFP and certified public accountant with Pon & Associates in Redwood City, California, Roth 401(k) contributions are generally advantageous to younger workers who anticipate making more money down the road. He stated, “In the event that you fall into the 22%, 24%, or lower tax bracket, investing in a Roth contribution appears to be a wise decision, considering you will be in a more elevated bracket during retirement.”
The city council has made the decision to not enact the proposed policy.
The city council has decided against enacting the proposed policy.The situation changed dramatically
The circumstances underwent a drastic shift.
It remains to be seen how Congress may adjust tax policy; certain aspects of the Tax Cuts and Jobs Act of 2017 are expected to expire in 2026, including more favorable tax brackets and a higher standard deduction. This could lead to a need for a new approach to deciding between pre-tax and Roth contributions. Catherine Valega, CFP and founder of Green Bee Advisory in Boston, commented that at present, "we're in this low-tax sweet spot," and advised that "taxes are on sale."
Valega said Roth contributions are now a great option for both young, lower earners and higher-income clients. She noted that it can be possible for the latter to contribute up to $22,500 for three years, allowing them to build a sizeable sum of tax-free funds. Plus, Secure 2.0 has made Roth 401(k)s more attractive through Roth employer matches and the removal of RMDs. Though, it is up to employers to decide which features to implement.
When considering which type of retirement contribution - pretax or Roth - to go with, legacy goals must also be taken into account, noted Lawrence from Mariner Wealth Advisors. "Estate planning has come to the fore of what many individuals are mulling over," he said. The Secure Act of 2019 has complicated things when it comes to individual retirement accounts inherited by a nonspouse. Previously, it was possible to "stretch" withdrawals over a longer period of time. Under the "10-year rule," though, all funds must now be removed within 10 years.
Lawrence commented that the new withdrawal timeline has been condensed, which could have a noteworthy effect on the recipient if they are in their most lucrative working years. He also suggested that Roth IRAs can be a better estate planning option than conventional pretax accounts, as recipients who are not a spouse won’t be subject to taxes upon withdrawals. To conclude, Lawrence said that their goal is to provide the best options to reach their clients’ desired outcomes.
Comments