Ask all your Finance, Insurance, Banking, Investment, Loans, Mortgage related questions and get answers from expert for FREE !
0 votes
asked in Investment by

My question is: should I invest in a traditional 401(k), a Roth 401(k), or some combination of the two? On the one hand, tax rates may be much higher when I retire, and I might be in a higher tax bracket, so a Roth 401(k) would be good. On the other hand, I might be in a lower tax bracket when I retire, so a traditional 401(k) might be better. It's hard to know where I will stand in 30 years.

1 Answer

0 votes
answered by (19.8k points)

First, income tax rates in the U.S. may, in general, rise in the future. If tax rates are expected to rise, then it makes sense to pay the tax now and not later, even if your own income level were otherwise unchanged. While guessing what tax rates might be in retirement does amount to speculation, I suggest there's little chance of income tax rates remaining low in the U.S., with continuing large budget deficits each year.

Second, even when you select the Roth option for 100% of your 401(k) contributions, your employer's matching contributions are still made on a pre-tax basis and will be accounted for in a pre-tax portion of the account! This may make a decision to go 100% Roth easier, considering you'll have some pre-tax dollars as a hedge in case rates or your tax bracket end up actually lower in retirement.

Below is a supporting reference for that second point, from IRS Publication 4530 (PDF), a pamphlet called "Designated Roth Accounts under a 401(k) or 403(b) Plan". Here's the relevant excerpt:

Q. Can my employer make matching contributions on my designated Roth contributions? And, can the matching contributions be allocated to my designated Roth account?

A. Yes. Your employer can make matching contributions on your designated Roth contributions. However, only an employee’s designated Roth contributions can be allocated to designated Roth accounts. The matching contributions made on account of designated Roth contributions must be allocated to a pre-tax account, just as matching contributions are on traditional, pre-tax elective contributions.

[...]

The remainder of the pamphlet is worth reading, too.

Welcome to pfGuru Q&A, is a question and answer site for people who want to be financially literate. It's 100% free. You can ask all your Finance , Insurance, Banking, Investment, Loans, Mortgage related questions and get answers from expert.
© 2017 pfGuru
 
· Disclaimer 
· Privacy Policy
 · Contact Us
...