Intellectual Capital

Retirement Investing

Evaluating Roth and Pretax Retirement Savings Options

Roger Young, CFP®, Senior Financial Planner

Executive Summary

  • There are two ways to get Roth account exposure: a Roth IRA or through a retirement plan that has a designated Roth account
  • While Roth IRAs have income eligibility limits, those do not apply to contributions within a 401(k) plan
  • Pretax contributions are generally preferable for people who expect their income tax rate to decrease in retirement.
  • Having Roth accounts may make sense for tax diversification, flexibility and as a hedge against higher tax rates.  

Many investors have the ability to save for retirement with Roth contributions. There are typically two ways to get Roth exposure:

  • Roth IRA: You must have earned income and meet IRS income limitations. You are not required to take distributions, and you have access to your contributions, anytime, tax-free.
  • Through your 401(k) plan1: Your plan must offer a designated Roth account. There are no income limitations, but distributions are generally required upon attainment of age 70½ unless you roll it over to a Roth IRA.

If you can save with a Roth option, it’s important to evaluate whether you may benefit more from pretax or Roth retirement contributions.

A Roth contribution, unlike a traditional pretax contribution, doesn’t reduce your taxes today, but qualified distributions2 are tax-free. The primary factor to consider is whether your marginal tax rate will be higher or lower during retirement. If your tax rate will be higher later, paying taxes now with the Roth makes sense. If your tax rate will be lower, you want to defer taxes until then by using the pretax approach.

For someone whose marginal tax rate remains constant from the working years through retirement, choosing between a Roth and pretax contribution is a toss-up mathematically,3 but Roth usually wins in a tiebreaker.

Unfortunately, tax rates are hard to predict due to changes in the law, income levels, or both. Consider the following hypothetical taxpayers that may help illustrate the pros and cons of the two types of contributions.

Individual Profile Example4 Likely Benefits From
Millie Young person in a low taxbracket who is likely to be in a higher bracket later Earns $50,000; 12% bracket (single). Next higher bracket is 22%. Roth
Edward Someone with tight cash flow who wants the company match while maximizing paycheck Earns $30,000; 12% bracket (single). Contributes 6% to 401(k) to get full match. Pretax provides $216/year more net pay. Pretax
Xavier Person near peak earnings years who could be in a lower bracket during retirement Household income $360,000; near bottom of 32% bracket (married). Next lower bracket is 24%. Pretax
Bernard Someone who already has large pretax balances and wants to minimize RMDs in retirement Earns $160,000; 22% bracket (married). Approaching retirement with $3.2 million 401(k). RMD (around $171,000 at age 805) plus Social Security is more than his spending need, and could bump him into 24% bracket. Roth
Patricia A prodigious saver who can afford to contribute the IRS maximum either way Earns $130,000; 24% bracket today (single), with uncertain outlook for future rate. Can comfortably save $18,500 in 401(k). After-tax savings are effectively $4,440 higher with Roth. Roth

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Evaluating Roth and Pretax Retirement Savings Options

Having a meaningful level of Roth assets via a Roth IRA or Roth option in a 401(k) can help you manage taxes effectively in retirement.

1Designated Roth accounts may also be offered in 403(b) and governmental 457(b) plans.

2Generally, a distribution is qualified if taken at least 5 years after the year of your first Roth contribution and you’ve reached age 59½.

3Kutner, George W.; Doney, Lloyd D.; Trebby, James P. Investment Performance Comparison Between Roth And Traditional Individual Retirement Accounts. Journal of Applied Business Research (JABR), [S.l.], v. 17, n. 1, Feb. 2001. ISSN 2157-8834. Available at: cluteinstitute.com/ojs/index.php/JABR/article/view/2064. This analysis directly compares Roth and pretax contributions that result in equivalent impact on after-tax pay at the time of contribution. For most people, our view is that this methodology is more realistic than one which assumes an individual will fund a taxable account with the tax savings generated by a pretax contribution.

4Brackets are for federal taxes, based on rates as of January 1, 2018. While rates are scheduled to revert to pre-2018 levels after 2025, those rates are not shown in this table. Note that reversion to generally higher rates in the future would make Roth savings relatively more favorable today. Income refers to gross earnings; current bracket reflects the standard deduction and potential retirement contributions. State taxes are not considered in the examples. Married status reflects joint filing.

5Based on 5.35% RMD at age 80 on $3.2 million balance. The steady balance assumes earnings on the account until that point are sufficient to fund withdrawals. 

This material has been prepared by T. Rowe Price Group, Inc., for general and educational purposes only. This material does not provide fiduciary recommendations concerning investments or investment management. T. Rowe Price Group, Inc., its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this material.

Retirement plans and IRAs should be considered long-term investments. Both retirement plans and IRAs generally have expenses and account fees, which may impact the value of the account. Nonqualified or early withdrawals may be subject to taxes and penalties. Maximum IRA contributions are subject to eligibility requirements. For more detailed information about taxes, consult a tax advisor regarding personal circumstances.

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