Michael Bell is a young lawyer on the fast track. He has maxed out annual contributions to his 401(k) over the past four years. Now he faces a choice: Should he continue to contribute to his traditional 401(k) -- which saves him more than $5,000 a year in state and federal taxes -- or should he switch to a Roth 401(k), which offers no upfront tax breaks but promises tax-free income in retirement?
Bell, who works for a law firm in Washington, D.C., wants to make sure his retirement account is as large as possible and hesitates to give up the current tax break. "But there's a good possibility that tax rates will increase in the future," he says. "Maybe the Roth 401(k) is a more appropriate approach."
Tax HedgeJames Lange, a CPA and attorney in Pittsburgh, agrees that Bell, 34, is a good candidate for a Roth 401(k). "If he is going to be in the same tax bracket or higher when he retires, which is quite likely, the Roth 401(k) is the best way to go," says Lange, author of Retire Secure (Wiley, $24.95;
www.paytaxeslater.com). Even if tax rates are slightly lower when Bell retires in 30 years, the Roth 401(k) would still be a better choice because of the potential for three decades of tax-free earnings, says Lange. In a traditional 401(k), your earnings also grow unfettered by taxes, but all of your withdrawals (including your earnings) are taxed at your ordinary income-tax rate.
Just as investors should diversify their retirement assets across a broad class of stocks and bonds, they
