Roth 401k vs 401k for High Income Earners, Understanding the Differences

For high income earners, choosing between a Roth 401k and a traditional 401k can be a daunting task. The main difference between the two is tax implications, with traditional 401k contributions being made pre-tax and Roth 401k contributions being made post-tax.

Roth 401k contributions are made with after-tax dollars, which means you've already paid income tax on that money. This can be a disadvantage for those who are in a high tax bracket, as they may end up paying more in taxes upfront.

High income earners often have a higher tax bracket, which can impact their decision. For example, if you're in a 35% tax bracket, putting $10,000 into a traditional 401k would save you $3,500 in taxes that year.

A Roth 401(k) has no income limits, making it a good fit for high earners who can't invest in a Roth IRA due to income limits.

High-income earners can benefit from a Roth 401(k) as it allows tax-free growth and withdrawals, which can be especially valuable in retirement.

A traditional 401(k) requires contributions to be made with pre-tax dollars, reducing taxable income for the year, but taxes are owed on withdrawals in retirement.

Contributing to a Roth 401(k) means paying taxes upfront, but all future withdrawals are tax-free, which can be a big advantage for high-income earners who expect to be in a higher tax bracket in retirement.

Roth 401(k) contributions are made with after-tax dollars, which means they don't reduce taxable income for the year, but they also don't provide an immediate tax benefit.

For high-income earners, it's essential to consider the income and contribution limits of a Roth 401k.

The Roth 401k has no required minimum distributions, which means the money can stay within the account and grow for as long as you keep it in the account.

This can be particularly beneficial for individuals with successful careers, as their income could increase in the future with promotions or job changes, potentially keeping them in a lower tax bracket.

Higher contributions to a Roth 401k can also help avoid higher tax brackets in retirement, where tax rates may be higher due to the growth of the money over its lifetime within the account.

Income from a married couple's joint tax return can affect social security tax rates, with couples earning over $44,000 potentially paying up to 85% of their social security benefits in taxes.

A married couple filing jointly with income between $33,000 and $44,000 will pay 50% of their social security benefits in taxes.

Roth 401k income is not included in the income that determines social security tax rates.

This means that a couple's Roth 401k income won't affect their social security tax rates.

The SECURE Act requires beneficiaries of an inherited Traditional 401k to withdraw the entire balance within 10 years and pay income tax on the amount inherited over that period.

In contrast, a Roth 401k allows the beneficiary to receive the full amount and continue to grow the account with significant tax savings.

High income earners often think they can't contribute to a Roth 401(k) because of income limits, but that's not true. Unlike Roth IRAs, Roth 401(k) contributions have no income limitation.

You can contribute to a Roth 401(k) regardless of your income level. This is a big difference from Roth IRAs, which have strict income limits.

For example, single filers can't contribute directly to a Roth IRA if their incomes exceed $161,000 in 2024 or $165,000 in 2025. But with a Roth 401(k), you can contribute as much as you want, regardless of your income.

The income limits for Roth IRAs are quite high, but they do exist. This means that even if you're not eligible for a Roth IRA, you can still contribute to a Roth 401(k).

Split Between Accounts can be a smart move, especially if you're unsure about your future tax rate. You can split your savings between a traditional 401(k) and a Roth 401(k) to hedge your investments.

This strategy guarantees you'll have some tax-free and some taxable income in retirement. You might want to consider this option if you're unsure about your tax rate in the future.

You can also roll over your traditional 401(k) into a Roth, but be aware that you'll owe taxes on your contributions upfront. This can be a good idea if you think your tax rate will be higher in retirement.

High income earners who plan to pass their wealth to the next generation can benefit from a multi-generational wealth accumulation strategy. This strategy involves forgoing tax deductions and maxing out 401(k) contributions to a Roth source.

By doing so, the Roth contribution can experience 25 years of compounding investment returns, allowing the account to grow significantly. This is especially beneficial for high income earners who can take advantage of the higher contribution limits.

The Roth IRA is not subject to RMDs, meaning the money can stay in the account and continue to accumulate returns without being forced to take distributions. This allows the account to grow even more, providing a tax-free inheritance for loved ones.

