Which option is right for you?
Pension Maxima Investment Advisory
Traditional versus Roth 401(k)
Traditional
Roth
Employee Contributions
Pre-tax
After-tax
Contribution Limits
$16,500
$22,000 if 50 or over.
Same as Traditional.
Additional criteria:
Total Traditional and
Roth contributions can
not exceed Federal Limit
of $16,500 or $22,000 if
50 or over.
Company Match
Pre-tax
Pre-tax
Distribution
Subject to tax
Tax-free Distribution
Which one is more advantageous?
Scenario (1): Tax rates at contribution and
withdrawal are the same.
Scenario (1), Same Tax Rates
Traditional
Roth
Tax Rate at Contribution
20%
20%
Contribution
$100
$80
$100*1.08^20
80*1.08^20
20%
20%
$100*1.08^20*.8 or
$80*1.08^20
$80*1.08^20
Identical
Identical
Growth (8%, 20 years)
Distribution Tax Rate
Final Account Balance
Results
Which one is more advantageous?
Scenario (2): Tax rate at contribution is greater
than tax rate at distribution
Scenario Two ( Contribution Tax
Rate > Distribution Tax Rate)
Traditional
Roth
Employee Contribution
100
100
Tax Rate at Contribution
40%
40%
$100*1.08^20
$60*1.08^20
30%
30%
$100*1.08^20*.7 or
$70*1.08^20
$60*1.08^20
More Money
Less Money
Growth (8%, 20 Years)
Distribution Tax Rate
After tax balance
Results
Which one is more advantageous?
Scenario (3): Tax rate at contribution is lower than
tax rate at distribution
Scenario Three ( Contribution Tax
Rate < Distribution Tax Rate)
Traditional
Roth
Employee Contribution
100
100
Tax Rate at Contribution
30%
30%
$100*1.08^20
$70*1.08^20
40%
40%
$100*1.08^20*.6 or
$60*1.08^20
$70*1.08^20
Less Money
More Money
Growth (8%, 20 Years)
Distribution Tax Rate
After tax balance
Results
Application: Traditional or Roth?
Scenarios
Traditional
Roth
1. Expects future tax rate to be lower
due to lower income at Retirement.
More Money
Less Money
2. Expects future tax rate to be higher
due to change in government’s fiscal
policy.
Less Money
More Money
3. High Income Earners: Wants to
maximize tax deferral capability
Defer less money
Defer more money since
$15,500 (or $22,000 if over 50)
is now calculated on an after tax
basis
4. Young Participants: Expects tax
rates to go up as earning power goes
up
Less Money
More Money
5. Avoid Required Minimum
Distribution at 70 ½
No
Yes. Maximize estate by paying
taxes now.
6. Avoid Social Security Taxes
No, unless your income is
below SS exempt level.
Maximize Social Security
payouts since Roth Distributions
are not considered as SS
income
Other Tax Considerations for Traditional
1. Moving money to Traditional can help
drop a tax bracket.
Example dropping from 25% to 15% can
mean huge savings!
2. First $11,500 in earnings are normally
tax free or taxed at a very low rate. You
should always keep some money in
Traditional for tax free or low tax
withdrawal before you start distributing
from Roth.
The End
The information regarding investment contained
herein is general in nature and should not be
considered legal or tax advice. Pension Maxima
Investment Advisory does not provide legal or tax
advice. This information is provided for general
educational purposes only and you should bear in
mind that laws of a particular state and your
particular situation may affect this information. You
should consult with your attorney or tax advisor
regarding your specific legal or tax situation