Part 2: Your 401(k): Pre-Tax vs. Roth and Where to Invest
This is Part 2 of a two-part series. If you haven’t read Part 1 on the basics of 401(k)s, employer contributions, and vesting, start there.
In Part 1, we covered what a 401(k) is and why getting the full employer match is non-negotiable. Now let’s tackle the two decisions that trip people up the most: Should my contributions be pre-tax or Roth? And what should I actually invest in?
I review my 401(k) at least once a year. Not because I’m constantly tinkering — I’m not. But because these decisions aren’t one-and-done. My pre-tax vs. Roth split has changed as I’ve gotten older and moved through different tax brackets. My investment choices have evolved as I’ve learned more. The framework stays the same, but the application changes with your life.
The big choice: pre-tax vs. Roth. When you contribute to your 401(k), you have to choose: pre-tax (traditional) or Roth? Most people pick one without really understanding what they’re choosing. Here’s the core idea: Traditional is a tax break now; Roth is a tax break later.
Pre-tax (traditional) contributions go into your 401(k) before income taxes are calculated. Your taxable income goes down, so you pay less in taxes today. When you withdraw in retirement, you pay income taxes on everything — your contributions and all the growth.
Example: You earn $80,000 and contribute $10,000 pre-tax. Your taxable income is now $70,000. At a 22% bracket, you saved $2,200 in taxes this year. But when you pull that money out in retirement — say it’s grown to $40,000 — you pay income taxes on all $40,000.
Roth contributions go in after you’ve already paid income taxes. No tax break today. But when you withdraw in retirement, you pay nothing — not on your contributions, not on the growth.
Same example: You contribute $10,000 to Roth. Your taxable income stays $80,000. No tax savings now. But that $40,000 in retirement? You pay $0 in taxes.
So which is better? It depends on one question: Will you be in a higher or lower tax bracket in retirement than today?
Lower bracket in retirement → pre-tax wins. You avoid taxes at a high rate now, pay at a lower rate later. Higher bracket in retirement → Roth wins. You pay taxes at a low rate now, avoid them at a higher rate later. Same rate → roughly a wash, though some argue future tax rates could rise due to national debt and policy changes, which tilts toward Roth. Nobody knows for sure.
The stage-of-life framework. Here’s how I think about it:
In your 20s and 30s, you’re probably not at peak earnings. Your bracket is likely lower now than it will be later. Lean heavily Roth — maybe 80-100%. The money has decades to grow tax-free.
In your 40s, you’re approaching peak earnings. The pre-tax break is more valuable. Shift toward pre-tax — maybe 50/50 or 60/40 favoring pre-tax.
In your 50s and beyond, you’re at or near peak earnings with less time for tax-free growth to compound. Lean pre-tax, but keep some Roth — maybe 80/20 favoring pre-tax.
That’s what I do at 54. About 80% pre-tax, 20% Roth. I get the tax break now in a higher bracket, but I’m also building tax-free money for retirement flexibility. This split has changed over time — in my 30s, I was heavier Roth. I revisit it once a year to make sure it still fits.
Why having the right mix in retirement matters more than people realize. If ALL your retirement money is in pre-tax accounts, you could end up with a tax problem.
You retire with $1.5 million in a traditional 401(k). Every dollar you withdraw is taxable. Required minimum distributions force you to take money out. Add Social Security (partially taxable). Add any pension. Suddenly you’re not in a lower bracket — you’re in the same one, or higher.
I’m seeing this more and more. People focused on getting the tax break during working years without thinking about what happens when everything is taxable.
The solution: have money in different “buckets.” A pre-tax bucket (traditional 401(k), traditional IRA) is taxable when you withdraw. A post-tax bucket (Roth 401(k), Roth IRA) is tax-free when you withdraw. A taxable bucket (regular brokerage account) means you pay taxes on gains, but you have flexibility.
With all three buckets, you have options. You can manage which bucket to pull from based on your income that year.
This is why I recommend some Roth even in your 50s. And Roth 401(k)s no longer have required minimum distributions — this changed with SECURE 2.0 in 2024. Your money can stay invested and grow tax-free as long as you want.
One important nuance: the employer match. Your employer’s contribution always goes into the pre-tax side, even if you’re making Roth contributions. So if you contribute $10,000 to Roth and your employer adds $5,000, you have $10,000 Roth (tax-free later) and $5,000 traditional (taxable later). You’ll have both buckets regardless — which is actually a good thing.
Where to invest: keep it simple. Your 401(k) will offer a menu of options — maybe 20 choices, maybe 200. This is where people overthink it.
Option 1: Target-date fund. Look for a fund with a year close to when you plan to retire — “2045 Fund” or similar. These automatically adjust your mix as you age: more aggressive when young, more conservative as you approach retirement. You don’t have to think about it.
Is it perfect? No. Some say fees are too high or allocations too conservative. But a target-date fund is vastly better than leaving money in a money market fund earning nothing, picking random funds you don’t understand, or not contributing because you’re paralyzed.
If you don’t know what to pick, pick the target-date fund closest to your retirement year.
Option 2: Index funds. If your 401(k) offers them, you can build a simple portfolio: S&P 500 or total stock market index, international index, bond index. Look at the expense ratio — for index funds, it should be under 0.10% ideally. If your plan charges 0.50%+, that’s high.
I wrote a whole piece on why index funds work. The short version: Warren Buffett tells regular people to buy index funds. If it’s good enough for him to recommend to his own wife, it’s good enough for me.
What NOT to do. Don’t leave it in a money market fund — some 401(k)s default to this, and your money sits earning almost nothing. This was my mistake early on. Don’t pick funds based on recent performance — last year’s winner is often this year’s disappointment. Don’t buy your employer’s stock — you’re already dependent on them for your paycheck.
My annual check-in. I review once a year: Is my contribution rate still right? Is my pre-tax/Roth split appropriate for my current bracket? Are my funds still performing reasonably with low fees?
Most years I don’t change anything. My investments are index funds and target-date funds — not much to tinker with. But I do the due diligence. Circumstances change. Fifteen minutes once a year is worth it.
The action steps. Find out how much you’re contributing. Make sure you’re getting the full match. Check whether you’re doing pre-tax or Roth — does it fit the stage-of-life framework? Look at what you’re invested in. Simplify if needed. Then review once a year.
The bottom line. Contribute enough to get the full employer match. Choose pre-tax vs. Roth based on your stage of life — younger leans Roth, older leans pre-tax, but have some of both. Invest in target-date funds or low-cost index funds. Think about your mix in retirement — different tax buckets give you flexibility.
You now have a framework. Use it.