High-income earners who have saved diligently in their 401(k) plan for 30 plus years may amass huge pre-tax balances in their retirement plans.

The IRS forces you to begin taking distributions from your pre-tax retirement account when you reach a specific age, which is now between 73 to 75 years old, depending on your date of birth.

If you have $3,000,000 in a Traditional IRA or pre-tax 401(k) and you turn age 73 in 2024, your RMD for the year would be $113,207, which is the amount you'd be forced to withdraw and pay tax on.

You may also be showing income from social security, investment income, pension, or rental income at age 73.

If your pre-tax balances become too large, you may not be in a lower tax bracket in retirement, which is the goal of taking income off the table now and pushing it into retirement.

In Scenario 4, Multi-generational Wealth, individuals often find out they have enough to retire and can pass on a significant portion of their retirement plan assets to their kids as inheritance.

Financial planners sometimes discover that clients will not need a large portion of their retirement plan assets to live off, and instead, it will be passed on to their loved ones.

The inheritance rules for non-spouse beneficiaries have changed, forcing them to deplete the entire account balance 10 years after the decedent has passed and potentially take Required Minimum Distributions (RMDs) during that period.

High-income earners can avoid this unfavorable tax situation by forgoing the tax deduction and maxing out their 401(k) contributions to the Roth source, which allows for 25 years of compounding investment returns.

Roth sources are not subject to RMDs, unlike pre-tax retirement plans, so the money can stay in the Roth source and continue to compound investment returns.

This multigenerational wealth accumulation strategy is incredibly powerful, allowing the Roth IRA to continue accumulating returns for another 10 years after the decedent passes away, and then distribute the full account balance all tax-free.

You can contribute up to $19,500 to a 401k in 2022.

High-income earners may benefit from tax-advantaged investment strategies, such as tax-loss harvesting, which can help offset capital gains.

Consider consulting a tax professional to determine the best approach for your individual circumstances.

With Traditional 401ks, the taxing occurs when you make withdrawals in retirement, at whichever income bracket you would be in, based on your annual withdrawals.

A common rate of retirement savings is for individuals to accumulate enough money to take out 70-80% of their pre-retirement annual income, per year.

You might be taxed in a higher income bracket if you withdraw more than 80% of your pre-retirement income, potentially leading to a higher tax rate.

Once you reach retirement, your tax bracket can shift significantly if you have other sources of income, such as a pension or investments.

With Roth 401ks, the tax rate is locked in at the time you contribute, so you won't have to worry about your tax bracket changing in retirement.

In most cases, you'll pay taxes on your Roth 401k contributions at the time you make them, but the rest of your money will grow tax-free.

Tax diversification is a strategy that can help you manage your taxes in retirement. By contributing to both Traditional and Roth 401k plans, you can reduce your tax liability.

In Traditional 401ks, taxes occur when you make withdrawals in retirement, based on your annual income bracket. This can be a concern, especially if you're planning to take out 70-80% of your pre-retirement income each year.

With Roth 401ks, taxes are paid upfront, and you won't owe any taxes on withdrawals in retirement. This can lead to significant tax savings over time.

For example, if you contribute $23,000 to a Roth 401k plan at age 40, it can grow to $157,515 by age 65 with an 8% annual rate of return. You can then withdraw the entire balance tax-free.

This tax-free growth can add up to a substantial amount over the years. By taking advantage of both Traditional and Roth 401k plans, you can create a more tax-efficient retirement income stream.

With a Roth 401(k), your employer deducts contributions from your net income after taxes, so you won't get a tax deduction on your contributions.

To withdraw earnings tax-free, you must be at least 59 ½ years old or have had at least five years since your first contribution to a Roth IRA, regardless of your age when you opened the account.

The clock starts ticking on January 1 of the year you made your first contribution, and you have until the tax filing deadline of the following tax year to make a contribution.

Here are the specific rules for withdrawing Roth 401(k) earnings tax-free:

The Roth Account is a type of retirement savings plan that allows you to contribute after-tax dollars, which means you won't get a tax deduction for the contributions.

Contributions are made from your net, after-tax income, and are removed from your take-home pay after income tax has been taken out.

