Pre-Tax vs. Roth: Which Option is Better For Your Business?

Setting up retirement benefits often involves choosing pre-tax or Roth accounts, but how do you determine which is better for your team? Both options help your employees build long-term financial security. However, they affect your employees’ paychecks and retirement outcomes in different ways. Let's break down pre-tax vs. Roth contributions and how to decide which option is best for your workplace.

What are Pre-Tax vs. Roth Contributions?

Pre-tax contributions come out of an employee’s paycheck before taxes. They immediately lower taxable income, letting your employees keep more of their paycheck today. For example, if someone earns $3,000 a month and contributes $300 pre-tax, their taxable income for that month drops to $2,700. They’ll pay less in taxes now, but they’ll owe taxes on that money when they withdraw it in retirement. Examples of pre-tax accounts include:

• Traditional 401(k)s

• Individual retirement accounts (IRAs)

• 403(b)s for nonprofit organizations

Roth contributions, on the other hand, get taken out after taxes. Employees don’t see an immediate tax break, but the long-term benefit is that withdrawals in retirement are generally tax-free if they meet all requirements. For instance, if that same employee contributes $300 to a Roth account, their taxable income stays at $3,000 today, but they’re building a source of retirement income that won’t be taxed later. Examples include:

• Roth 401(k)

• Roth IRA

Offering both options is an integral part of designing an inclusive benefits package for a multi-generational workforce. It gives your employees the flexibility to align their contributions with their financial priorities. They can decide whether they want extra cash now or greater certainty in the future.

Which Option is Better for Your Business?

There isn’t a one-size-fits-all answer, but offering pre-tax and Roth retirement accounts can give businesses an advantage. Providing both options lets you meet the needs of a diverse workforce.

If you choose only one option, pre-tax is the most common starting point for small businesses. That's because it provides employees with an immediate benefit in their paychecks. As your business grows, adding Roth contributions can make your benefits package more competitive and attractive to top talent. To see why, consider how each contribution type affects employees differently:

How Pre-Tax vs. Roth Affects Paychecks and Retirement Plans

The impact of the two contribution types varies based on employees' life stages and financial priorities. By noting these differences, you can better guide employees and highlight the advantages of each option.

• Pre-Tax: Employees can lower their current taxable income. It might be a plus for employees balancing budgets or maximizing savings during high-earning years. However, future tax rates are uncertain, so withdrawals later may cost more than expected. 

From an employer’s standpoint, pre-tax contributions are familiar and easy for employees to understand, making them a practical starting point.

• Roth: Employees forgo an immediate tax benefit but gain predictable, tax-free income in retirement. This option often appeals to younger workers who expect to advance in their careers and move into higher tax brackets over time. 

For employers, offering Roth contributions indicates a forward-looking benefits approach. It supports a strong employee retention strategy and appeals to those who value long-term financial planning.

Pros and Cons

Each contribution type comes with trade-offs. Understanding the pros and cons helps employees make informed choices and allows you to highlight the value of offering multiple options. Here's a side-by-side comparison:

Helping Employees Choose the Right Option

You should educate your employees about each option and how it may affect them. The following list can help:

1. Taxes Due: Pre-tax contributions are taxed at withdrawal during retirement, while Roth contributions are taxed at the time of contribution today.

2. Impact on Paycheck: Pre-tax contributions increase take-home pay now by lowering taxable income. Roth contributions are after-tax contributions that result in slightly lower take-home pay.

3. Retirement Withdrawals: Pre-tax contribution withdrawals are taxable in retirement. Roth contribution withdrawals are generally tax-free.

4. Best For: Pre-tax contributions are best for employees who expect to be in a lower tax bracket in retirement. Roth contributions are best for employees who expect to be in the same or a higher tax bracket in retirement.

Gaining Access to High-Quality Benefits Through Justworks

Weighing pre-tax vs. Roth retirement plans is about which option fits your employees’ current needs and future goals. By understanding the difference, employers can guide their teams to make informed decisions and offer benefits that have a lasting impact. The right tools can help.

Justworks gives you access to high-quality employee benefits, including retirement plans, and simplifies benefit administration and HR tasks. Offering flexibility helps attract and retain talent while demonstrating that you care about your employees' long-term financial well-being. Support your team in building a brighter financial future. Get started with Justworks today.