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Pre-Tax vs Roth: What’s the Best Option for You?

Shannon Davis


An In-Depth Analysis to Help You Decide


One of the first comments I get when talking with people about money is “I want to start a Roth because it’s best, right?” It’s not always a simple decision. Many people struggle with choosing between Roth and Pre-Tax retirement savings, and it's understandable why. There are many considerations to take into account. Let me summarize the difference between those two options.

 

Pre-Tax Retirement Savings:

With Pre-Tax accounts like 401(k), 403(b), and 457(b) plans, you save money from your paycheck before paying taxes on it. This means you have more money to invest right away, potentially leading to greater growth over time. However, you’ll pay taxes on this money when you withdraw it during retirement. Additionally, if you need to access your money before age 59½, you might face a 10% penalty. Once you turn 73 (75 for those born after 1960), you must start withdrawing funds (this is what is referred to as RMD’s – Required Minimum Distributions), regardless of whether you need them, and you will have to pay taxes on those withdrawals.

 

Roth Retirement Savings:

Roth accounts work differently. You use money that’s already been taxed, so when you put it into a Roth IRA or Roth 401(k), you don’t owe any more taxes when you withdraw it in retirement. If your account has been open for at least 5 years and you’re over 59½, you can take out your money tax-free. You might think, “Of course, it is tax-free, I already paid my taxes!” Well, this also includes the earnings on your investments that you did not pay taxes on. This option is particularly appealing for younger individuals who have many years for their investments to grow. For someone closer to retirement, the immediate tax benefit might not be as impactful, but the tax-free withdrawals in retirement can be a significant advantage.  In addition, since taxes were paid on the contributions, typically, there are no RMD’s.

 

For better visualization, for tax purposes, think of your Roth as a bucket of seed and you have to pay taxes on that amount. On the other hand, the Pre-Tax account is the whole harvest at the end of the season and you get to pay taxes on all of it.

 

Ultimately, the right choice depends on your personal situation. While general advice can be helpful, it’s best to discuss your specific circumstances with a financial advisor to determine the best strategy for you. Reach out to schedule a consultation and get tailored advice for your retirement planning. I’d love to talk with you!

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