Now or Later?
Audio Version: Let Me Hear It!
Instant coffee, instant photos, instant underpants (yep, they’re a thing!). Instant gratification has become a cultural norm. But sometimes, waiting can provide greater satisfaction in the long run. For those of you (and/or your spouse) that are offered a Traditional and Roth 401(k) option through work, the decision on which plan to fund essentially comes down to whether you want the income tax benefit now or later. Specifically, does it make more sense to receive a tax deduction this year or tax-free income later? A quick summary of tax benefits and timing for each plan type follows.
How to Choose? If you believe that your tax bracket is higher now than it will be when you expect to withdraw the funds in retirement, then it likely makes more sense to take advantage of the current-year tax deduction you would get by contributing to a Traditional 401(k). If, on the other hand, you believe that your tax bracket is lower now than it will be when you plan to withdraw funds, then you might be better off funding a Roth 401(k).
It’s also important to consider the value of an income tax deduction throughout your working years. Deductions become more valuable as your income goes up. If you are just starting out and believe your income is lower than what it will be in later years (insert prayer emoji here, flesh color of your choice) then the deduction may be more valuable in the future. So, it may make sense (pun intended) to forgo the income tax deduction now with Roth contributions and switch to a Traditional 401(k) in peak earning years. If you’re somewhere in-between, a combination approach may be worth considering. You can contribute to both plans in equal, or unequal amounts, provided your total contributions do not exceed $18k ($24k if age 50+) in 2015.
Before Googling instant underpants, get with your financial advisor to help make the right 401(k) decision for you!