Pre-Tax versus Post-Tax Plans Options
Which is the better option – a pre-tax or a post-tax plan?
If you invest in a pre-tax plan, it reduces your tax liability while you are actively contributing. Also, it puts you in a lower income-tax bracket during your retirement. This means the taxes you pay on your money when you withdraw your account is less than what you would have had to pay at the time you earned your compensation.
But, you may no longer be in a lower-income tax bracket when you retire. If you do not take up a full-time job after you retire then there may be lesser income-tax deductions. Chances are that your income may remain the same during retirement. Or your pension benefits, Social Security and other benefits may actually increase your income.
So, if you are in a higher-income tax bracket during retirement, then a post-tax plan can be a better option for you. Give Roth 401(k) a thought if you are ready to bear a higher cost of post-tax investing now. You may receive a little less in net pay now, but it can mean great savings for later.
Of course, you also have the option of retiring in a state where the state taxes and local taxes are lower. For more information on Roth 401(k), visit the CheifLeader website.
What about future tax rates?
We can never be certain about the future tax rates. Also, we do not know whether we will be in a lower-tax bracket when we retire or whether tax rates will rise. In that case, the best bet is to contribute on both a pre-tax and post-tax basis at the same time. This way, you can spread out your tax liability. A good solution could be to:
- invest in company 401k up to the company match
- invest in ROTH IRA up to the $4,000 limit
- invest in company 401k up to the $15,000 limit
- invest post tax dollars in stocks or real estate
Traditional 401k plan or a Roth 401k plan?
In a traditional 401k plan, you make annual contributions with pre-tax dollars while for a Roth 401k plan, you need to put in annual contributions post tax. With a traditional 401(k), you pay lower taxes as you are only taxed on your after-tax income. But, if you contribute the same amount in a Roth IRA, what you get is a less take-home pay as your gross income has been taxed at a higher rate. If you have started to plan early for your future years, you can afford to opt for a Roth because your retirement money will have a longer time to grow.
What are your other options?
The other option you can consider is variable annuity. A variable annuity is a tax-deferred product offered by the insurance industry. Your interest and earnings grow free of taxes until you withdraw them.
You can also invest in a tax-efficient stock or bond fund. These funds minimize annual taxable distributions of capital gains and dividends. When you sell your shares, you pay capital gain rates which are typically 15%. The argument over pre-tax versus post-tax plans will continue. It is for you to figure out your resources and opt for the plan that you think will suit you best.