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Saving for Retirement

When It Doesn't Pay to Use a Roth 401(k)

Stick with a traditional 401(k) if you know your tax bracket will drop.

By Kevin McCormally

Now that Congress has made the Roth 401(k) permanent, more firms are offering employees the option to take their retirement-saving tax break later rather than sooner. Despite the growing popularity of the Roth 401(k), it's not right for everyone.Contributing to a Roth means giving up the traditional 401(k)'s immediate break of depositing pretax money. After-tax money goes into the new breed of 401(k), and the money comes out tax-free when it's withdrawn in retirement. With a traditional plan, all withdrawals are taxed in your top tax bracket.

James Lange, author of Retire Secure!: Pay Taxes Later -- the Key to Making Your Money Last as Long as You Do (Wiley, $25), is an unabashed fan of this new breed of 401(k), although he usually supports postponing taxes.

"With the Roth 401(k), I look at it as paying tax on the seed -- the contribution -- and reaping the harvest income tax-free," he says. "With the regular 401(k), you get a tax deduction on the seed but pay tax on the entire harvest." In most cases, you (and your heirs) will come out ahead with the Roth.

But Lange sees two situations when you should stick to the traditional 401(k). First, he says it makes sense to forgo the Roth if you're in the 33% or 35% tax bracket now and expect to fall into a lower bracket in retirement. Why pass up a tax break worth 33 cents on a dollar now to avoid a tax bill of 15 cents or 25 cents on the dollar a few years down the road?

Also, if the money will go to charity, you should take the traditional plan's up-front tax break. "Charities don't care in what form they get their money, because they do not pay income taxes," he notes.

If a charity will be a beneficiary of your traditional 401(k) -- or subsequent IRA rollover -- you'll save taxes on your contribution and the charity won't pay tax on the distribution.