The pre-tax benefit allows you to receive a tax deduction on your 401(k) contributions in the current year. These contributions are taken as a percentage of your gross income, and will grow tax-deferred until you begin withdrawing funds in retirement.
Withdrawals of pre-tax contributions are considered ordinary income, and are taxed at your statutory income tax rate when they are withdrawn.
Roth contributions are deducted from your net income and therefore do NOT provide a tax benefit in the current year.
However, since you have technically paid the taxes on these contributions at the time they are made, funds from Roth contributions are 100% tax-free when they are withdrawn.
Your 401(k) contributions are deducted directly from your paycheck, each pay period, in amount determined by multiplying your contribution rate to your income. As mentioned above, pre-tax contributions will be based on a percentage of your gross income, while Roth contributions will be based on a percentage of your net income.
Determining your preferable tax benefit can be somewhat subjective. For investors interested in reducing their current year tax liability, the pre-tax option is optimal. On the other hand, someone looking to establish a tax-free source of income in retirement would logically prefer the Roth option.
Lastly, individuals looking to diversify their tax liabilities throughout their life may opt to use a combination of both options. Ultimately, the pre-tax/Roth decision is based on each individual’s specific financial needs. Your plan’s financial advisor can help you determine the optimal strategy to achieve your retirement goals.