Your $3 Million 401(k) Isn't Worth $3 Million: Why Executives Need Investments Outside Their 401(k)
The quick answer
A traditional 401(k) is funded with pre-tax money, so every dollar you withdraw in retirement is taxed as ordinary income. A $3 million balance might be worth closer to $2 million to $2.3 million after taxes, depending on your tax rate. That's why executives benefit from also saving in Roth accounts and taxable brokerage accounts. Having money in different tax buckets gives you more control over how much tax you pay in retirement and more flexibility to access your money when you need it.
Why isn't a $3 million 401(k) really worth $3 million?
When you contribute to a traditional 401(k), you skip paying income tax on that money today. But the tax doesn't disappear. It's waiting for you when you take the money out.
Think of your 401(k) as having a silent partner: the IRS, and usually your state. Every withdrawal is taxed as ordinary income, the same as a paycheck.
Here's what a $3 million balance could look like after taxes:
At a 25% average tax rate: about $2.25 million
At a 30% average tax rate: about $2.1 million
At a 33% average tax rate: about $2 million
That's a gap of $750,000 to $1 million between what your statement shows and what you can actually spend.
What other costs come with a large 401(k)?
The income tax is only part of it. Large pre-tax balances can create a chain reaction in retirement:
Required minimum distributions (RMDs): Starting at age 73 (75 if you were born in 1960 or later), the IRS requires you to withdraw a minimum amount each year, whether you need the money or not. On a large balance, those withdrawals can push you into a higher bracket.
Higher Medicare premiums: Higher income can trigger Medicare surcharges, known as IRMAA, that raise your premiums.
More of your Social Security taxed: Up to 85% of your Social Security benefits can become taxable when your other income is high.
Less flexibility: Withdrawals before age 59½ generally come with a 10% penalty, unless you qualify for an exception, such as leaving your employer in or after the year you turn 55.
What are the three tax buckets?
Most investment accounts fall into one of three buckets, each taxed differently:
Pre-tax: Traditional 401(k), traditional IRA, and deferred compensation. You get a tax break now, and pay ordinary income tax on every dollar you withdraw.
Roth: Roth 401(k) and Roth IRA. You pay tax now, and qualified withdrawals in retirement are tax-free. Roth IRAs have no required minimum distributions during your lifetime.
Taxable brokerage: A regular investment account. You pay tax on dividends and gains along the way, but long-term gains are taxed at lower capital gains rates, you only pay tax on the growth when you sell, and you can access the money at any age.
Most executives have plenty in the first bucket and very little in the other two.
Example: two executives, each with $3 million
Executive A has all $3 million in a traditional 401(k). Every dollar she spends in retirement adds to her taxable income. When she needs $150,000 for a new roof and a family trip in the same year, she has to withdraw even more to cover the tax, which pushes her into a higher bracket and raises her Medicare premiums.
Executive B has $1.8 million in a 401(k), $600,000 in Roth accounts, and $600,000 in a taxable brokerage account. Each year, she withdraws from her 401(k) only up to the top of a lower tax bracket, then fills the rest of her spending from her Roth and brokerage accounts. When the same $150,000 expense comes up, she pays for it from her Roth, and her tax bill doesn't change.
Same balance on paper. Very different tax bills, and very different flexibility.
How can executives build money outside their 401(k)?
Use the Roth option in your 401(k): Many plans let you direct some or all of your contributions to a Roth 401(k). Even splitting contributions builds a tax-free bucket.
Make backdoor Roth IRA contributions: High earners can't contribute to a Roth IRA directly, but can contribute to a traditional IRA and convert it.
Check for a mega backdoor Roth: If your plan allows after-tax contributions and in-plan Roth conversions, you may be able to add tens of thousands of dollars a year to Roth savings.
Invest your RSU and bonus proceeds: Selling vested RSUs and investing the cash in a diversified brokerage account builds your taxable bucket and reduces company stock risk at the same time.
Convert to Roth in low-income years: The years between retiring and starting Social Security or RMDs are often a good window to convert pre-tax money to Roth at lower rates.
Frequently asked questions (FAQs)
Should I stop contributing to my traditional 401(k)? Not necessarily. Pre-tax contributions still make sense in high-income years. The goal is balance, not avoiding pre-tax savings altogether.
Is a Roth 401(k) better than a traditional 401(k)? It depends on whether your tax rate is higher now or in retirement. Many executives benefit from having both.
Do I pay state tax on 401(k) withdrawals? In most states, yes. Moving to a state with no income tax in retirement can reduce the bill.
Find out what your savings are really worth
Not sure how much of your 401(k) you'll actually keep, or how to build savings outside of it? Reliant Wealth Advisory helps executives plan for taxes in retirement, not just today.
Click here or book a time below:
About the author
Michael Walstedt, CFA, CFP®, is the founder of Reliant Wealth Advisory, a fee-only fiduciary firm in Hoboken, New Jersey. He helps business owners, executives, and tech professionals in the New York/New Jersey area, as well as nationwide, with financial planning and investment management.
This article is for educational purposes only and is not tax, legal, or investment advice. Examples are hypothetical. Tax rules change, and your situation may differ. Consult a qualified tax professional before acting.
