To Roth or Not to Roth? Navigating Retirement Contribution Choices for Lawyers

I’ve had many conversations with new lawyers about a critical retirement question: should you go with Roth or traditional contributions in your retirement plans? It's an important decision that can significantly impact the taxation of your withdrawals in retirement, especially for those in high-earning roles within Biglaw seeking tax deductions now or for those in lower tax brackets maximizing tax-free growth. Let’s dive into the key differences and considerations for both options.

Understanding the Basics: Roth vs. Traditional Contributions

First, let's clarify what we mean by Roth and traditional contributions. In employer-sponsored retirement plans like 401(k)s as well as individual retirement accounts (IRAs), you generally have the option to choose between Roth or traditional contributions or accounts.

Roth Contributions:

• Made with after-tax dollars, meaning you pay taxes on the money now.
• Earnings grow tax-deferred.
• Withdrawals in retirement are tax-free, provided certain conditions are met.
• Ideal for those who expect to be in a higher tax bracket in retirement.

Traditional Contributions:

• Made with pre-tax dollars, meaning you get a tax deduction now.
• Earnings grow tax-deferred.
• Withdrawals in retirement are taxed as ordinary income.
• Suitable for those who expect to be in a lower tax bracket in retirement.

Considerations for Higher Earners

For lawyers working in Biglaw, who often fall into higher tax brackets, the strategy tends to lean towards maximizing tax efficiency. Here’s where the combination of traditional 401(k) contributions and “backdoor” Roth IRAs comes into play.

Traditional 401(k) Contributions:

• By contributing to a traditional 401(k) up to annual limits, you lower your taxable income, which can be particularly beneficial given the steep progressive tax rates.
• This immediate tax break can be significant, freeing up more income for investing or other financial goals, like paying down student loans.

“Backdoor” Roth IRAs:

• Due to income limits, high earners often can’t contribute directly to a Roth IRA. However, the “backdoor” Roth IRA strategy allows you to convert traditional IRA contributions to Roth IRA, enabling tax-free growth and withdrawals.
• This involves contributing to a non-deductible traditional IRA and then converting those funds to a Roth IRA. The key here is ensuring minimal tax implications during conversion, often achieved by having little to no existing traditional IRA balance, and/or doing it all at once in a lump sum using a bonus.

Strategies for Savers in Lower Tax Brackets

For those in lower tax brackets, the Roth option holds particular appeal. Here’s why:

Roth Contributions:

• Although you pay taxes on contributions now, you lock in your current low tax rate. This means your retirement savings grow tax-free, and you won’t have to worry about taxes on withdrawals.
• Given the potential for rising tax rates in the future, securing a tax-free income stream in retirement can be a tremendous advantage.

Roth IRAs and Employer-Sponsored Roth Contributions:

• If your employer offers a Roth 401(k) option, consider taking advantage of it. This allows for higher annual contribution limits compared to a Roth IRA.
• For those without access to employer-sponsored plans, maximizing Roth IRA contributions can help accomplish the same goal.

The Upside of Traditional Contributions:

If you’re still torn between Roth and traditional contributions/accounts, there is a “perk” to consider. Traditional contributions lower adjusted gross income (AGI), which is used in the calculations for income-driven repayment plans. So, if your main goal is lowering your student loan payments, traditional 401(k) and IRA contributions can help with that. That said, this is only beneficial to a certain point, since income-driven calculations ignore a chunk of your income anyway, lowering your AGI below that point has no strategic value.

Balancing Both: A Hybrid Approach

Sometimes, the best strategy might be a mix of both Roth and traditional contributions. For instance, you could split your contributions between a traditional 401(k) and a Roth 401(k), allowing you to enjoy immediate tax benefits while also filling a tax-free bucket of income for retirement.

Solo practitioners can contribute to traditional or Roth IRAs, or use Simplified Employee Pension (SEP) IRAs, which are generally easier to establish and administer than solo 401(k)s and offer several benefits for those going solo.

Conclusion: Your Personalized Strategy

Ultimately, the choice between Roth and traditional contributions depends on your current financial situation, expected future income, the direction you think tax brackets will go over time, and retirement goals. For high earners in Biglaw, leveraging traditional 401(k) contributions combined with “backdoor” Roth IRAs can offer significant tax advantages from both angles. Meanwhile, those in lower tax brackets might find the Roth 401(k) option more beneficial, ensuring tax-free growth and withdrawals.

No matter your income level, it’s crucial to plan ahead and consider the long-term implications of your retirement contributions. Consulting with a financial planner or plan administrator when the time comes can help you create a strategy that aligns with your unique circumstances and maximizes your financial well-being.

So, to Roth or not to Roth? The answer lies in understanding your financial picture and making informed decisions to secure a comfortable and tax-efficient retirement. Happy saving!

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