Recently I spoke on a panel of financial planners, here in my home of Bellingham, WA. The two other planners immediately made clear their love for Roth accounts. I was a bit taken aback because I don’t hold that unequivocal enthusiasm.
As I reflected on it, I realized that the audience we were speaking to (people whom my colleagues are likely to work with) was a bit different from the demographic I work with. Largely, my clients have higher incomes, live in higher-income-tax states (hard to be lower, given that Washington doesn’t have an income tax), have different forms of compensation, and have access to more “luxurious” workplace retirement plans.
The experience made me want to collect my thoughts about the “pre-tax vs. Roth contributions” topic, despite it being one of the most overdone and usually uninteresting topics in personal finance.
Usually, the resolution to the “pre-tax or Roth?” question is pretty basic: “If you think your tax rate will be higher when you’re retired, contribute Roth now. If you think your tax rate will be lower when you’re retired, contribute pre-tax.”
And, you know, if you can remember only one thing when making the choice, that’s probably the best one thing!
But the discussion can be soooo much richer (and I think more interesting, but I realize most people don’t share such feelings). I really like these two articles about this topic because they go into a lot of that nuance, are both persuasively argued…and happen to be on opposite sides of the debate:
You might think this is a pure math problem, but I would argue there’s a lot of behavioral input that goes into making the right decision…for you. (And let me take this opportunity to reiterate that this applies to all of personal finance: It’s not just a math/optimization problem.)
What are Pre-Tax and Roth Contributions?
Let’s just make sure we’re starting with the same basic understanding of the terminology here:
When you contribute to your 401(k), you can contribute “pre-tax” or “Roth.”
When you contribute pre-tax, every dollar you contribute is $1 of income you don’t get taxed on this year. If:
- You earn $400k and
- Contribute $20k pre-tax to your 401(k), then
- You pay taxes on only $380k, which saves you in taxes.
When you contribute instead to Roth, you still pay taxes on that contributed amount, so you pay taxes on the full $400k.
One point to Pre-tax.
But later on, in retirement, when you take the money out of your 401(k), you pay taxes then on the money in your pre-tax account. By contrast, you don’t pay taxes on the money you take out of your Roth account.
One point to Roth.
The lesson here: The IRS is gonna get its pound of flesh, either on the front end or the back end.
I don’t want to belabor this discussion, so if you want to learn more, please see what Investopedia has to say about the two kinds of contributions, two kinds of accounts.
A couple clarifying notes:
- I’m talking about that $23,500 portion (the 2025 limit) of your 401(k) contribution, not any “after-tax contribution,” a wonderful feature that many tech companies offer.
- “Pre-tax” and “Roth” apply to IRAs, too. I’m focused on 401(k)s for a couple reasons: you can put so much more money into them than into IRAs ($23,500 vs. $7000 in 2025), and there are no income limitations on tax deductibility for and contributions to 401(k)s, as there are for IRAs.
Why You Might Choose Roth
Let’s start with the classic analysis: a comparison of tax rates now vs. in retirement. It has more nuance than you might anticipate!
You think your tax rate in retirement will be higher.
There’s a rule of thumb saying that you should contribute Roth when you’re younger and earning less. We just assume, generally, that your income—and therefore tax rates—are lower when you’re younger.
When you’re older and later in your career, earning more and thus paying a higher tax rate, that same rule of thumb tells you to contribute pre-tax.
To put numbers to it:
- If you contribute Roth now, when your tax rate is 32%, you don’t save any taxes.
- But if you expect your tax rate to be 35% in retirement, and you’ll be able to withdraw Roth money tax free, then that’s a win!
- You paid taxes at 32% instead of 35%.
While the math makes sense, it begs the question: How can you possibly know what your tax rate will be in 20 or 30 or 40 years? Both your finances and the government’s tax structure can change in meaningful and unpredictable ways.
Further confusing the matter is that your income (technically, your Adjusted Gross Income) in retirement can increase the premiums you pay for Medicare Parts B and D and the percent of your Social Security income you owe taxes on, which create in effect higher tax rates on your income. The more Roth income you have (which doesn’t get included in your AGI), the more chance you have of avoiding these “effective” taxes.
You live in a state that doesn’t impose income tax, and you might move to one that does.
In a way, this is just a specific case of the above tax rate comparison, but I think it warrants being discussed on its own.
If you live in Washington state, your income tax is only your federal rate. There is no state income tax. (Would that there were. Good lord does it make state administration and revenue raising and adequate school-funding a nightmare.)
If you plan to stay in Washington (or another no-income-tax state) while in retirement, then this isn’t really an issue. But in retirement, if you might move to California or NYC, where there is a high income tax rate, then your current tax rate, even if you’re earning a high income now, might be lower than it will be in retirement.
Similarly, there are several states that impose an income tax, but they specifically exclude distributions from retirement accounts from taxation (ex., Illinois, Iowa), which makes it as good as Washington for this conversation.
