Nuts and Bolts: When Do Roth Contributions Make Sense?

Differentiating between types of retirement contributions is typically explained as a choice between paying taxes now or later. However, that simplification can gloss over key details, particularly between Roth contributions and after-tax contributions. Advisers say the differences matter not only for tax treatment, but also for asset growth, withdrawals and broader retirement strategy.

“I put them into different buckets of money,” says Ben Rizzuto, a wealth strategist in Janus Henderson’s specialist consulting group. “You’ve got your pre-tax money, which of course goes into the bucket without being taxed, which is great. … It’s able to grow on a pre-tax basis.”

Roth contributions, by contrast, are funded with after-tax dollars, but grow and are distributed tax-free. But Roth is only one kind of after-tax contribution.

Non-Roth, after-tax contributions grow on a tax-deferred basis, with earnings potentially subject to capital gain taxes upon withdrawal.

Angela Talbot, a retirement and investment consultant at Hub International, says there is a clearer way of understanding the differences.

“Do you need a tax deduction today? Then choose pre-tax,” she says. “Want a tax benefit later? Choose Roth. … Have additional money to save beyond that? That’s where [non-Roth] after-tax comes in.”

Flexible Future?

Rizzuto says the lens of current or future tax rates is too narrow.

“I think we assume advisers are talking about current versus future taxes, but I’m not sure clients are hearing it that way,” he says, mentioning a possible gap between what advisers say they communicate and what investors recall.

Instead, he recommends advisers ask about their clients’ expectations of future use and flexibility.

“What is this going to mean for a client when they need that money … in 10, 20 or 30 years?” he says. “Thinking about it from the standpoint of future flexibility is key.”

For advisers, explaining the differences between tax contributions to clients should be less about the labels and more about what the client is trying to solve for, according to Jonathan Reilly, senior vice president of wealth management and advisory solutions at Voya Financial and the president of Voya Financial Advisors Inc.

“What tends to work best is narrowing it down to a few clear, relatable scenarios instead of walking through every possible option,” Reilly wrote in an email to PLANADVISER. “Just as important: reminding clients that this isn’t a one-and-done decision; it’s something they can adjust as their situation changes. 

Personalizing Tax Strategy

As participants accumulate assets across different tax “buckets,” those distinctions begin to influence portfolio construction.

“Those assets with the highest expected return, but least tax efficiency, should go in your Roth bucket,” Rizzuto says. “Tax-efficient investments can go in taxable accounts, and everything else [should go] in traditional accounts.”

He notes that this is a simplified version of a framework to use in thinking about tax-efficient investments, and the most important considerations are a client’s assets, holdings and overall financial plan.

This introduces a concept Talbot calls “asset location”—placing certain investments in accounts based on how they are taxed.

Still, not all retirement plans offer the flexibility to fully implement this strategy, making withdrawal planning equally important.

“You have to steer distributions,” Talbot says, noting that retirees may draw from different accounts, depending on their income each year.

Having multiple “buckets” of assets can help retirees manage tax brackets and navigate required minimum distributions. It may also

help clients understand that the best tax contribution decisions evolve as income, personal goals and tax situations change.

“Some higher earners may look to after-tax contributions as a way to save more overall, while others can benefit from layering in Roth earlier to build some tax diversification,” Reilly wrote. “Stay proactive, stay involved and give examples of scenarios that should make them consider a change in the future.” 

More on this topic:

	DC Plan Roth Contributions, by the Numbers
	In-Plan Roth Conversions: Complicated, yet Appealing
	Rollover Rules for Roth 401(k), 403(b) and 457(b) Account Assets