Most retirement plan participants have the option of making regular pre-tax 401(k) contributions or Roth 401(k) after-tax contributions. Roth 401(k) contributions (along with all accumulated earnings) can be withdrawn tax-free if distributed due to a qualifying event from an account that has been in existence for at least five years. Regular, pre-tax 401(k) contributions (and the associated earnings) are taxable when removed from a qualified retirement plan.

A rule of thumb: If you believe tax rates will be higher in the future, it makes sense to make more Roth 401(k) contributions now rather than regular 401(k). The logic is that it is better to have your contributions taxed at a lower rate now as opposed to a higher rate in the future (since regular 401(k) contributions aren't taxed until withdrawn).

That rule of thumb can probably be enhanced a bit based upon a participant’s age.

  • Plan participants now in their 20s are probably always better off making 100% of their 401(k) contributions as Roth 401(k) contributions for their entire careers. Given that they have 40 or more years to contribute, the large balances that they could accumulate and withdraw tax-free at retirement make a Roth 401(k) contribution strategy very attractive.
  • Plan participants now in their 30s and 40s probably will benefit from a mixed contribution strategy. In other words, it may be best for them to make some of their contributions as Roth 401(k) and some as regular 401(k).  This is a period of time when participants may be earning good wages and may benefit from the tax deferral that 401(k) contributions provide.
  • Plan participants now in their 50s and 60s may find that making Roth 401(k) contributions provides a way to diversify their overall financial plan.  Some participants may benefit from making only Roth 401(k) contributions because they can afford to pay the taxes now while they are working. Since participants in this age group are closer to retirement, consideration of a Roth 401(k) contribution strategy should be harmonized with a participant's financial plan in retirement.

Regardless of age, every participant should probably explore establishing a Roth 401(k) account since the tax-free withdrawal provisions are so attractive.

Contributing Editor Robert C. Lawton is President of Lawton Retirement Plan Consultants, LLC a Registered Investment Advisory firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. Mr. Lawton has over 25 years of experience working with corporations on their retirement plans and is a Chartered Retirement Plan Specialist (CRPS) and Accredited Investment Fiduciary (AIF).  Mr. Lawton may be contacted at mailto:bob@lawtonrpc.comor 414.828.4015.


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