Dear Liz: I just turned 50. My company has an option to contribute pretax money to a regular 401(k) or after-tax money into a Roth 401(k). Should I put the maximum contribution ($17,500) plus the catch-up ($5,500) into the Roth? Or should I split my contributions?
Answer: Given that you’re close to retirement, putting most of your contributions into the traditional 401(k) is probably the way to go.
Most people’s tax brackets drop once they retire. That means you can benefit from a bigger tax break now and qualify for a lower rate on your future withdrawals.
If you had a few decades until retirement, the math might be different. Younger people with good prospects may well be in a lower tax bracket currently than they’ll eventually be in retirement. In their case, it can make sense to gamble on making after-tax contributions to a Roth 401(k), betting that their tax-free withdrawals in retirement will be worth much more.
You may want to put some money into the Roth 401(k) so you’ll have flexibility with your tax bill in retirement. Being able to choose between taxable and nontaxable options gives you what financial planners call tax diversification. But the bulk of your contributions should still go to the traditional 401(k).
A point that I rarely see addressed in articles like this is that your “tax bracket in retirement” itself depends on how you split your savings between traditional and Roth retirement accounts.
If you have a high income in retirement, but all of it comes from withdrawals from your Roth 401(k)/IRA, then your tax bracket is 0%. You would have been better off putting at least a portion of your retirement savings in traditional, rather than Roth, accounts, to take advantage of that low bracket.
By that reasoning, it follows that pretty much everyone whose federal income tax liability is greater than 0 should put at least some of their savings in traditional accounts – regardless of whether you think tax rates will go up, down, or stay the same.
Or am I missing something here?