No income tax is owed on withdrawals from a Roth 401(k) account once you retire, because the contributions were taxed years ago and are now tax-free.

You can withdraw your earnings from a Roth 401(k) without owing taxes or penalties if you meet two conditions: you're at least 59 ½ years old and it's been at least five years since you first contributed to any Roth IRA.

Here are the two conditions for tax-free withdrawals from a Roth 401(k):

The 5-year rule applies regardless of your age when you opened the account, so you'll still have to wait the full five years even if you're older when you make your first contribution.

Contributing to a retirement account can be a smart move, especially if you're a high-income earner.

With a Roth 401(k), you can make higher contributions to your retirement savings account, which can be beneficial if you expect your income to increase in the future.

You can also avoid being forced into higher tax brackets in retirement with a Roth 401(k), since the money grows tax-free and withdrawals are tax-free too.

Traditional 401(k)s can be a hindrance when required minimum distributions kick in, forcing your taxable income into higher tax brackets.

With a Roth 401(k), you pay taxes upfront on your deductions, which can be beneficial to remain in a lower tax bracket.

You can make contributions from your net, after-tax income, meaning you pay the taxes upfront and avoid higher tax brackets in retirement.

A Roth 401(k) can be a game-changer for your retirement savings. You get to enjoy tax-free withdrawals, which means you can use the entire sum without worrying about the IRS taking a share.

Traditional 401(k)s, on the other hand, give you a tax break upfront, but you'll need to account for taxes when withdrawing in retirement. This can be a challenge, especially if you're not sure how much to withdraw each year.

If you're a highly compensated employee, you might face lower contribution limits with a Roth 401(k). However, you can still save more in the long run since you don't have to worry about tax expenses when withdrawing.

Consider funneling some funds into a Roth IRA, either directly or through the backdoor Roth IRA strategy, to have maximum control over your income taxes in retirement.

For high-income earners, choosing between a Roth 401(k) and a Traditional 401(k) can be a crucial decision. If you expect your income to increase in the future with promotions or job changes, taxing your income on the front end with a Roth 401(k) can be beneficial to remain in a lower tax bracket.

This approach can help you avoid higher tax brackets in retirement, which can be triggered by required minimum distributions from a Traditional 401(k). With a Roth 401(k), your money can stay within the account and grow tax-free for as long as you keep it in the account.

Splitting your savings between a Traditional 401(k) and a Roth 401(k) can also be a good idea, as it guarantees you'll have some tax-free and some taxable income in retirement.

Choosing an Account can be a daunting task, especially with so many options available.

High-income earners may find the Roth 401k a great choice due to its potential for huge compounded growth and tax benefits.

With a Roth 401k, the money can stay within the account and grow for as long as you keep it in the account, thanks to no required minimum distributions.

For individuals with successful careers, income may increase in the future with promotions or job changes, making it beneficial to remain in a lower tax bracket by taxing income on the front end.

This strategy can help minimize taxes in retirement, when your tax bracket may be higher due to higher contributions to your retirement savings account.

Required minimum distributions from Traditional 401ks can force your taxable income into higher tax brackets, eliminating the possibility of continued compounding growth on the account.

So, which plan works better for you? There's a lot to consider. For example, can your budget handle the strain of a smaller take-home paycheck? If it can, the Roth 401(k) may be the better choice. If not, opt for the traditional type.

You can defer up to the contribution limits set by the IRS, which can be found in the "Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits" section. This limit is subject to change, so be sure to check it regularly.

If you expect to be in a lower tax bracket after you retire, the tax hit you'll owe on your withdrawals isn't as big of an issue, so the traditional 401(k) may be better for you. This is because you'll be paying taxes at a lower rate.

You can find more information on the tax implications of 401(k) withdrawals in the "Retirement Topics - Required Minimum Distributions (RMDs)" section. This section explains how RMDs work and how they can affect your taxes.

If you can't decide—or can't fully predict the future—then you may want to split your assets between these two types of accounts. It doesn't have to be an all-or-nothing decision.

Here are some key differences between traditional and Roth 401(k) plans to consider:

Ultimately, the choice between a traditional and Roth 401(k) plan depends on your individual circumstances and financial goals.