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Ask an Advisor: I’m 31, Make $80k Per Year and Have About $250k in Assets. Should I Switch to a Roth 401(k)?

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Ask an Advisor: I'm 31, Make $80k Per Year and Have About $250k in Assets. Should I Switch to a Roth 401(k)?

My company provides both a traditional and Roth 401(k) option. My question is whether I should contribute to a traditional 401(k), Roth 401(k) or a mix of both. I am 31 years old, single and live in San Francisco. My current rent is $1,000 per month and I have no major debts. I make about $80,000 for my work, and I have $44,000 in my 401(k), $33,000 in a Roth IRA and $7,700 in an HSA. I’m on track to max out all three accounts this year. I also put $1,100 per month into a taxable investment account, which is worth $150,000, and invest any extra cash I do not spend for the month. Lastly, I have about $15,000 in cash and high-yield savings accounts. 

– Caleb

This is a great question but not one with a definitive answer.

The good news is that no matter which way you go, you’re making a good choice. Both traditional and Roth contributions will serve you very well as you work toward retirement. The bad news is that there’s no way to know for sure which one will come out ahead over the long term.

Still, there are some helpful things you can consider as you make this decision. (And if you need more help with your financial plan or retirement accounts, consider working with a financial advisor.)

Consider Your Tax Bracket

Ask an Advisor: I'm 31, Make $80k Per Year and Have About $250k in Assets. Should I Switch to a Roth 401(k)?

Since Roth contributions are taxed upfront and traditional contributions are taxed when they’re withdrawn, you’ll want to think about whether you’ll be in a higher tax bracket now or when you start making withdrawals.

If you’re likely to be in a higher tax bracket later, then you should generally prioritize Roth contributions now so that you benefit from a bigger tax benefit when you withdraw the money. If it’s more likely that you’ll be in a lower tax bracket later, you should generally prioritize traditional contributions in order to take advantage of the larger deduction today.

Since you’re early in your career and will likely earn more later on, it seems probable to me that your tax bracket will increase over time. That would point to making Roth contributions now. (And if you need additional help with retirement planning, this tool can help match you with potential advisors.)

What’s Your True Contribution?

If the amount you contribute is going to be the same either way, then you are actually contributing more money by making Roth contributions. This is because those Roth contributions will have already been taxed, so all of that money will be yours.

For example, if the decision is between making a $22,500 Roth 401(k) contribution or a $22,500 traditional 401(k) contribution, the Roth contribution will be worth about 31.3% more given your estimated federal and state income tax brackets.

That may incentivize you to go the Roth route. But you could also calculate the tax savings from your traditional contributions and potential earnings if you invested that money elsewhere. (And if you need help selecting and managing investments, consider working with a financial advisor.)

For example, if your marginal tax rate is 31.3%, you’d save you about $7,042.50 per year in taxes by making a $22,500 pre-tax contribution. Investing those tax savings in a brokerage account may make the traditional 401(k) the better option, depending on the returns that your taxable investments produce.

Tax Flexibility

Ask an Advisor: I'm 31, Make $80k Per Year and Have About $250k in Assets. Should I Switch to a Roth 401(k)?

With all of that said traditional contributions do offer more tax flexibility than Roth contributions.

With a Roth contribution, you’re locking in whatever tax cost you have to pay today. With a traditional contribution, you can wait and see if there are opportunities to pay fewer taxes down the line.

For example, maybe you decide to take a year off at some point. Or maybe you start a business or start a family and have a couple of years of lower income. Those years could be opportunities to convert some or all traditional contributions into a Roth account while you’re in a lower tax bracket compared to today, saving you money and boosting your retirement savings. (And if you need help with your tax strategy, this tool can help match you with potential advisors.)

Retirement Account Accessibility

In general, money in a Roth account is more accessible than money in a traditional account  – especially if it’s in a Roth IRA.

Once you leave your company, you might decide to roll your Roth 401(k) money into a Roth IRA. If you do that, the amount you’ve already contributed can be withdrawn at any time and for any reason, without taxes or penalties. You’ll have to be more careful with the earnings, however, which could be subject to taxes and penalties.

That flexibility can be valuable as you navigate an ever-changing life moving forward. (And if you need help managing your retirement accounts, consider working with a financial advisor.)

Next Steps

At the end of the day, you’re going to be in good shape whether you make traditional contributions, Roth contributions or a combination of the two. I wouldn’t worry too much about getting it “right.” With that said, hopefully, the considerations above help you make the best decision you can in your current situation.

Tips for Finding a Financial Advisor

  • Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Consider a few advisors before settling on one. It’s important to make sure you find someone you trust to manage your money. As you consider your options, these are the questions you should ask an advisor to ensure you make the right choice.

Matt Becker, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Matt is not a participant in the SmartAdvisor Match platform, and he has been compensated for this article.

Photo credit: ©iStock.com/Jitalia17, ©iStock.com/Thapana Onphalai

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