Roth 401k vs 401k for high earners – what is the difference between the two and when should you worry about it?
I remember the day when I finally made enough money and had paid off enough debt to fully maximize both my wife’s and my’s 401k contributions. I then started to wonder how much should I put into a Roth 401k or if should I leave it as a Traditional 401k.
It was a first-world problems moment and one I was happy to legitimately have. The issue is that my family didn’t and still doesn’t have a lot of money. So I had no one to turn to. When I was asking around about this at work most people were barely getting their company match and didn’t know our company even offered a Roth 401k.
Maybe you feel like you are on your own as well. If you feel like that join my free Facebook group to ask questions like these and others.
What is the difference between a Roth vs Traditional 401k?
If you are trying to decide between a Roth 401k and a Traditional 401k, it is important to understand the differences between them. A Roth 401k is an employer-sponsored retirement savings account that allows your contributions to grow tax-free over time. The main difference between a traditional 401k and a Roth is the way taxes are handled when contributing money into the account.
With a traditional 401k, contributions are made with pre-tax dollars which can reduce your taxable income now, but will be taxed later when you withdraw the funds in retirement. On the other hand, with a Roth, you pay taxes on your contribution now and can enjoy tax-free growth of earnings over time as well as tax-free withdrawals in retirement.
High income earners often benefit from contributing to both types of accounts since they have more disposable income available for saving for retirement.
Is Roth 401k worth it for high income earners?
For high income earners, the decision between a Roth 401k and a traditional 401k can be difficult. A Roth 401k allows for tax-free income in retirement, but contributions are subject to taxes. On the other hand, traditional 401ks offer potential tax deductions on contributions now, but withdrawals are taxed as ordinary income later. Comparing the two options side-by-side can help determine which plan is best suited for your individual situation.
When deciding whether a Roth or traditional 401k is worth it for you as a high income earner, there are several factors to consider. First, if you think you will be in a higher tax bracket when you retire than when you make the contribution then it may be better to choose a Roth 401K because your withdrawals would not be subject to taxation.
So you have to ask yourself then if you think that taxes will be higher in the future than now. If you think that then you may want to put more in a Roth 401k as that would save you tax money. If you think taxes will stay roughly the same or will be lowered then stay in a Traditional 401k.
Is 401k good for high income earners?
The answer is yes, but it’s important to choose the right type of 401k. For many high-income earners, a Roth 401k can offer a number of advantages that other types of retirement accounts can’t match. A Roth 401k allows you to contribute after-tax dollars and then pay no taxes on your withdrawals. This means that all growth in the account is tax-free, which can result in more money for retirement.
This could be very appealing because then you don’t have to worry about what party or person is in office in 20 – 40 years when you are ready to retire for example. It gives you more control. But that control means you pay more taxes today.
But as a high income earner, you may not be legally able to invest in an IRA anymore and thus a Traditional 401k is the only way to reduce your taxable income. Reducing your taxable income might be the only way you will max out your 401k contribution. If that is you, then work on maxing out your contribution in pre-tax and then make the decision later to move a portion to a Roth 401k if you want to have pre and post-tax money in your retirement.
The 2023 limits for a 401k are as follows:
Under 50 – you can contribute up to $22,500 total in a Traditional / Roth or Mix of the two.
Over 50 – you can contribute up to $30,000 total in a Traditional / Roth or Mix of the two.
If your employer matches any of your contributions that is free money and doesn’t count toward these limits. So if you give the maximum of $22,500 and your employer matches $5,000 then you would have $27,500 at the end of the year.
Is Roth better than traditional for high income earners?
It isn’t a matter of better or worse, but rather ability, belief, and options.
Ability: If you can maximize your post-tax 401k contributions and still live your lifestyle as you want then look at the next two points below. If you can’t maximize your 401k then don’t worry about this question and work on putting in the most you legally can pre-tax. Gaining more money will beat out any amount of tax you have to pay. Even if you are taxed at 50% of that investment you still made money.
Belief: Now that you can maximize your contributions do you believe that when you will retire the tax brackets will be higher or lower? Let’s chat numbers. Don’t hang with me as this could save you lots of money.
