The Curious Math of Roth 401(k)s: You Can Save More Than If You Use a Pre-Tax 401(k)

If your 401(k) offers a Roth option, how do you know if you should contribute to it instead of the usual, pre-tax 401(k)?

The Usual “To Roth or Not?” Advice

The typical advice is to look at your current tax rate and try to guess whether your future tax rate will be higher or lower.

• If it’ll be higher, then contribute to the Roth now.  You’ll pay taxes now, but avoid taxes later, when they’ll be higher.
• If your future tax rate will be lower, then contribute to your pre-tax now. You get the tax break now, when it’ll be higher, and pay taxes later, when they’ll be lower.

Even though this involves guesswork and assumptions (who knows what tax law will be in a few decades? who knows how much income you’ll have later?), it’s a good starting point.  

Sometimes the answer is obvious. You took a half-year sabbatical and earned very little money this year, so your top tax rate is low. Use the Roth!

And sometimes it’s not. Your top tax rate is 34% this year. Your future tax rate could reasonably be higher, as you continue to grow your career and earn more money. But it could also reasonably be lower, if you move to a different state or change roles or careers or take time off to parent. In which case, go halvsies!

[By the way, this discussion applies to IRAs, too, but their contribution limits are much lower than a 401(k)’s, and most people in tech have access to a 401(k), so I’ll focus there.]

An Additional Consideration: You Can Save More to a Roth 401(k)

One benefit of a Roth 401(k) that I rarely see people discuss is that you can simply save more money to a Roth than to a pre-tax 401(k).

“What?!” you say. “I can only contribute $18,500 in 2018 to my 401(k). And that limit stands, whether I contribute to the Roth account or the pre-tax account. ” [At least, I imagine you saying that, though, realistically, you don’t. Please just roll with me and my shoe-horned narrative device.]

But it’s true!

Saving a dollar to your Roth 401(k) is in fact more savings than saving a dollar to your pre-tax 401(k)

And certainly putting $18,500 into your Roth 401(k) is more savings than putting $18,500 into your pre-tax 401(k).

“How can this be?!” you ask.

Let’s walk through an example. Let’s say you save $100 to your 401(k).

In Scenario #1, you put that $100 into your pre-tax 401(k). When you take that money out in retirement, you’ll have to pay taxes on it. Let’s say you’ll owe 30% in taxes. Which means that, effectively, the government owns $30 of your $100 401(k). You only own $70 of it. Which means that even though you contributed $100, you only really saved $70.

In Scenario #2, you put that $100 into your Roth 401(k). When you take it out, you don’t pay any taxes (that’s the deal the IRS strikes with Roth).You get to keep the full $100. So, by gum, you’re not only contributing $100, you’re also saving $100.

So, if we’re talking the full 401(k) contribution:

• With a Roth, you’re saving $18,500.
• With a pre-tax IRA, you can save a maximum of $18,500 minus future taxes. If your future tax rate is 30%, you’re saving only $12,950 ($18,500 – 30%).

It works this way because you’re actually using more money when you save to your Roth. You don’t get any tax reduction because of it. It costs you a full $100.  Whereas, when you contribute $100 to your pre-tax IRA, it only costs you $70.

Yes, please, take a moment to think about this. I, at least, find it somewhat non-obvious, and I have to actively engage my brain to fully grok it.

Why This Probably Matters to You

The curious math of Roth 401(k)s…sure, it’s a fun brain teaser. But why should you care?

Because the IRS limits the number of dollars we can put into retirement accounts that give us tax benefits, like 401(k)s and IRAs. And you might need to save more than that.

After all, a rule of thumb about retirement savings is that you should save 15% of your income for retirement. That $18,500 401(k) max is 15% of $123,000.  So, if you make over $123,000 a year, you can’t save a full 15% of your income by using just your 401(k).

Or let’s ignore the rule of thumb and think more specifically about your situation.

• Are you 40 and just really starting to think seriously about saving for retirement? Well, if you haven’t been saving assiduously up until now, you’re going to have to save more, maybe much more than 15%.
• Or are you 30 and hoping to retire by the age of 45? That 15% ain’t gonna cut it. You’ll need more like 30+% saving rate just for early retirement/financial independence.

401(k)s are generally great savings devices. So, it’d be nice to be able to stick with them. In addition to the objective financial benefits, there’s also the giant benefit of them being easy to use, which makes it so much more likely that we’ll actually do the savings.

Saving to your Roth 401(k) is one way to get more savings capacity out of your 401(k).

Other Things to Think About

Personal finance follows the 80/20 rule: you get most of the benefit from just a few, simple decisions. However, there are several other considerations when it comes to your 401(k) that can help you get that remaining 20%.

• Maybe you want to save more for retirement, even after getting more savings out of your 401(k) with Roth contributions. You’ll need to save for retirement elsewhere, on top of your 401(k).
• If your current tax rate is high enough, saving to a Roth might just be a silly choice, and you’d benefit more from a pre-tax contribution. Now you need to save all those tax savings you just got (plus some, most likely, because if your tax rate is high enough, that means you’re making a lot of money).
• After-tax contributions to your 401(k)–if your plan allows it, which not all do!– can give you Roth money in the future, when you roll your 401(k) into an IRA.
• If you make over $135k as a single person in 2018, or over $199k as a couple, you simply may not contribute to a Roth IRA. If you want Roth money in the future (and you would definitely benefit from having that), your Roth 401(k) might be the only way to get it.

If I could leave you with one piece of advice, it’d be to save 15% of your income however you can. The Roth vs. pre-tax decision is simply an optimization.

Do you want to be certain you’re making the right choices with your 401(k)? Reach out to me at  or schedule a free consultation.

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