Guideline 401(k) plans offer both pre-tax and Roth contribution options for participants. The major difference between these contribution types is when you are taxed. See these articles to learn more about the differences between pre-tax and Roth 401(k) contributions.
In general, it’s a good strategy to try to pay the least amount of taxes over the course of your lifetime. Though it may sound counterintuitive, you’ll actually want to pay your taxes in the years that you make less money and defer your taxes in the years that you make more money.
Chances are, in the years that you make less money, you’ll be in a lower tax bracket, meaning the overall amount of taxes you’ll pay will be lower. In the years that you make more money, you’ll be in a higher tax bracket and will be paying more taxes. Generally, it’s better to make Roth contributions and pay less taxes on them when you are receiving less income, than to pay a higher income taxes on those contributions when you’re earning more.
You can consider using the following contribution strategy based on your current tax bracket and review the tax bracket you’re in here. (1) If you’re thinking of saving an amount that is enough to lower you into the next tax bracket, consider making at least enough pre-tax contributions to get you into that bracket. Then you can use that new tax bracket as your starting point for applying these guidelines to the remainder of your contributions.
|Your tax bracket:||You may consider contributing:|
|10% or 12%||100% into Roth|
|22%||75% into Roth and 25% into pre-tax|
|24%||50% into Roth and 50% into pre-tax|
|32%||25% into Roth and 75% into pre-tax|
|35% or 37%||100% into pre-tax|
(1) Keep in mind that these are general recommendations provided by Guideline and should not be taken as personalized financial advice. What is right for an individual participant will vary based on that individual’s specific financial or life circumstances and you should always consult your personal financial advisor. Although you may be in a “high” tax bracket comparatively (at 35 or 37%) right now, historically tax brackets overall are very low right now. This means that in 20 or 30 years from now there is a possibility that your tax bracket may be “lower” on the spectrum but may actually end up being equal to or more than your actual bracket now. Though it’s impossible to predict future tax brackets, many people have been taking advantage of these historical lows by making more Roth contributions even when in one of the higher tax brackets.