Pre-tax or Post tax?

Pre-tax or Post tax?

April 29, 2024

A question that I am frequently asked is whether it is better to make retirement account contributions on a pre-tax basis (Traditional) or a post-tax basis (Roth).  The answer to this question is highly specific to each individual and their current/future earnings, however we can consider the way think through this question.

For all retirement account contributions, you are going to pay tax and the concept of something being “tax-free” is not only over-used but also a misnomer in my opinion.  Withdrawing assets out of a Roth in retirement is tax free but that is only because you have already paid taxes on the contributions before you put them in the account.  It’s not that you don’t pay tax, it’s simply that you are putting your hard-earned income into an account after the taxes have already been paid.  This is in contrast with a Traditional pre-tax contribution where you are allowed to deduct the contribution from your current year’s earnings.  In that case you will pay taxes in the future, when the funds are withdrawn in retirement. 

So how do you decide which you should do?  The answer is that the ideal scenario is to pay tax during whichever period you will have the lowest marginal tax rate.  When faced with the choice between pre-tax and post-tax contributions, unfortunately this becomes a little bit of a guessing game.  You are going to attempt to make an educated guess of when your tax rate will be lower.  For most people, the answer is that their tax rate will be lower in retirement.  There are many reasons for this, but in this case, a lower retirement tax rate means that you would prefer to contribute to retirement accounts on a pre-tax basis, take the deduction at your current higher marginal tax rate, and then pay taxes in the future at a lower tax rate.   Conversely, you might be in the relative minority of people who have a higher tax rate in retirement.  If this is so, then you would benefit more from a Roth Contribution.  The theory holds that you always want to pay tax at the time when your marginal tax rate is at it’s lowest.  Hypothetically, if your tax rate was the same in the current year and in retirement, if you invested in either a Traditional Retirement account or a Roth and invested both assets the same way, you would end up with the same after tax result and be completely indifferent on which method you choose. 

Please note that these are the guidelines that you can use to think through this problem. To get the best result for your situation you should speak with a tax professional directly.

Advisory Services Network, LLC does not provide tax advice.  The tax information contained herein is general and is not exhaustive by nature.  Federal and state laws are complex and constantly changing.  You should always consult your own legal or tax professional for information concerning your individual situation.