To Roth (401k) or Not to Roth

That is the question......

We are just about finished with tax preparation and filing for our clients and now move into tax planning for the rest of the calendar year. As Roth 401k’s expand, whether to contribute to a Roth is easily one of the most confusing questions facing our clients.

The question we get is - I'm currently in the work force, should I contribute to a traditional 401k or a Roth 401k? As with so many financial planning questions, the answer is: It Depends!

In many ways, the philosophical answer is simple - if your tax bracket today is the same as your tax bracket in retirement, it’s a complete wash. Yep, that’s right. If you are in the same tax bracket today as you will be in retirement, the final amount of spendable money is the same. Let’s use an example: Say you put $20,000? into your traditional, pre-tax 401k in 2024 and you have 10 years until retirement. If instead you put $15,600 into your Roth 401k (remember, you would have 22% less to put in because you pay the tax up front). As soon as you retire, in year 11, you begin taking $10,000 spendable cash from the account. In 5 years, you will take out the exact same amount of cash and the money will be drained.

Investment Annual Return: 10%

Tax Bracket: 22% (during contribution years AND withdrawal years)

Deposit: $20,000 into a traditional 401k, saving $4,400 in taxes up front. OR deposit $15,600 into a Roth 401k since the taxpayer owes $4,400 in tax up front (remember, Roth is after-tax money)

This is simply confirmation that if the tax bracket is the same during the contribution year(s) and withdrawal year(s), the account balances are exactly the same!

When does it make sense to contribute to a traditional 401k rather than Roth 401k? If you are in a higher tax bracket today than you expect to be in retirement, then you are better off in a traditional 401k. You save the tax today and agree to pay the tax when you pull the money out in retirement. Let’s?say you are in the 35% tax bracket today and expect to be in the 22% tax bracket in retirement, you are better off putting your money into the traditional 401k.

Conversely, if you expect to be in a higher bracket in retirement, you are better off contributing to a Roth 401k. Why? You pay the taxes today at the lower rate. When you pull it out in retirement, you pay no tax at the higher rate.

How do you know your projected tax bracket comparison? That’s where planning comes in. Feel free to give us a call and we can set up time to do a tax planning session.

Jared Kline, CFP, EA

Kellett Wealth Advisors

513-768-2238

www.kellettwealth.com