MONEY HACKS: Should Your Retirement Savings be Pre-tax, Roth, or Both?

Roth utilization in 401(k)s keeps growing, yet there is still some debate among advisors on which type – Roth or pre-tax, makes the most sense for each investor and their career stage (among other things). Today in this Money Hacks episode, Alex shares why he’s a big believer that Roth makes sense for MOST investors, and why many more of us should be saving Roth in our 401(k) or 403(b) accounts.

Check out these resources:

• Want to get technical? Here are some good questions to ask yourself too.
• Traditional 401(k) vs. Roth 401(k): Which should you choose? 

Any money questions you’d like answered? Our Money Hacks series is created from conversations we have with employees, investors, savers, and all people planning for their financial futures. What topics are on your mind for our next episode? Email us here!

Video Transcript:

Hey, this is Alex with AFS 401(k), and welcome to episode # 81 of Money Hacks. As many of you know, these sessions are short, direct videos on different personal finance topics that we think are important to investors and savers when it comes to your financial life, and today I'm talking about Roth. So, in most 401(k) plans or 403(b) plans, you have the ability to save on an after-tax Roth basis. A lot of investors know about Roth savings via Roth IRAs and inside our retirement industry, there is an ongoing discussion and debate as to whether you should save on a pre-tax basis, kind of one of the frameworks of the 401(k) plan versus a Roth basis. And while our content is geared towards investors, savers, and the employees we serve as retirement consultants I have some peers in the industry that are doing great videos for retirement committees and plan sponsors and I think this video has a dual purpose in that. And so, I'll just call out two of my friends and industry practitioners, Jeanne Fisher and Jake Rushton, who had a debate maybe a month or so ago about Roth versus pre-tax, and I am squarely and I think even more so now in favor of Roth investing for the vast majority of investors, not all, but for most investors, when it comes to your long-term retirement savings and part of the reasoning is simple.

So, when you're putting money into a 401(k) or a 403(b) or even an IRA on a Roth basis, you're doing so after-tax, you're getting taxed today, but that money becomes tax-free in retirement. Assuming you meet some basic requirements, you've had the account open for at least five years, for example. And so, you, you get to all of that tax-deferred growth and accumulation, and then at retirement age to start taking the money out it's tax-free and part of the debate, I think the criticism, the Roth would be well you're paying tax today, but if you did it pre-tax and you got all that tax for growth at the end of the day, that money you're saving on a pretax basis today could be invested and grow as well. Then, so you have this additional bucket, but the reality is when most investors make the decision to save, either Roth or pre-tax, they're not necessarily deciding to save 5% Roth versus 7% pre-tax. Most people are saving, saying, I'm going to save 5% or I'm going to save 10%.

Should I do a pre-tax or should I do it, Roth? And if you fall into that category or if you're, you know, a great saver and you say, I'm going to put the maximum in this year, it's $19,500. Should I do that pre-tax or Roth? Then I think in, in most scenarios, unless you're getting really, really close to retirement, Roth is the way to go because the compounding growth of those contributions over a 10-, 20-, or 30-year period creates this big bucket of assets for you, this big account balance that is now Roth, and you can take the money out tax-free. Now in a perfect world, if you were going to save 5% Roth or 5% pre-tax and you did it pre-tax and then you took the money that you saved on your tax liability, the extra thousand or $1,500 or $2,000, and invested that money to it's probably a wash the comparison when you get to retirement.

But in reality, we don't do that. Most people don't take those tax savings that you get on saving pre-tax and invest that as well. We end up usually spending that money or is that really real money, it's shadow money because it just lowers our tax liability. We never see that extra money as, as an investment vehicle.

So, with that kind of behavioral approach to how we save and invest, I'm a big believer that Roth makes sense, and many more of us should be saving Roth in our 401(k) or 403(b) accounts, but we don't because you know, automatic enrollment typically happens on a pre-tax basis or the standard contribution when you go in and you're looking to make your contribution to the 401(k), usually, it seems like it was a little more geared towards traditional or pre-tax savings. So, my takeaway from this session is to revisit your own financial picture and explore if saving Roth and paying the tax today would benefit you 10, 20, or 30 years down the road to have that tax-free money in retirement.

In most cases, it does and take that step to perhaps change your traditional pre-tax, 401(k) deferral into Roth. It's going to reduce your take-home pay a little bit more once you do it, but the long-term growth and success for your financial picture could be exponential. So, I hope this is helpful, if you have more questions on Roth versus pre-tax, we have a session or I think a recorded session to Roth or not to Roth, you can check on our MoneyNav site. We'll see you again next time. Thanks!