6-minute read

When it comes to investing in a 401(K), it can be difficult to make decisions—especially if you’re unfamiliar with how retirement accounts work.

Texa$aver Retirement Plan Advisor Mike McLellan knows it can be confusing for you if you’re not familiar with the language of the investment world.

“I love my job. I love my industry. One of the things I don’t like is the jargon,” said McLellan. “You got 401(k) and 457 and 403—all kinds of different stuff.”

That’s why he remains committed to breaking it all down for you—especially when it comes to pre-tax and post-tax contributions. Mike said state employees frequently ask him “What is better: pre-tax or post-tax?” during retirement planning meetings.

“I love questions that have the word ‘better’ or ‘good’ or ‘best’ in them because the first thing I have to point out is what's better for you is not necessarily better for me or someone else,” McLellan said. “We have to kind of get a little bit of perspective on what better actually means.”

Whether you make traditional pre-tax or post-tax (Roth) contributions, the Texa$averSM 401(k) / 457 Program offers a tax-advantaged way to save for your future.

With pre-tax contributions, you don’t pay taxes on the money you contribute from your paycheck or any earnings made until you withdraw money in retirement.

“What that means is money is coming off of the gross amount of your paycheck, before your check gets taxed,” McLellan said. “Your payroll sends that money to us here at Texa$aver and we invest for you. That money grows and grows and grows and one day in the future, when you pull it out, that’s when you get taxed."

McLellan said a pre-tax investing account is known as a “tax deferred account.” It allows you to defer taxes now and pay the lower tax rate when you begin withdrawing your money in the future.

“If somebody makes $70,000 a year and they decide to divert $10,000 of it into their pre-tax 401(k), their W-2 is not going to say $70,000 [on it]. It's going to say $60,000 that year and that might throw that person into a lower tax bracket,” McLellan said. “That can be a huge benefit that's right up front that they're going to get in tax year 2025.”

If you choose Roth contributions, you contribute money after you’ve paid taxes. McLellan said it’s like a mirror image of the pre-tax contribution but the money comes off of the net of your paycheck rather than the gross amount.

“That money comes to us, we invest it and it grows and grows and grows. And when you pull after-tax money out or Roth money out in retirement, you pay zero in income tax,” McLellan said."

Would you rather pay taxes on your retirement savings now or in the future? That’s the question to consider.

“Generally speaking, the benefit of pre-tax investing comes right now in this tax year. Whereas the benefit in post-tax or Roth investing comes at the end of the rainbow when you're pulling money out in retirement,” said McLellan.

Scenario   Pre-tax pay later Roth (post-tax/after-tax) (pay now)
Money invested $10,000 (your current taxable income is reduced by this amount)   $7,800 ($10,000 – 22% tax = $7,800 after-tax)  
Immediate tax impact $2,200 saved in taxes today (22% of $10,000)   No immediate tax savings; $2,200 is paid in taxes now  
Growth (20 years go by) Grows to $100,000   Grows to $78,000  
Withdrawal Pay 22% in taxes on full amount upon withdrawal ($22,000)   Pay 0% tax upon qualified withdrawal  
After-tax result $78,000 ($100,000-$22,000 tax)   $78,000 ($78,000-$0 tax)  

In some cases, people expect that they’ll be in a higher tax bracket in the future — when they’ll be making withdrawals from their retirement account — than they are right now. Given the choice, some of those people would prefer to pay taxes now on the money in their accounts so they don’t have to worry about taxes in retirement (at a potentially higher rate).

McLellan also points out that the younger someone is, the more time they have for their money to grow until retirement when they will begin taking distributions. The more attractive option would be the post-tax or Roth account because of the tax-free growth. Conversely, people on the other end of the age spectrum and closer to retirement won’t have the time for their money to grow.

“Most people make more money in their 50s, than they did in their twenties, so that 52-year old, for instance, might find the idea of sheltering some income a little bit more valuable to them this year.”

People who expect to be in a lower tax bracket in retirement may prefer to stick with the traditional pre-tax approach. This allows them to defer taxes now and pay the lower tax rate when they take distributions in the future.

“There's benefits for everybody and there's not a hard and fast rule for everyone,” said McLellan. “But the question of should you be doing pre-tax or post-tax is a really, really important concept to understand because that's one of the biggest decisions that someone can make inside of their choice to participate in Texa$aver. And it's a real benefit that you've got either choice. So that's a really nice thing to know about.”

If you're putting money into a pre-tax account, you can switch to a Roth account. A Roth conversion lets you move pre-tax money from your retirement plan directly into a Roth account within the same plan. The money you move gets taxed as regular income in the year you do the conversion. However, once it's in the Roth account, you won’t pay taxes on any future earnings when you take qualified withdrawals. The amount you convert might push you into a higher tax bracket for the year. You may also need to pay some extra taxes during the year of conversion before you file your return. The money you move won’t be subject to the 10% extra tax for early withdrawals.

There’s a lot to consider with an in-plan Roth rollover. Keep in mind that you can’t “undo” an in-plan Roth rollover. Schedule a no-cost meeting with your  to help weigh the costs, risks, and potential benefits before you make your decision.

And remember, whether you save via the pre-tax or Roth approach, you’re taking positive steps toward a more financially secure retirement. Either choice can help you build the retirement income you’ll rely on in the future.