If you are making $150,000 a year then you are paying 24% on any amount over $95,375 dollars. Now let’s say you will retire on 80% of $150,000 which is $120,000 a year. If you believe that the taxes will be higher then you will pay more on that last portion of the money. If you think they will be lower then it makes sense to NOT invest in a Roth 401k.
Options: Lastly, you may want to put some percentage in both Roth and Traditional IRA just to “hedge your bets.” Investing is all about diversification and this is another way you can diversify so that you have a bucket of money that is pre-tax and post-tax. Having post-tax money will allow you to determine how much your taxable income will be as well because you can use more of your Roth 401k to reduce your tax rate as taking money from a 401k is considered income. And at a certain age (70.5 now) you will be required to start taking a required minimum distribution to make sure you have no money in your retirement.
The government has lots of rules to make sure you don’t leave money to future generations – but there are ways around that – see the rich man’s Roth below in this article.
Can a highly compensated employee contribute to a Roth 401k?
Yes, a highly compensated employee can contribute to a Roth 401k even if their income is above the maximum allowed for a Roth IRA. The Roth 401k is an employer-sponsored retirement plan that allows workers to save after-tax money for retirement. It allows workers to invest in their future now, and pay no taxes on their earnings when they withdraw them. This benefit makes it a great option for high earners who want to reduce their tax burden today, while still having access to the funds when they need them later in life.
Why can’t high earners use Roth IRA?
When it comes to retirement savings, many high-income earners are left wondering what the best option is for them. The Roth 401k and traditional 401k both offer different advantages that could make one a better choice than the other for certain individuals. However, another factor to consider is whether or not a high-earner can use a Roth IRA. Unfortunately, due to IRS regulations, those who make too much money are excluded from using this type of account.
In order to be eligible for a Roth IRA, an individual must meet certain income requirements set by the IRS.
Can I invest in Roth IRA if I make over 200k?
See the chart directly above. In 2023 if you are married and filing jointly with a spouse then yes you can contribute $6,500 a year (under 50 / $7,500 if 50 or older) until you jointly make $218,000 a year. Then you can do a reduced amount until you make over $228,000 a year and then you cannot contribute anything. If you are single you can’t contribute anything after you make $153,000 a year.
What is a rich man’s Roth?
This is the concept of being your own bank. This concept is to invest in cash value whole life policies to create generational wealth (if insuring children or grandchildren) or being your own bank (if insuring yourself). In a nutshell, you buy a half-million-dollar policy for example. You then overfund this account each month/year. Then at any time, you can take a loan (no tax) from the cash value of your policy to use on whatever you would like. Most people use it to buy real estate, cars, or vacations. Buying real estate is a great way to use wealth to buy more wealth-bearing assets.
Then if you want you can pay the loan back. If you don’t then when you die the insurance company takes out the loan from your death benefit. The huge advantage to these accounts is if you pull out $50,000 in cash it isn’t income as it is a loan and because it is a loan you still make money (yearly guaranteed minimums depending on the market) on that money.
To read more about how to be your own bank read my article on it here.
Alternatively, if you want to deep dive into this concept read the book, “What Would the Rockefellers Do? How The Wealthy Get and Stay That Way and How You Can Too” by Garret Gunderson.
I have set up three of these: one for my granddaughter, one for my wife, and one for me.
Do I do a Roth 401k, a Traditional 401k, or both?
In summary, if you have the means to only fully fund a traditional pre-tax 401k do that first.
If you can fully fund a post-tax Roth 401k then weigh out if you think taxes will be lower or higher for the amount you will live on in retirement (which is typically 70% – 80% less than what you are living on now). Also, you may want to do some in a Roth and some in a Traditional account so that you have some post-tax money that you can play with to reduce your taxable burden later no matter how the tax situation pans out.
About Dwight Scull
I have been married to my wonderful wife, Rebecca, who puts up with me since 1999. I am a proud father to my Gen Z, son, and daughter-in-law. Grandfather to my favorite granddaughter who was born in 2021.
I lost my mom, father-in-law, and 12 others in 2013 and was DEEPLY in debt. I started reading and watching all the financial info I could find.
I chipped away at my debt and went from a negative $105k net worth having one home paid off, no credit card debt, and saving/investing 45%+ of my gross salary.
I used these daily habits to lose 100 pounds and keep it off.
I believe that you can overcome any challenge you face if you just take small daily actions and be consistent with them. It is how you will be financially successful.