Q: I’m contributing to my 401(k). Should I designate those as regular contributions or Roth contributions?

A: Depends. When do you want to pay your taxes?

Here’s a quick refresher on the tax consequences of Regular vs Roth contributions–and the timing of the payment of taxes.

  • Regular 401(k) contributions are tax-deductible and reduce the amount of income you must report on your income tax return in each year you make a regular contribution. In other words, part of your regular 401(k) contribution comes from tax savings.
  • When distributed, regular 401(k) contributions and earnings are taxed as ordinary income.
  • In the year you turn age 70 1/2, you are required to take a minimum distribution of the balance in your regular 401(k) account.
  • You cannot deduct a Roth contribution. The amount you contribute is made from after-tax dollars.
  • You are not required to take a minimum distribution from your Roth account (but your non-spouse beneficiaries must.)
  • When distributed, earnings on Roth contributions might* be tax-free AND your initial contribution is never taxed.

Some people decide to make a regular contribution versus a Roth contribution on tax consequences. The logic is if your tax rate in the year you make your 401(k) contribution will be…..

  • …..the same as the rate when you withdraw the money, it should make no difference if the contribution is regular or Roth.
  • …..lower than the tax rate when you withdraw the money, make a regular contribution.
  • …..higher than the tax rate when you withdraw the money, make a Roth contribution.

Do you know what your tax rate will be in retirement? (Bonus Question: Do you know your tax rate now?)

If claiming the tax deduction will materially impact your ability to make a larger contribution to your 401(k), make a regular contribution.

If you have a very low tax rate now, a Roth contribution can be a good choice–especially if you expect in future years to see your income grow with your career.

If the ability to postpone a distribution from your 401(k) account will be advantageous given your retirement income planning, then make a Roth contribution.

* What do you mean, “Earnings on Roth contributions might be tax-free?” To receive tax-free treatment of the distribution of earnings, the distribution must be “qualified”, i.e., occur after age 59 ½ AND the Roth account has been in existence for 5 years.