Author: Paul A. Carl, CHSA, CPFA^™​Vice President, Retirement Plan Consulting, Registered Representative
 

Years ago, I listened to a retirement plan participant summarize a retirement educator’s lengthy explanation of the differences between pre-tax and Roth employee deferrals. They explained, “If I retire with a $100,000 account balance that is Roth, I get the whole $100,000. If I retire with $100,000 that I contributed pre-tax, I only get to keep a portion of the $100,000 because I still need to pay federal and state income taxes.” It was a simple statement with basic truths.

So why wouldn’t every participant contribute Roth if you receive your entire account balance? 

Prior to EGTRRA , 401(k) plan participants had pretty much one choice for deferring contributions: pre-tax that grew tax deferred. Contributions were withheld from a participant’s pay prior to applying any federal (and state, as applicable) income tax withholding. 

In 2001, EGTRRA¹ introduced the very popular Roth IRA concept to 401(k) plans whereby, if permitted by the plan provisions, an employee could defer contributions on an after-tax basis from the paycheck; these contributions would then grow tax-free provided certain criteria was met. 

The decision to make pre-tax or Roth deferrals is based on the individual’s personal situation. Both are tax-advantaged. Some of the basic questions that a retirement participant should consider:

• Does my 401(k) plan allow for Roth deferrals?
• Do I need a higher net take-home-pay currently?
• Do I want to pay taxes now or later?
• Will I be contributing the same amount regardless of the pre-tax or Roth strategy?
• What tools and calculators have I utilized and what do the projected results indicate?

Regardless of your stance on the pre-tax versus Roth contribution debate, the most important step towards a successful retirement is to save. 

Which method of deferring do you think is best for you?

¹EGTRRA is the acronym for the Economic Growth and Tax Relief Reconciliation Act of 2001.
 

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