Pre-Tax or Roth: How Should You Contribute to Your 401(k)?
When I lead a Personal Finance 101 session, without fail, someone asks whether they should be contributing to their 401(k) on a pre-tax or Roth basis. While there are no one-size-fits-all solutions, this is how I explain to attendees what they should consider.
Tax Bracket
No one can predict with exact certainty how their annual income will track, but if you are a recent graduate or only worked for a portion of the year, you may be in a relatively low tax bracket (i.e., 10% or 12% for 2025). If you expect your annual income to increase as you progress in your career, it may make sense to contribute to your 401(k) on a Roth basis. That is, pay taxes on the money you contribute today while you're in a low tax bracket, and enjoy tax-free withdrawals later.
On the flip side, if you're in the highest tax bracket (i.e., 37% for 2025), it could make sense to contribute to your 401(k) plan on a pre-tax basis. Since you're in the highest marginal tax bracket, you'll realize a bigger tax benefit for contributing on a pre-tax basis, and may be more likely to be in a lower tax bracket when you begin taking withdrawals.
To help you understand what the difference in current year tax savings would be, let's say you plan to contribute $10,000 to your 401(k) on a pre-tax basis. If you were in the 10% marginal tax bracket, the $10,000 contribution would decrease your current year taxes by $1,000 ($10,000 x 10%). On the other hand, if you were in the 37% tax bracket, the $10,000 contribution would save you nearly four times as much in taxes in the current year — $3,700 ($10,000 x 37%).
Put another way, being in a lower tax bracket results in less tax savings for pre-tax retirement contributions, but that also means the tax costs of contributing to a Roth are less as well. On the other hand, being in a higher tax bracket results in higher tax savings for pre-tax retirement contributions and higher tax costs of contributing to a Roth.
Tax Diversification
Tax diversification is another key consideration and refers to having investments across contribution buckets rather than being concentrated in just one type.
There are three main types of contribution buckets where you can hold your investments:
Pre-Tax: Money is contributed on a pre-tax basis and when withdrawn, funds are taxed at your marginal tax rate.
Roth: Money is contributed on an after-tax basis. Withdrawals at retirement are generally not taxed.
Taxable: Money is contributed on an after-tax basis. Any income and gains from investments are taxed at short-term or long-term capital gains rates, depending on the type of investment and holding period.
In the past, many people just threw as much money as they could into the pre-tax bucket. While withdrawals from pre-tax accounts are taxed at your marginal tax rate, many assumed they would be in a lower tax bracket in retirement. However, that may not be the case at all.
At age 73, people must begin taking required minimum distributions from their pre-tax accounts, whether they need the money or not. The exact amount of these annual distributions is based on your life expectancy and account balance. As an example, let's say you have a 401(k) with a current balance of $1.5 million and you're 73 years old. According to Schwab’s calculator, your required minimum distribution for this year would be about $57,000. Ignoring deductions and other income, as a single filer, that would put you in the 22% tax bracket. Add to that social security and other fixed payments, and you may be on your way to a much higher tax bracket than you anticipated. The withdrawals from pre-tax accounts not only affect your tax bracket, but could also impact your Medicare Part B and D premium amounts and the portion of your social security benefits that are subject to tax.
Having investments spread across contribution buckets can provide "future you" with flexibility to pull money from pre-tax, Roth, or taxable accounts, allowing you to better control your tax bracket in retirement.
Bottom Line
Deciding whether to contribute on a pre-tax or Roth basis will depend on your individual circumstances, and the right answer could vary from year to year. Key factors to consider include your current and future tax bracket, as well as how concentrated your investment portfolio is around account types.
Generally, for those in lower tax brackets now who anticipate progressing to higher tax brackets, a Roth contribution may make sense. For people in the highest tax bracket currently, but who expect to be in a lower tax bracket later, a pre-tax contribution could be the mathematically optimal solution.
For those ultra savers, your answer may be to do both contribution types through a combination of pre-tax contributions up to $23,500, and utilizing the backdoor Roth IRA and mega backdoor Roth IRA strategies for additional savings.