A new twist on 401(k) question

Some questions resonate throughout the ages.

Who am I?

Why am I here?

Which came first, the chicken or the egg?

Should I choose a regular 401(k) or the Roth option?

That last one seems particularly popular based on my e-mail inbox, but a recent question from a reader named Vivian puts a different twist on it.

Vivian wrote that she works for a not-for-profit health care organization that offers both regular and Roth 401(k) options.

"This year they will match my deposits 4 percent, which will go into the regular 401(k)," she wrote. "I had been splitting my deposits between the two accounts, then recently I had switched all my deposits to now go into the Roth.

"But in conversation with a co-worker yesterday, he felt like it is always better to save taxes now, as you don't know what (they) will be down the road. I am able to deposit 16 percent, so I wondered what is the better way to go, all in the Roth or split between the two?"

Excellent question, Vivian. But before we get to an answer, let's define some terms.

With a traditional 401(k), employee contributions, employer matches and earnings are not taxed when they are put into an account, but they are taxed when the money is withdrawn. With a Roth 401(k), employee contributions are taxed up front, but those contributions and their earnings can be withdrawn tax-free later.

Sharla Jessop and James Derrick of Salt Lake-based Smedley Financial Services tell me that many companies do not offer the Roth 401(k) as an option for employees. However, Smedley still receives many questions similar to Vivian's.

Sharla says Vivian must consider several factors when making her decision. For example, if she is younger and has children at home, or she has mortgage interest or other tax deductions, she is now in a low tax bracket. As such, it would not make sense to worry about deductions now.

"People lose a lot of deductions in retirement," James says. "So even though their income drops, their deductions drop, as well."

Sharla adds that, in retirement, much of a person's income comes from accounts that were not taxed previously. And it is likely, although not guaranteed, that taxes will be higher in the future than they are now.

"Historically, we've been in a period where we've had very low tax rates," she says, but the growing deficit and burgeoning baby boomer population are likely to lead to increasing rates in years to come.

"We spend a lot of time worrying about risk and managing risk," James says. "The chance of taxes going up is a risk in and of itself. A Roth 401(k) gives you a chance to reduce that risk, so it's got a real benefit there."