The Roth question: Should I pay or should I stow?

Timothy Connor

Your employer offers you the opportunity to make contributions to a Roth 401(k). You may even have the choice to convert the current balance in your regular 401(k) into a Roth 401(k). So should you? 

It goes without saying the key questions involve tax implications.  After all, you’re deciding whether to pay taxes now or perhaps pay them later on an investment.  Let’s put aside for a moment estate planning and other special circumstances where Roths are very effective. In a more general use, there exists a common viewpoint that warrants some scrutiny. It goes something like this:  “I think tax rates are going to increase. Therefore, I should go Roth now.” Hmm, is that the right way to go? 

Perhaps not. Rather than just trying to guess which way tax rates will move, you may wish to consider the difference between your “marginal” tax rate today versus your “effective” tax rate in retirement.

Your marginal tax rate today is the tax bracket that would apply to your next dollar of income. A single filer making $200,000 is in the 33% marginal tax bracket, meaning a raise to $200,001 would result in an extra 33 cents of taxes. However, because of our progressive tax system, the effective tax rate we pay is a combination of all the tax brackets that apply to our income (only 25.4% for the single filer making $200,000). When you contribute to a Roth instead of a regular 401(k), you’re effectively adding a slice to the top of your income, which gets taxed at your marginal tax rate. In retirement, your income may be comprised of virtually nothing but annual distributions from your retirement balances. And so the question to consider is this: When you take those retirement distributions, how will the effective tax rate you’ll pay on that income compare to the marginal tax rates you were subject to at the time you were deciding to go Roth or not? Even if you predict tax rates will increase, you may have been better off not going Roth. 

It’s not a simple subject, and certainly not as simple as laid out here, as there are many other factors involved including state taxes, account purposes, and other retirement assets. If you talk to experts, or search for help online, you’ll find arguments for either side. Many individuals in many situations are better off with Roth. Read up as much as you can. Ultimately, it’s a question you should explore with your tax planner and financial advisor.

DISCLAIMER: This post is for informational purposes only. Milliman does not provide tax advice. For more, see our terms of use.