Having been retired seven years the idea of tax-free income is appealing especially when most of my Social Security and all of my pension is taxed. I wish now I had used my employers Roth 401k option.
However, there is a debate as to which strategy is better; pre-tax contributions now or after-tax contributions now, taxes paid later or sooner? When will you be in the higher tax bracket? Which option will give you the best spending power in retirement?
A new study says there is a clear winner; the Roth 401k or the Roth IRA. However, there is a caveat. The assumption is that the participant’s savings rate does not drop when choosing the Roth. So, if you are saving 10% on a pre-tax basis, to maximize your spending power in retirement, when you switch to a Roth you must stay at 10% thereby lowering your take home pay by your tax rate times the value of the 10% per-tax amount. Let’s say you are earning $1000 a week and saving $100 pre-tax which become taxable. If you are in the 15% effective tax bracket, your take home drops by $15.00.
In return, when you need your 401k in retirement every penny you take out is tax-free. This may allow you to take out less above the minimum required distribution or spend less of the RMD.
New research shows that employees who choose a Roth 401(k) from their company’s menu of retirement plans might end up with more purchasing power in retirement than if they pick a traditional 401(k).