What is the Difference Between Traditional and Roth Contributions?

A retirement plan may offer two savings options: Traditional (Pre‐Tax) and Roth (After‐Tax).  Each option can offer significant tax advantages to some taxpayers.  The advantages depend on a number of factors, and some of those factors require predictions of the future.

Traditional (Pre‐Tax) Contributions
Pre‐tax contributions are deducted from gross pay before taxes are withheld from a participant's paycheck.  This provides a tax break up front, helping to lower the participant's current income tax bill.  Pre-tax contributions and any earnings on those contributions, grow tax‐deferred until the funds are withdrawn. At that time, withdrawals will be taxed as ordinary income. Federal taxes and any applicable State taxes will be due based on a participant's tax rate in the year of distribution. A ten percent penalty may also be assessed if funds are withdrawn prior to age 59½.

Contributions = pre-tax (Federal/State), avoid taxes now
Distributions = pay tax (later)

Pre-tax contributions may be especially beneficial for older participants in a higher tax bracket now, who may be in a lower tax bracket at time of distribution.

Roth (After‐Tax) Contributions
Roth contributions are deducted from after‐tax dollars.  As a result, there is no upfront tax deduction. After‐tax dollars are the amount that remains after the deduction of all Federal, State, and withholding taxes.  However, when Roth funds are withdrawn, both contributions and earnings are tax‐free at age 59½, as long as the Roth account has been held for at least five years. 

Contributions = after-tax (Federal/State), pay taxes now
Distributions = avoid taxes (later) 

Roth contributions may be especially beneficial for younger participants in a lower tax bracket now, who may be in a higher tax bracket at time of distribution.

Please consult your tax advisor for additional guidance that may benefit your personal tax situation.