To Roth or Not to Roth?

With an increasing number of companies adapting "tax-advantaged" Roth 401(k) plans, what's the best retirement savings option to choose?

That's the topic of new research by Laurence Kotlikoff, Ben Marx, and David Rapson of Boston University.

Some 22 percent of companies including Morgan Stanley, I.B.M., and G.M. now offer the newish Roth 401(k) plan.

Much like regular 401(k)s, Roth 401(k)s allow employees to save for retirement through payroll deductions. The primary difference is that funds entering Roth 401(k) accounts are post-tax whereas it's pretax for traditional 401(k)s. For the Roth option, this means thats when distributions are made after retirement no taxes are taken out, unlike traditional 401(k)s. (This is similar to the difference between regular and Roth IRA accounts.)

The standard reason given to choose a Roth account is if you think your future tax bracket will be higher than your current one.

But the researchers say it's not that simple, particularly if the tax system is overhauled.

They create a fictional world of 14 different families (ranging in attributes like marital status, earnings, assets, housing expenses, college expenses, and age) and model what would happen under three different tax scenarios: no change, income tax is increased, or income tax is replaced with a 23 percent consumption tax -- the level that would arise under a Mike Huckabee-like tax plan.

They find that in a world where income tax rates are 30 percent higher in retirement, the Roth option is generally the winner except for very low-income single households earning $10,000 and for married households earning $200,000.

Under a consumption tax scheme, the Roth 401(k) is the decided loser because households are basically getting taxed twice: once before putting funds into the Roth and again when those funds are used in retirement.

And if everything was to stay the same, the regular 401(k) usually offers the same kick as the Roth except in two cases: Low-income single households ($35,000) in their mid-40's do a little better with the Roth and high income earners do much better with the regular.

If nothing else, the study highlights the benefits of tax breaks for the rich under our current system:

Consider, for example, the 30 year-old married household earning $500,000 a year and assume no future tax changes. For this household, contributing to a regular 401(k) raises lifetime consumption by $437,693 - or by almost a full year's earnings! Contributing to the Roth 401(k) raises lifetime consumption by $373,932. Though smaller, this is still a huge gain. These gains dwarf the $12,840 and $10,041 respective gains provided to the same age-30, married household earning only $50,000 a year.

Update
Jesse Eisinger reminds me that I forgot to mention the upshot of all this: you should stick with the regular 401(k) unless you have ESP and know for sure that a significant income tax hike is in the offing.