Pre-tax vs. Roth 401(k): Which is Best for You?

If you are making 401(k) contributions, you have probably wondered which is better: Roth or Pre-tax (Traditional). It isn't an easy decision and the names of each account don't provide much clarity. A Roth contribution is made after taxes have been withheld. A Pre-tax contribution is made before any taxes are withheld. The rule of thumb is to choose pre-tax (Traditional) if you expect your tax rate to be lower in the future and Roth if you expect it to be higher.

It's your first day at a new law firm, and your HR onboarding meeting mentions a 401(k) you can contribute to — but then asks "How much would you like to contribute to your Pre-Tax (or Traditional) 401(k) and Roth 401(k)?" without much explanation. Here are answers to the most common questions.

What's the difference?

Both are funded through payroll contributions and share the same total contribution limit ($19,500 in 2021) and investment options. A pre-tax (Traditional) 401(k) lets you contribute without paying taxes on that income now. A Roth 401(k) taxes the contribution as part of your income for the year.

Example: Laura earns $100,000 with a 24% federal tax rate. A $10,000 pre-tax contribution reduces her taxable income to $90,000, saving her $2,400 in taxes she can spend or save elsewhere. A $10,000 Roth contribution does not reduce her taxable income — she pays the full $24,000 in taxes regardless.

The other half of the equation is how withdrawals are taxed in retirement. Pre-tax withdrawals are taxed as income. Roth withdrawals — both contributions and growth — are tax-free. In a simplified example where Laura reinvests her pre-tax tax savings, both options can net out to the same amount in retirement, assuming the same tax rate applies at withdrawal. The real decision comes down to whether you expect your tax rate to be higher or lower in retirement than it is today.

Growth is always tax-deferred until withdrawal

Neither account owes taxes for dividends, capital gains, or distributions along the way — those events would be taxable in a regular brokerage account, but not inside a 401(k).

Employer match

Employer matches always go into a pre-tax (Traditional) 401(k), even if all of your own contributions go to a Roth 401(k). Match schedules vary — some employers match once a year, others every paycheck, and vesting schedules (cliff or graded) determine when you fully own the matched funds.

You can split your contributions

You don't have to choose one or the other — splitting contributions between pre-tax and Roth gives you tax rate flexibility both today and in retirement. A pre-tax 401(k) also gives you the option to convert to a Roth later; you cannot convert a Roth 401(k) into a pre-tax account.

How tax rates change over your life

Your starting salary as a lawyer may be the lowest you'll earn for the rest of your career, though some lawyers take pay cuts later for public service or non-profit work. Tax rates in retirement are also typically lower — a rule of thumb is that you'll need 70-90% of your working years' income to support your retirement living expenses.

So which account should you contribute to?

If you expect a lower tax bracket today than in the future, Roth may make more sense. If you expect a lower tax bracket in retirement than today, pre-tax may be better. There's no single correct answer for everyone — it depends on unknowns like future career earnings, tax rate changes, retirement length, and income needs, all of which can shift over your lifetime.

The best advice is to contact a financial planner or tax professional to help you decide which is currently best for you. Developing Financial offers 401(k) planning as part of the Employer Benefits solution in the Developing Financial Process.