Executive Brief
We commonly find early-career high earners who are unlikely to save on lifetime taxes by contributing to a tax-deferred 401(k). We look at the tax math and how the arbitrage works.
A 401(k) on autopilot is helpful for the discipline of saving, but it’s risky when it’s left unchanged for 10+ years. We discuss target date funds, rebalancing, and reviewing 401(k) updates.
We heavily caution against front-loading your 401(k) match. We share a story on how one review lost potentially ~$1M in lifetime savings because of a well-meaning, long-term mistake.
I’m thankful to say that the majority of the executives we meet are disciplined about their 401(k). They set a contribution rate, they hit the annual maximum, and they move on. We’re big fans of that discipline.
The problem is that the 401(k) is also where three of the most expensive and consistently repeated mistakes in executive financial planning live, and they almost never get caught until the damage has already compounded for years. Autopilot is good discipline, but it makes the system you choose all the more important.
Mistake One: Contributing Pre-Tax When You Should Be Doing Roth
The default setting for most 401(k) contributions is pre-tax. You reduce your taxable income today, the money grows tax-deferred, and you pay taxes on everything when you withdraw in retirement. It sounds like the responsible move.
I’m starting with more of a niche case–most of our clients should NOT be prioritizing Roth dollars for their retirement–but it’s been coming up with younger, ascending executives.
Here is the math that changes the picture. If your household income is below $400,000 married filing jointly, you are in the 24% federal bracket or below. That feels like a meaningful tax deduction today, but consider what happens on the other end.
Social Security alone will cover the 0%, 10%, and 12% brackets in retirement. By the time that income layers in, you are already likely sitting in the 22 to 24% bracket before you have withdrawn a single dollar from your 401(k). This means every pre-tax dollar you contributed, and every dollar of growth it generated, gets taxed in retirement at essentially the same rate you would have paid when you put it in.
You deferred the tax. You did not reduce it.
For executives who are ascending and expect their income to remain elevated throughout their careers and into retirement, Roth contributions at the 24% bracket or below could very well be the better choice. You pay the tax now at a rate you can see, and everything that grows from that point forward comes out tax-free, including the compounding over a 20 or 30-year horizon.
The bracket math is the first thing we review with any client before touching their contribution elections.
(This, of course, is not a blanket tax strategy. Every personalized tax strategy needs personalized review and advice, including from qualified tax professionals.)
Mistake Two: Set It and Forget It Allocation
The second mistake is less about strategy and more about inertia. Most executives set an initial allocation when they first enroll, often a single target-date fund or a simple mix of whatever was in the default options and never look at it again.
A 401(k) that was appropriately allocated at 35 is not automatically appropriate at 50. Risk tolerance changes, let alone market conditions that shift the composition of what you own. A portfolio that started as a balanced mix can drift significantly over a bull run, leaving you with a concentration in equities that no longer matches where you are in your career or how close you are to the point where you will need to start drawing from it.
Rebalancing should be happening consistently to better align your risk profile with the timeline and goals of your life currently.
Mistake Three: Front-Loading and Missing the Match
This is the one that surprises people most, and the one where the math is most brutal. I have a rough story here to make the point.
A new client came to us after decades in the pharma industry, approaching retirement. He had always been proud of how aggressively he funded his 401(k), contributing at a high enough rate that by the time his annual bonus arrived in the first quarter, he had already hit the annual contribution maximum for the year. He thought of it as discipline. He called it giving himself a raise for the rest of the year.
What he had not accounted for was the company match.
His employer matched 6% of his salary, but only on pay periods where he was actively contributing. Once he hit the annual maximum in the first quarter, his contributions stopped. Which meant the company's matching contributions stopped, too.
For nine months out of every year, he was leaving the full employer match on the table.
When we ran the numbers, the math was stark. At a $250,000 salary, a 6% match works out to $15,000 per year. Missing nine months of that is roughly $11,000 in forfeited matching contributions annually. Compounded over 30 years at a 7% return, that is over $1 million in lost employer contributions and growth. (Illustrative numbers only, not guaranteed)
He had no idea. Most people in this situation have no idea, because the match language in the plan documents is written in a way that does not make the consequence obvious. I might also suggest that most employers are not going to call you to explain why they have been sending you a smaller retirement contribution than they could have.
The fix is simple: spread contributions evenly across all pay periods throughout the year, making sure the rate is set to maximize the full match before the end of December, not the end of March.
When’s The Last Time You Looked At Your 401(k)?
If any of these three situations sound familiar, the starting point is a straightforward review of three things: your contribution type (pre-tax versus Roth), your current allocation and when it was last rebalanced, and your contribution schedule relative to your employer's matching structure.
The good news is that none of these are complicated fixes. They are just the kind of thing that does not get caught unless someone is looking for them.
Want to run these numbers against your own plan? Schedule a conversation: calendly.com/waynewagner/introduction
Illustrations are for educational purposes only and are not prescriptive. Individual situations vary. Consult a qualified financial and tax advisor before making changes to your retirement plan.