(Note that while a couple states don’t give you income tax deductions for contributions to IRAs, all states give you tax deductions for contributions to 401(k)s. Yet another way that 401(k)s are so much better than IRAs and it’s a moral crime that your access to such accounts depends entirely on your employer’s choice, not yours.)
You earned way less income this year than usual.
This is yet another variation on the “current tax rate vs. future tax rate” analysis.
Did you not work for the first, say, eight months of the year, and earned money only for the last four? Lots of this going around nowadays, what with frequent tech layoffs.
You’ll probably be at a lower tax rate than you’re accustomed to and more likely to be at a lower tax rate than you will be in retirement.
It’s likely a good year to make your 401(k) contributions (during those four months, when you have access to your job’s 401(k)) Roth. (As an aside: It might also be a good year to do a Roth conversion, shoveling even more money into a Roth bucket and out of a pre-tax bucket.)
Your future tax rate on this money is now predictable. It’s 0%.
This reason has nothing to do with math.
I personally contribute Roth because I value predictability. (I mean, I also live in Washington state, with no income tax, and I’m not at the top federal tax rate.) I don’t know what tax rate I’ll have in retirement. But I do know what tax rate I’ll have on all of this Roth money. And that tax rate iiiiiis? 0%.
So now, to the extent I have Roth money, I don’t have to care about my tax rate in retirement. Not having to care is a wonderful feeling.
(For your Not Caring entertainment, if you’re a woman in perimenopause or menopause, I present the We Do Not Care Club. My favorite part is that she always has three pairs of glasses hanging off her.)
You can effectively SAVE more to a Roth 401(k) than to a Pre-Tax 401(k).
Hunh? Isn’t the contribution limit $23,500 (in 2025) no matter if you contribute Roth or pre-tax? Yes, yes it is.
But in effect, the money you contribute to your 401(k) is only worth $23,500 minus the taxes you will owe on it in the future. Whereas the $23,500 you contribute to your Roth 401(k) is worth the full $23,500.
That said, theoretically, if you save $8700 in taxes by contributing to your pre-tax 401(k) and then save that $8700 elsewhere (like in a taxable investment account), you will have saved kinda the same amount as if you’d made a Roth contribution.
Problem is, a lot of people won’t think about it that way and even if they did, they wouldn’t get around to setting up the system by which they save and invest that $8700. So, this argument for making Roth is more behavioral than it is mathematical.
(Why $8700? Because the highest federal tax bracket is 37%, and 37% of $23,500 is roughly $8700.)
You Want Access to Some of this Money Before Age 59 ½.
If you end up retiring early or if a large, unexpected expense comes up before retirement age-ish, it can be really helpful to have access to retirement money. Usually, however, if you take money out of IRAs or 401(k)s before age 59 ½, you get penalized (on top of owing whatever income tax is required).
A big exception to these constraints is contributions to a Roth IRA. If you have contributed to a Roth IRA, you can pull those contributed dollars out any time, for any reason, no penalty, no tax. How helpful!
Unfortunately, if you have contributed to a Roth 401(k), withdrawing that money isn’t nearly as nice. There is a way to fix this, though! When you leave your job, you can roll your 401(k) over in such a way as to make that Roth money equally accessible.
If you have both pre-tax and Roth money in your 401(k), when you roll it over:
- Roll the pre-tax money to either your new 401(k) or a pre-tax IRA. For today’s discussion, it doesn’t matter.
- Roll the Roth money into a Roth IRA, specifically. (Yes, you can do this, rolling different buckets of money in your 401(k) to different destinations.) Now you have that kind of unfettered access I mentioned above.
Warning: Don’t Make Everything Roth
Keep in mind that it’s ideal—from the perspective of minimizing lifetime taxes—to have at least some pre-tax money in retirement.
Why?
Because at least some of the money in your pre-tax accounts is going to come out at either 0% or low % tax rates. Which means you get the tax benefits now when you contribute and also later when you withdraw.
A primary way that money will come out at low or 0% tax rates is thanks to our income tax brackets:
In 2025, the first $23,850 (for a couple) and $11,925 (for a single person) of income are subject to no income tax. After that, it’s only a 12% tax rate up to $96,650 and $48,475, respectively.
Your withdrawals from a pre-tax retirement account count towards that income. So, some of your pre-tax contributions now (at a high tax rate) can be taken out at such low (or even zero!) tax rates in retirement.
Below I discuss other ways to get money out of your pre-tax account completely tax-free.
Why You Might Choose Pre-Tax
Most of the reasons below boil down to “You think you’ll have a lower tax rate in retirement than you do now, when you’re making the contribution.” But I think it merits going through specific scenarios because it’s often not obvious!
You live in a high-tax state now and might not in retirement.
Making $100ks and living in California? You’re gonna have a banger of a combined tax rate between federal and state.
If you’re married and make $700k combined, and you live in California, combined federal and state income tax rates = 44.3% (35% + 9.3%). And if you make enough money to max out both state and federal income tax brackets, you’re paying roughly 50% (37% + 12.3%) on your topmost income dollars!
