Should your contributions to your retirement account be pre-tax or after-tax?

Pre-tax, or traditional, means that you don’t pay taxes with every contribution, but you will pay taxes when you withdraw the money.

On the other hand, the after-tax option, or Roth contribution, does not save taxes now but can if taken out tax free, assuming the account has been in place for at least five years.

Roth IRA

The Roth option is valuable and important to understand. Many in full-time ministry, or those on the lower end of the income spectrum, do not pay much income tax. We all complain about taxes, but you can make a mid to high 5 figure income with 3 children along with a commitment to tithing and be in a very low tax bracket.

One of the strong benefits of contributing to a retirement plan is the tax deductibility of your contribution. If you pay little income tax, that incentive goes away. A number of years ago, a congressman named Roth lead a campaign to create another tax incentive to save—no tax savings now, but no taxes to pay when you take the money out. Interestingly, we sometimes pay more in taxes during retirement than during our earning years. Because you will pay taxes upfront, your money will grow tax free so you don’t have to worry about potentially being hit with high taxes when you take your money out in retirement.

For most who pay little income tax, Roth is the way to go.

Traditional IRA

The main advantage of a traditional IRA is the tax break upfront. The money that is deposited into your IRA is not taxed, which means that you will pay less income tax for the year. If you’re in the higher-end of the income spectrum, this is the way to go. But don’t forget, eventually you will have to pay those taxes.

To sum it up:

1. Roth contributions are after-tax contributions, meaning you don’t get any reduction in taxes for making the contribution. However, when you go to withdraw the funds in retirement, you won’t pay any taxes on the funds—what you initially contributed or the earnings.

2. Roth makes sense for people in a low tax bracket, pastors, and overseas missionaries.

3. Traditional contributions are pre-tax contributions that do reduce your taxes today. However, the contributions grow tax-deferred, meaning that when you withdraw the funds, you will pay taxes on the amount you receive, both the initial amount and the earnings.

4. Traditional makes sense for people in a high tax bracket.

5. Lastly, you do have the option to divide your contributions between traditional and Roth.

Visit this side by side comparison of Roth vs Traditional IRAs.

Note that IRA options are only available for contributions by the participant, not for employer contributions. Please discuss this option more with your tax advisor.

Know the difference between a 403(b) and IRA. Click here.