When Should High-Income Earners Max Out Their Roth 401(k) Instead of Pre-tax 401(k)?
While pre-tax contributions are typically the 401(k) contribution of choice for most high-income earners, there are a few situations where individuals with big incomes should make their deferral contributions all in Roth dollars and forgo the immediate tax deduction.
No Income Limits for Roth 401(k)
It’s common for high income earners to think they are not eligible to make Roth deferrals to their 401(k) because their income is too high. However, unlike Roth IRAs that have income limitations for making contributions, Roth 401(k) contributions have no income limitation.
401(k) Deferral Aggregation Limits
In 2025, the employee deferral limits are $23,500 for individuals under the age of 50, $31,000 for individuals aged 50-59 and 64 and older and $34,750 for individuals age 60-63. If your 401(k) plan allows Roth deferrals, the annual limit is the aggregate between both pre-tax and Roth deferrals, meaning you are not allowed to contribute $23,500 pre-tax and then turn around and contribute $23,500 Roth in the same year. It’s a combined limit between the pre-tax and Roth employee deferral sources in the plan.
Scenario 1: Business Owner Has Abnormally Low-Income Year
Business owners from time to time will have a tough year for their business. They may have been making $300,000 or more per year for the past year but then something unexpected happens or they make a big investment in their business that dramatically reduces their income from the business for the year. We counsel these clients to “never waste a bad year for the business”.
Normally, a business owner making over $300,000 per year would be trying to max out their pre-tax deferral to their 401(K) plans in an effort to reduce their tax liability. But, if they are only showing $80,000 this year, placing a married filing joint tax filer in the 12% federal tax bracket, I’ll ask, “When are you ever going to be in a tax bracket below 12%?”. If the answer is “probably never”, then it an opportunity to change the tax plan, max out their Roth deferrals to the 401(k) plan, and realize that income at their abnormally lower rate. Plus, as the Roth source grows, after age 59 ½ they will be able to withdrawal the Roth source ALL tax free including the earnings.
Scenario 2: Change In Employment Status
Whenever there is a change in employment status such as:
Retirement
High income spouse loses a job
Reduction from full-time to part-time employment
Leaving a high paying W2 job to start a business which shows very little income
All these events may present an abnormally low tax year, similar to the business owner that experienced a bad year for the business, that could justify the switch from pre-tax deferrals to Roth deferrals.
The Value of Roth Compounding
I’ll pause for a second to remind readers of the big value of Roth. With pre-tax deferrals, you realize a tax benefit now by avoiding paying federal or state income taxes on those employee deferrals made to your 401(k) plan. However, you must pay tax on those contributions AND the earnings when you take distributions from that account in retirement. The tax liability is not eliminated, just deferred.
Scenario 3: Too Much In Pre-Tax Retirement Accounts Already
When high income earners have been diligently saving in their 401(k) plan for 30 plus years, sometimes they amass huge pre-tax balances in their retirement plans. While that sounds like a good thing, sometimes it can come back to haunt high-income earnings in retirement when they hit their RMD start date. RMD stands for required minimum distribution, and when you reach a specific age, the IRS forces you to begin taking distributions from your pre-tax retirement account whether you need to our not. The IRS wants their income tax on that deferred tax asset.
The RMD start age varies depending on your date of birth but right now the RMD start age ranges from age 73 to age 75. If for example, you have $3,000,000 in a Traditional IRA or pre-tax 401(k) and you turn age 73 in 2025, your RMD for 2025 would be $113,207. That is the amount that you would be forced to withdrawal out of your pre-tax retirement account and pay tax on. In addition to that income, you may also be showing income from social security, investment income, pension, or rental income depending on your financial picture at age 73.
If you are making pre-tax contributions to your retirement now, normally the goal is to take that income off that table now and push it into retirement when you will hopefully be in a lower tax bracket. However, if your pre-tax balances become too large, you may not be in a lower tax bracket in retirement, and if you’re not going to be in a lower tax bracket in retirement, why not switch your contributions to Roth, pay tax on the contributions now, and then you will receive all of the earning tax free since you will now have money in a Roth source.
Scenario 4: Multi-generational Wealth
It’s not uncommon for individuals to engage a financial planner as they approach retirement to map out their distribution plan and verify that they do in fact have enough to retire. Sometimes when we conduct these meetings, the clients find out that not only do they have enough to retire, but they will not need a large portion of their retirement plan assets to live off and will most likely pass it to their kids as inheritance.
