I’m 38 making $150k a year and I’m wondering if I should start pouring money into a Roth IRA now

Do you like math? Do you like math when it gets really complex, verging on overly complicated, and when the question goes so far into the weeds that it misses the swamp for the swamp-grass?

Then you’re going to love this one Reddit post I came across recently, whilst perusing discussions by people planning for become Financially Independent so that they can Retire Early (a group of people who refer to themselves as being part of the FIRE movement).

The numbers come fast and furious in this particular post, but let me see if I can put them in something approaching an intelligible order for you.

Today’s questioner, and let’s just call him “Bill” to keep things simple, is a well-off professional, age 38, earning a good income of $150,000 per year. Bill’s also fortunate in that he works for one of the few companies that still pays its employees a defined benefit pension when they retire. Combined with social security income and savings, Bill’s biggest problem is that he’s afraid that when he retires, he’s going to have so much money saved up that the IRS will make him pay a 32% tax rate on all the savings he’ll be withdrawing!

The math works like this:

Bill already has $390,000 saved up in a basic 401(k) retirement plan. Between contributions from his salary, and matching contributions from his employer, he’s adding a further $30,000 to his 401(k) every year. Plus, Bill’s salary is growing over time. Between salary hikes, which translate into larger and larger 401(k) contributions, plus the fact that assets in his 401(k) are growing over time, Bill anticipates that even if he retires early at age 62, he will probably already have at least $2.4 million in his 401(k).

Retirement math

Now, Bill is planning to follow the retirement rule of thumb, and withdraw 4% of his 401(k) assets annually upon retiring, so as to improve the likelihood that the 401(k) will not run out of money before he runs out of life. That means he’s expecting to withdraw about $104,000 annually.

In addition to these withdrawals, Bill expects to receive $51,000 a year in pension income, and another $30,000 from social security.

Add it all up, and Bill should have $185,000 a year to live on in retirement.

What worries Bill, though, is what happens if his 401(k) investment do better than he’s expecting them to? Potentially, the value of his 401(k) account could swell beyond the $2.4 million he expects to have saved up by his retirement date. If he ends up with $4 million in the 401(k) for example, he notes that a 4% withdrawal rate would see him pulling out $160,000 a year, and having annual income of $241,000.

(I know. The horror!) But here’s what has Bill worried:

Since the IRS’s 32% tax bracket currently starts at about $191,000, this means $50,000 of his retirement income might be subject to a 32% tax rate, while the rest of his income is taxed at no more than 24%. This, in a nutshell is what Bill wants to avoid: Growing his 401(k) too fast, with the result that he has to pay high taxes on his withdrawals in retirement.

The Roth 401(k)

To prevent this from happening, Bill wants to know if he might be wise to stop making pre-tax contributions to his 401(k). He proposes instead opening a Roth 401(k), which can be funded with after-tax contributions now (meaning he would pay his current 24% tax rate on contributions), so that when he retires, he won’t have to pay any tax at all on withdrawals from his Roth 401(k).

And I have to say, this sounds to me like Bill has both asked and answered his own question.

Granted, tax law is a complex business. Tax rates change all the time, and there’s no guarantee that the rates Bill is relying on in his planning today will hold true by the time he retires. It’s probably best Bill consult a qualified tax professional for advice on a situation with math as complex as all this.

Also granted, having “too much money” saved in a 401(k) is a nice problem to have. It’s almost as nice a problem (and as rare) as having a guaranteed pension adding to your retirement income! But if Bill is really worried about having to pay an extra 8% tax to the IRS in retirement, then switching to making after-tax 401(k) contributions now, instead of the pre-tax contributions he’s been making to his ordinary 401(k), sounds like a pretty good solution to me.