Personal Finance

I'm a 38 year old with $380k coming in annually and looking for optimal tax strategies that would impact my 401k

Kristin Hitchcock

Published: December 8, 2024 12:02 pm

In a recent Reddit post, a user (32M) and their husband (36M) posed an important question about maximizing their retirement contributions. I like this Reddit post because it’s a good example of how retirement accounts aren’t always the best option for retirement. 

The poster asks specifically if they should contribute an additional $28,000 in post-tax contributions to their 401(k), given that they already have heavy reliance on retirement accounts. They’re currently planning to retire early, within the next 10-15 years, which throws a wrench in utilizing their retirement accounts. 

(Also learn “Is there such a thing as too much in 401(k)s?”)

Let’s look at what readers can learn from this situation and the best path forward for the poster. Remember, this is just my opinion, not financial advice. 

24/7 Wall St. Key Points:

• In the case of the Reddit poster, contributing to a post-tax 401(k) can provide long-term tax-free growth and increase retirement savings. However, the trade-offs include liquidity concerns and the administrative hassle of tracking post-tax contributions. 
• For those planning for early retirement and financial independence, balancing between tax-deferred, tax-free, and taxable accounts is key.
• Also: Is your 401(k) optimized for your retirement plans? (Sponsored)

Understanding the Post-Tax 401(k) 

A post-tax 401(k) is often less well-known than its pre-tax or Roth counterparts, but it can be a powerful tool for high-income earners. Here’s how it works:

• Post-Tax Contributions: These contributions are made after you pay taxes, which means that they don’t reduce your taxable income for the year. 
• Roth Conversion: Once your post-tax contributions are in the 401(k), you can potentially convert them to a Roth IRA (through the backdoor Roth IRA process) and enjoy tax-free growth and withdrawals in retirement.  For those who are already maxing out their Roth IRA, this can be particularly useful. 
• Long-Term benefits: The benefits here are really long-term, as the Roth conversions can begin to add up, leaving you with a tax-free income source in retirement. 

So, when does this approach make sense?

Pros of Contributing to the Post-Tax 401(k)

The poster’s financial advisor recommended that they take advantage of the post-tax 401(k), and for good reason:

• Tax-Free Growth: Post-tax 401(k) contributions, when converted to Roth, grow tax-free. For those who expect to pay a higher tax bracket in retirement, this can be a huge benefit, as it can lower the amount of taxes you owe. 
• Additional Retirement Savings: The biggest benefit of maxing out your retirement contributions is that it allows you to invest more money into retirement. In this particular post, the Redditor has already contributed aggressively, but continuing to contribute the extra money can provide some additional security. 
• Tax Diversification: Having a mix of tax-deferred (traditional 401(k)), tax-free (Roth IRA), and taxable (investment accounts) assets can give you more flexibility in retirement.
• Larger Nest Egg for Early Retirement: For those looking to retire early, contributing more money to tax-free accounts like Roth IRAs is important, especially for those who plan to retire before they can withdraw from a 401(k). Otherwise, you may have to pay fees. 

That said, this method isn’t always a great choice. 

Cons and Other Considerations

A post-tax 401(k) can be very beneficial for a high-earner who plans to retire early. However, these accounts do have some factors you need to consider.

1. Tracking Complexity: As the Reddit poster mentioned, managing post-tax contributions and ensuring they’re correctly converted into a Roth IRA can be a bit of a hassle. A financial advisor can be very helpful in this regard, though it is possible to DIY the conversion. 
2. Liquidity: The primary downside of contributing to a post-tax 401(k) is that while the money is growing tax-free, it’s not easily accessible until you reach retirement age. Unlike a taxable investment account, you cannot pull the money out for other purposes, like purchasing a home. Taxable investment accounts offer a lot more flexibility. 
3. Employer Plan Limits: Many 401(k) plans have limitations and fees when you make post-tax contributions. It’s important to check for these before you decide on a path forward. Otherwise, you may be stuck paying extra fees. 
4. Opportunity Cost: Given that the couple is already saving aggressively, they might consider whether the $28,000 in post-tax contributions could be better utilized elsewhere. When you invest in a specific account, there is always an opportunity cost. 

Still, I think the pros outweigh the cons in this situation, especially if the poster doesn’t see any larger purchases in the future. This is especially true since it’s what their financial advisor recommended.