When deciding between contributing to a traditional pretax 401k or a Roth 401k, the implications on long-term tax savings can be profound. Your choice affects all three phases of the money management lifecycle: contribution, growth, and withdrawal. Yet, many investors (even financial advisers and CPAs) often make suboptimal or incorrect decisions based on oversimplified assumptions, which could lead to a loss of tax savings in the order of six digits or more over the long term. Here is an example that illustrates why careful, data-driven analysis matters.

The Scenario

Lisa plans to contribute the 2025 maximum elective deferral of $23,500 to either a pretax 401k or a Roth 401k. Her current marginal tax rates are 30% for regular income and 20% for capital gains. She estimates that her marginal tax rates in retirement will be 25% and 20%, respectively. These tax rates include federal, state, and local taxes. We denote her tax rates as [30%/20%; 25%/20%] for shorthand. She intends to invest in an S&P 500 index fund over 30 years before making withdrawals.

The central question: Should Lisa choose the traditional pretax 401k or the Roth 401k? And by how much would the right choice benefit her?

Common Misconception

Since Lisa expects her future tax rates to be lower, many financial professionals would suggest the traditional 401(k). This advice seems intuitive but is incorrect in this case. Following it could cost Lisa over $100,000 in potential tax savings.

The Analysis

To provide a data-driven analysis, let me write down the two scenarios:

Scenario 1: Contribute $23,500 to a Roth 401k.
Scenario 2: Contribute $23,500 to a pretax 401k.

Note that these two scenarios are stated very intuitively, and many people do not think deeper from here but just focus on current tax savings from Scenario 2. Let me point out that this is not an apple-to-apple comparison. In Scenario 1, she contributes an after-tax amount of $23,500 to her Roth 401k. However, in Scenario 2, she contributes a pretax amount of $23,500 to her pretax 401k. These two amounts of $23,500 are not equal.

To fully understand the issue, we need to start with an apple-to-apple comparison and calculate the total tax savings covering all three phases (not just at the time of contribution). The pretax equivalent of the after-tax contribution of $23,500 in Scenario 1 is:
23500 / (1 - 0.3) = $33,571.
For Scenario 2, we need to start with the same amount of pretax money. In Scenario 2, starting from pretax $33,571, after contributing $23,500 to her pretax 401k, she still has $33,571 - $23,500 = $10,071 left. Then she needs to pay income tax and has an after-tax amount of 10,071 * (1 - 0.3) = $7,050 afterwards. Let me assume that she invests this after-tax amount of $7,050 in an extra taxable brokerage account (below I will call it Account E).

Now, the apple-to-apple comparison of these two scenarios looks like this:

Scenario 1: Invest an after-tax amount of $23,500 in a Roth 401k. The pretax equivalent of this after-tax contribution is: 23500 / (1 - 0.3) = $33,571, as her current marginal tax rate is 30%.
Scenario 2: Starting from the same pretax amount: $33,571, 1) invest the pretax amount of $23,500 in a traditional 401k; 2) invest the after-tax amount: [33,571 - 23,500] * (1 - 0.3) = $7,050 in an extra taxable brokerage account (Account E).

Performance Over 30 Years

Let us assume that Lisa invests in Vanguard 500 Index Fund (VFINX) in both scenarios above for 30 years with a buy and hold strategy. Using the historical performance data for the 30-year period from 1987-12-31 to 2017-12-31, the results under the marginal tax rates of [30%/20%; 25%/20%] are:

Scenario 1: Invest an after-tax amount of $23,500 in a Roth 401k. The balance at the end of the 30-year period is: $477,848.
Scenario 2: 1) Invest a pretax amount: $23,500 in a traditional 401k, whose balance at the end of year 30 is: $477,848 and after-tax value is: 477848 * (1 – 0.25) = $358,386; 2) Invest an after-tax amount: $7,050 in Account E, whose balance at the end of year 30 is $116,833 with cost basis: $24,716 and after-tax value: 116833 – (116833 - 24716) * 0.2 = $98,410. The total after-tax value of Scenario 2 is: $358,386 + $98,410 = $456,796.

The Difference

Wow, Scenario 1 (the Roth 401k option) results in much more tax savings than Scenario 2 (the pretax 401k option) and the difference is:
$477,848 - $456,796 = $21,052.
Repeat this annually over five years and Lisa could gain over $21,052 * 5 = $105,000 in additional tax-free growth with the Roth 401k option. Even better, contributing to the Roth 401k essentially eliminates the risk of future tax rate hikes, lowers future taxable income, and does not impact how Social Security benefits are taxed and Medicare premiums. Many tax planning strategies have similar effects. Over the long term, they may make a 6-digit difference or more for many people!

Insights from My Research

This example is taken from my recent book:

Tax Planning: Measuring Tax Inefficiencies of Index ETFs and Investment Accounts (Kindle Direct Publishing, 2025, ISBN: 9798304806473).

The book quantitatively measures the tax inefficiencies of different index ETFs and investment accounts at various tax brackets and provides data-driven analyses on how to invest in the most tax-efficient manner with maximum after-tax and after-cost returns.

This article uses an example for deciding whether a Roth 401k is better than a traditional 401k. Using examples in practice is very tedious and time consuming. How to get a general result that would apply to everyone? This is where mathematical modeling comes in handy. With mathematical abstraction, many cases can be easily covered with the same formula or logic. Such mathematical modeling was published in my book:

Retirement Planning: 401k vs Roth 401k, IRA vs Roth IRA (Outskirts Press, 2020, ISBN: 978-1977223579).

This book provides a mathematical model and analyses on when to choose a Roth 401k over traditional pretax 401k. The general rule derived from the book is as follows:

• If future tax rates are higher than current tax rates, then a Roth 401k would always lead to more after-tax income than a pretax 401k, provided both accounts are invested the same way.
• If future tax rates are lower than the current tax rates, a Roth 401k can still be better than a pretax 401k, provided the investment time horizon is long enough. And this investment time horizon can be calculated using a mathematical formula.

Final Thoughts

Smart tax planning pays off. Many people underestimate the long-term cost of suboptimal tax-saving choices. As Professor Scott Galloway from NYU said in a recent podcast: "Tax avoidance is a key skill to building wealth." Are you working hard to master this skill? Want to learn more strategies that could save you six figures in taxes?

Stay tuned for my next article where I debunk another common 401k misconception.