Due to the change in the inheritance rules for non-spouse beneficiaries that inherit a pre-tax retirement account, the non-spouse beneficiary now is forced to deplete the entire account balance 10 years after the decedent has passed AND potentially take RMDs during the 10- year period. Not a favorable tax situation for a child or grandchild inheriting a large pre-tax retirement account.
If instead of continuing to amass a larger pre-tax balance in the 401(k) plan, say that high income earner forgoes the tax deduction and begins maxing out their 401K contributions at $31,000 per year to the Roth source. If they retire at age 65, and their life expectancy is age 90, that Roth contribution could experience 25 years of compounding investment returns and when their child or grandchild inherits the account, because it’s a Roth IRA, they are still subject to the 10 year rule, but they can continue to accumulate returns in that Roth IRA for another 10 years after the decedent passes away and then distribute the full account balance ALL TAX FREE. That is super powerful from a tax free accumulate standpoint.
Very few strategies can come close to replicating the value of this multigenerational wealth accumulation strategy.
One more note about this strategy, Roth sources are not subject to RMDs. Unlike pre-tax retirement plans which force the account owner to begin taking distributions at a specific age, Roth accounts do not have an RMD requirement, so the money can stay in the Roth source and continue to compound investment returns.
Scenario 5: Tax Diversification Strategy
The pre-tax vs Roth deferrals strategy is not an all or nothing decision. You are allowed to allocate any combination of pre-tax and Roth deferrals up to the annual contribution limits each year. For example, a high-income earner under the age of 50 could contribute $13,000 pre-tax and $10,500 Roth in 2025 to reach the $23,500 deferral limit.
Remember, the pre-tax strategy assumes that you will be in lower tax bracket in retirement than you are now, but some individuals have the point of view that with the total U.S. government breaking new debt records every year, at some point they are probably going to have to raise the tax rates to begin to pay back our massive government deficit. If someone is making $300,000 and paying a top Fed tax rate of 24%, even if they expect their income to drop in retirement to $180,000, who’s to say the tax rate on $180,000 income in 20 years won’t be above the current 24% rate if the US government needs to generate more tax return to pay back our national debt?
To hedge against this risk, some high-income earnings will elect to make some Roth deferrals now and pay tax at the current tax rate, and if tax rates go up in the future, anything in that Roth source (unless the government changes the rules) will be all tax free.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Frequently Asked Questions (FAQs):
Can high-income earners make Roth 401(k) contributions?
Yes. Unlike Roth IRAs, Roth 401(k)s have no income limits for eligibility, meaning even high earners can make Roth contributions through their employer’s retirement plan if the plan allows them.
When might it make sense for a high-income earner to choose Roth 401(k) contributions?
Roth contributions can make sense during years of unusually low income or reduced tax brackets — such as a down business year or a job change — since the tax cost of contributing after-tax dollars is lower. These contributions can then grow tax-free for retirement.
How do Roth 401(k) and pre-tax 401(k) contributions differ in taxation?
Pre-tax 401(k) contributions lower taxable income now but are taxed upon withdrawal. Roth 401(k) contributions are made with after-tax dollars, but both contributions and earnings can be withdrawn tax-free in retirement if certain conditions are met.
What happens if you already have large pre-tax retirement balances?
Having too much in pre-tax accounts can lead to large required minimum distributions (RMDs) and higher taxable income in retirement. Switching future contributions to Roth can help balance tax exposure and reduce the impact of RMDs later.
Why might Roth 401(k)s be beneficial for multi-generational wealth planning?
Roth accounts are not subject to RMDs during the account owner’s lifetime and can be passed to heirs who can continue to grow the funds tax-free for up to 10 years. This makes Roth assets a powerful tool for tax-efficient inheritance planning.
Can you combine Roth and pre-tax 401(k) contributions?
Yes. Employees can split their deferrals between Roth and pre-tax sources in any ratio, as long as the combined total does not exceed annual IRS limits. This approach provides tax diversification and flexibility in managing future tax risk.
Why might tax diversification be valuable for retirement planning?
Future tax rates are uncertain, especially given rising government debt levels. Having both pre-tax and Roth sources allows retirees to draw income strategically depending on future tax environments.
