One of the most advocated benefits of investing in a regular 401k plan is that your contributions are all tax deferred giving you a 401k deferral. This essentially means that you do not have to pay taxes on them when you put them into your account allowing you the benefit of having the extra work with the power of compounding interest and then pay taxes on this money when you withdraw it. However, the real question is how valuable is this benefit?
After all, one significant issue is whether tax rates will rise or fall by the time you retire. This one stumps financial analysts as opinions vary. Some experts suggest that tax rates will invariably rise and so it is a good idea to pay taxes upfront. However, others say there is no way to predict the future so tax deferred works fine. In addition, they suggest your tax bracket would have to jump much higher than 44% when you started a non tax deferred account to remove the benefit of tax 401k deferral and this percentage goes higher if the company is matching contributions.
However, another issue is the length of time you have before you retire. One of the best advantages of paying taxes up front in a Roth 401k (A Roth 401k is a 401k plan that allows you to pay taxes upfront on contributions) is that if you are given enough time you can actually overcome the time value of money in deferring taxes. The result is that you are making more money and these withdrawals are tax penalty free.
With consideration of the two above factors, the analysis of which is better is unclear to most analysts. Even with this backdrop, most financial advisors recommend that you choose a regular 401k deferral because of the certainty of the advantages of compounding interest and the uncertainty of other factors like tax rates and your length of time you will be able to make contributions.
However, for those who have a more stable financial forecast for the future, many analysts also recommend that people take out a Roth IRA or Roth 401k as well. This can be a great way of providing more diversification to your portfolio regardless of what the future holds and in the case of a Roth IRA enables you to put more money towards your retirement than just having a 401k plan or two 401k plans because the IRS treats all 401ks as one 401k which can limit the total amount you can contribute each year.
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