When it comes to retirement savings, you can either pay taxes now or you can pay taxes later. That decision can be an important part of choosing which kind of retirement savings account you want to use. You can choose one, or the other, or both.
Pre-tax 401(k) and 457(b) accounts provide a tax break now. Your contributions are not taxed at the time of investment. Instead, taxes are paid on withdrawals, including any earnings. Getting a tax break at the time of investment will leave more money in your pocket now — money that you can invest, save, or spend.
Roth 401(k) and Roth 457(b) accounts provide a tax advantage later. Roth contributions are made with money that’s already been taxed, so you won’t have to pay taxes on qualified withdrawals, including earnings*.
You can choose to allocate part of, or all of your salary deferral to the Roth, or all or part of your salary deferral to your traditional 457(b) or 401(k) pre-tax account.
*Distributions from the plan are subject to IRS and Plan rules, all references to taxes are Federal taxes only. State taxes laws vary.
The tax advantage comparison chart
Contributions are made pre-tax, which reduces your current adjusted gross income.
Roth contributions are made with after-tax dollars. So you'll pay more taxes today, but that could mean more money in retirement.
Distributions in retirement are taxed as ordinary income.
A Roth withdrawal will be tax free if the withdrawal is made 5 years or more after January 1 of the calendar year in which the first Roth contribution or Roth conversion was made and the withdrawal was made on account of death, disability, or attainment of age 59½.
Which option is right for me?
Only you can answer that question. But you may want to consider the following:
Do you want to pay taxes now or later?
Consider how much of your retirement sources of income are taxable in retirement. A Roth source of income may help reduce your taxes in retirement.
You don't need to choose between one or the other. Consider splitting contributions between Pre-tax and Roth.
If your withdrawal includes Roth assets, your withdrawal will be tax-free if the withdrawal is: (1) made five years or more after January 1 of the calendar year in which the first Roth contribution or Roth conversion was made; and (2) made on account of death, disability or reaching the age of 59 ½. A Roth withdrawal before requirements are met may result in taxation of your earnings and a 10% tax penalty. You may wish to obtain the advice of a tax advisor before you request a withdrawal.
If you take the distribution before you are 59 ½, the distribution is taxable.
If you make both pre-tax and Roth contributions, you can choose to make separate investment choices: one for your pre-tax contributions and one for your Roth contributions. Please note – this feature does not apply to investments to the Schwab Personal Choice Retirement Account (PCRA).