Jenny (35 years old) is considering making a one-time contribution to either a traditional 401(k) plan or to a Roth 401(k) plan.She plans to withdraw the account balance when she retires in 40 years.Jenny expects to earn a 7% before-tax rate of return no matter which plan she contributes to.Which of the following statements is true?
A)If Jenny's marginal tax rate in the year of contribution is higher than her marginal tax rate in the year of distribution,she will earn a higher after-tax rate of return on the traditional 401(k) plan than on the Roth 401(k) plan.
B)If Jenny's marginal tax rate in the year of contribution is lower than her marginal tax rate in the year of distribution,she will earn a higher after-tax rate of return on the traditional 401(k) plan than on the Roth 401(k) plan.
C)Jenny will earn the same after-tax rate of return no matter which plan she contributes to.
D)Jenny is not allowed to make a one-time contribution to either plan.If her marginal tax rate is higher in the year of contribution than in the year of distribution,her after-tax rate of return will be higher for a traditional 401(k) plan because she will be getting the tax benefit of the deduction at a higher rate and will have to pay the tax cost of the distribution at a lower rate.

Question

Quizplus · Accepted Answer

If Jenny's marginal tax rate is higher in the year of contribution than in the year of distribution, her after-tax rate of return will be higher for a traditional 401(k) plan because she will be getting the tax benefit of the deduction at a higher rate and will have to pay the tax cost of the distribution at a lower rate. Roth 401(k) plan would not be advantageous in this scenario as the tax rate during contribution would be higher than at the time of withdrawal. Therefore, Jenny should choose the traditional 401(k) plan.

Jenny (35 Years Old) Is Considering Making a One-Time Contribution