Before-tax contributions are deductible from current-year income, but the principal, interest, and capital gains are taxed at the ordinary income tax rate upon withdrawal.
The Roth is more attractive if workers anticipate a possible withdrawal before age 591/2, since Roth principal is exempt from the 10 percent early withdrawal penalty that applies to before-tax contributions. Moreover, workers who are constrained by the limits on total 401(k) contributions may find it advantageous to make Roth contributions because a dollar of Roth balances buys more retirement consumption than a dollar of before-tax balances.
Since many past studies have shown that workers are passive in their retirement savings decisions, the low usage of the Roth may reflect a slow response to its introduction rather than an active preference for making before-tax contributions. To explore this, the authors examine how Roth participation differs between 401(k) participants who were hired before and after the Roth introduction at their firm.
Section 125 plans also allow employees to make before-tax contributions
to personal spending accounts that can be used for qualifying health-care or child-care expenses.
This is the reverse of the traditional 401(k) which allows employees to make before-tax contributions
, but then fully taxes all retirement withdrawals (see chart, page 279).
When an employer who adopted a SAR-SEP prior to 1997 wants to continue to operate a simplified plan funded through employee salary reductions (before-tax contributions
However, these tax benefits still do not generally outweigh or overcome the tax advantages of making either after-tax contributions to a tax-free investment, such as a Roth IRA, or before-tax contributions
to a tax-deferred investment, such as a 401(k) plan.
First, in a client's early saving years when he/she is earning less money and is in a low tax bracket, the Roth provides higher withdrawals during retirement than the Traditional for the same before-tax contributions (because the Roth locks the payment and related gains into the current tax rate).
Therefore, if an investor expects to be in a higher marginal tax bracket during his/her earning and investing years than during his/her retirement years, the Traditional IRA provides higher after-tax withdrawals on an equivalent before-tax contribution.
Prior to TRA86, section 415 of the Internal Revenue Code limited before-tax contributions
to the lesser of 25 percent of employee compensation or $30,000.
A SAR SEP allows employees to make their own before-tax contributions towards retirement.
The main disadvantage of these plans, according to Rosen, is that you must follow all the IRS guidelines that govern them, as is the case for any IRS-qualified, before-tax contribution plan.