At those tax rates, it’s pretty nice to contribute $23,500 to a 401(k) and have it “cost” you only about $12,000 after your tax benefits.
If you plan to move for retirement to a state that has no income tax (hello from Washington) or a state that has an income tax but excludes distributions from retirement accounts from it, that argues for a pre-tax contribution now.
Get the state income tax tax break now and later. Nice!
You plan to donate to charity in retirement.
One way to not pay income tax on your pre-tax money is simply to not take it out of your retirement accounts. Clever, eh?
Problem is, the federal government is on to you and your schemes! The IRS forces you to take money out, via the “Required Minimum Distribution” (RMD; see Investopedia’s explanation).
For most people who read my blog, it will be at age 75 that you must (i.e., are “required” to) withdraw (i.e., “distribute”) a certain “minimum” amount of money from your pre-tax retirement accounts each year. And when that money comes out, you’ll have to pay income taxes on it.
Unless!
First, you roll your 401(k) into an IRA. Then you direct that RMD money straight from your IRA to a 501(c)3 charity. That is called a “Qualified Charitable Distribution.” The amount of your RMD that you direct to charity never hits your tax return. Voila, no taxes.
Again, you get the tax breaks now and later. Sounds pretty savvy to me.…
You plan to donate to charity when you die.
When you die with money in your pre-tax retirement accounts, and you leave it to a loved one (other than your spouse), they are forced to withdraw the money over 10 years and pay income taxes on those withdrawals.
At this point, you’re dead, so you might ask “what do I care?” And…fair! But if you’re also interested in optimizing for taxes for your heirs, you’ll think about this.
Just as you can direct money to a charity when you take RMDs from retirement accounts during your life, you can leave your pre-tax money to a charity upon your death. The charity doesn’t pay any taxes and they receive the full value of the account. (By contrast, if your adult child inherited your $1M IRA, they could receive only, say, $600,000 after taxes.)
At the same time, you can leave your other buckets of money (taxable investments, Roth accounts, etc.) to your adult child, which often gives them all that money with no tax bill.
Again, you’ll have gotten the tax deduction when you contributed…and no one had to pay taxes upon withdrawal. Neato.
You anticipate having years of no/lower income before or in the early years of retirement.
This is where the Roth conversion comes into play.
How does this play out?
- You make pre-tax contributions now, and get the tax deduction now, at your current high tax rate (let’s say 35% federal, 9.3% state).
- Then in 5 years when you take a sabbatical or retire early, and you have no-to-low income, you can convert that pre-tax money to Roth. Yes, you’ll pay taxes on this conversion, but it’ll be at a lower tax rate.
Now, in practice, many of my clients who have taken sabbaticals haven’t really been able to take advantage of Roth conversions because they are eligible for Medicaid or heavily subsidized ACA policies on their low income. They would lose that eligibility if they did a Roth conversion and are understandably quite loath to lose it.
So, in practice, this is probably most likely to happen in years when the cost of your health insurance doesn’t depend on your income. (If you’re a domestic partner to someone, but you each file taxes single, this is a banger of a proposition. You get health insurance through their employment, but you can purposely incur income without changing the cost of that health insurance. Another time when this can happen is after you become eligible for Medicare, at age 65.)
You have the discipline to save and invest the tax savings.
As I discussed above, contributing pre-tax to your 401(k) effectively saves less money than contributing Roth to your 401(k). But, if you are disciplined enough (or follow your financial planner’s advice sufficiently) to invest that tax savings (which we calculated as being $8700 in the above example) in a taxable account, then you have more or less saved the same amount of money.
In Practice, It’s Often Pretty Obvious.
If I have made you feel as if the “pre-tax vs. Roth” decision is overwhelmingly complicated, then let me reassure you that, in practice, with my clients at least, the decision is usually pretty simple.
Here’s a typical profile of a client I work with:
- They live in a state or city with high income tax rates (ex., CA and NYC).
- They have a high-enough income that they can save a lot of money in addition to the $23,500 pre-tax or Roth contribution limit.
- Their 401(k) allows them to make after-tax contributions (immediately converted to Roth) of roughly $30,000 on top of that $23,500, and more even to their taxable account.
- They are in their 30s or 40s and have probably one or two decades before full-fledged retirement planning, and even more decades before they die. Which is to say: there’s a looooot of unknowability in front of them.
So, what do they do? They get current tax breaks by contributing $23,500 pre-tax and then they also contribute after-tax-turned-Roth money and sometimes even to a taxable investment account, so now they have a nice pile of all three kinds of tax buckets (pre-tax, tax-free, taxable) in retirement.
If you find yourself struggling to make this decision, here’s my parting advice:
I don’t want to downplay the importance of minimizing taxes. Over the course of a lifetime, the right decisions can save you $10ks, $100ks, or possibly $Ms. But in cases when there’s no clear winner, then I’d stick with just trying to save a bunch of money and then wait for the tax picture to get a bit clearer.
Do you want to make sure you’re saving for retirement in a tax- and life-optimized way?