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When saving for retirement, you can often choose between traditional and after-tax Roth contributions – and determining the right choice can be trickier than you might expect.
Traditional deferrals offer an upfront tax break, but you’ll have to pay regular income taxes on future withdrawals. The opposite is true for Roth contributions, which are made after taxes, but the balance grows tax-free.
Many choose between traditional and Roth contributions by weighing current and future tax brackets, but that can be a mistake, according to certified financial planner Cody Garrett, founder of Measure Twice Planners in Houston.
“People always talk about marginal rates, but lived experiences are (your) effective rates,” said Garrett, who is also co-author of the new book “Tax Planning To and Through Early Retirement.”
Marginal or effective tax rates
Federal income tax brackets are progressive, meaning that income levels are subject to different rates. Your marginal rate is the percentage paid on your last dollar of taxable income. (You calculate taxable income by subtracting the greater of the standard or itemized deductions from your adjusted gross income.)
In comparison, your effective tax rate is taxes paid as a percentage of your total income.
The difference between these numbers matters when making traditional versus Roth contributions because your effective rate in retirement may be much lower than you expect, Garrett said.
Garrett shared an example of marginal versus effective tax rates in a LinkedIn post last month.
Let’s say you are single and 50 years old, with a gross income of $200,000. For 2025, your standard deduction is $15,750, bringing your taxable income to $184,250.
Distribution of tax for each bracket of taxable income:
$11,925 taxed at 10%: $1,192.50
$36,550 taxed at 12%: $4,386
$54,875 taxed at 22%: $12,072.50
$80,900 taxed at 24%: $19,416
Total tax: $37,067
Your highest marginal tax rate is 24%. But your effective tax rate is 18.5%, which is your total tax ($37,067) divided by $200,000 of gross income.
However, you would need gross income above $326,900 for your effective rate to reach 24%, Garrett said.
Depending on your situation, pre-tax contributions might make sense if you expect a much lower effective tax rate in retirement, he said.
Consider Your Lifetime Tax Bill
Advisors may have different opinions on traditional versus Roth contributions during your working years. But ultimately, tax decisions must be weighed from a multi-year perspective, experts say.
“Your goal is to pay taxes when the rate is lowest,” accountant Jeff Levine previously told CNBC.
Without pre-tax savings, some retirees may miss out on future planning opportunities, such as Roth individual retirement account conversions during early retirement years.
