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Choice between pre-tax and Roth 401(k) plans trickier than you think


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You may have to decide between Roth and pre-tax 401(k), depending on whether you are a current or future employee. It may prove more difficult than you think.

The difference is that pre-tax 401k deposits lower your adjusted gross income and grow tax-deferred. This means you will pay levies for withdrawals. Roth 401(k), however, contributions do not provide an upfront writeoff. However, earnings are free of tax.

Financial experts warn that there could be additional tax tradeoffs. You’ll have to consider all the options before you divert funds.

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According to the Plan Sponsor Council of America, 86% of all 401(k), plans will offer a Roth account by 2020. This is up from 75% for 2019.

Ken Waltzer is a certified financial planner and co-founder of KCS Wealth Advisory. 

Tax-free Roth contributions are a good option if you anticipate higher income and/or lower taxes. However, tax-deferred Roth contributions can be more beneficial if your earnings are expected to decline.

Michelle Gessner is a Houston-based CFP, founder and CEO of Gessner Wealth Strategies.

She said that Roth contributions are often rejected by investors if the tax bracket is high. They want to take the deductions associated with regular 401(k).

The upfront write-off might not be worthwhile if there are potential consequences for taxable. required minimum distributionsShe said, 

Social Security and Medicare Costs

A person withdraws money tax-deferred from a 401 (k) to increase their income. This can trigger Social Security levies and raise Medicare premiums. 

These formulas are for Social Security taxes, Medicare Part BAnd Medicare Part DYou can use modified adjusted gross, or MAGI.

Half of Social Security payments and MAGI exceed $34,000 (or $44,000 for joint returns), then up to 15% of these benefits could be taxable.

The bigger problem for those who have retired above certain income levels is the Medicare Part B surcharge, also known as the IRMAA (Income Related Monthly Adjustment Anmount).  

Medicare Part B premiums are $170.10 in 2022. Payments go up if income is greater than $91,000 ($182,000 for joint filers). Calculated using MAGI data from the previous two years.     

Gessner stated that Roth withdrawals will not show up in tax returns. Therefore, retirees do not have to worry about the distributions increasing Medicare premiums.

Diversify your taxes

Experts advise that you consider diversifying your investments by creating both pre-tax as well as after-tax funds, since no one knows what the future tax rate will be.

Catherine Valega is a CFP, wealth consultant and Wealth Advisor at Green Bee Advisory, Winchester, Massachusetts.

It may be possible to create a more efficient retirement income plan if there are both pre-taxed and after-tax assets, said she.