Should You Max Out Pre-Tax Contributions During Your High-Earning Years?

You finally start doing the right thing. You raise your 401k contribution, you get serious, you sacrifice now because you want to wise later.And then one real life moment changes how you see that whole strategy. You watch someone retire, you see what their income actually looks like in practice, and you notice what happened to their tax bracket.And suddenly a new question hits you. If your income is higher now than it may be in retirement, why would you pay taxes on retirement contributions today instead of taking a tax break?Now, if you've ever wondered whether pre tax or after tax investing makes more sense, especially during your strongest earning years, today's show is for you. I'm going to break it down on today's show. Hey friend, I'm Ralph Estep Jr. And I want to welcome you to Financially Confident Christian.And today we're talking about a question that comes up once you start getting serious about retirement planning. A lot of people hear that Roth is good, pre tax is good, and hey, diversification is great.But at some point you want to know what actually makes sense for your life. If you're in your higher earning years and trying to Decide whether your 401k dollar should go up, this is a very wise question to ask.So let me get to today's listener question. Listener writes this Ralph, I'm in my early 30s and over the last couple years I've increased my 401k contributions from 6% all the way to 22%.I know that's a real step forward, but recently I was helping my dad with his first 401k withdrawal and something hit me. My dad's retired now.He's living on Social Security and a small pension, which means his income is actually lower in retirement than it was when he was working. His tax bracket dropped significantly. And that made me realize something about my own strategy.I've been doing this blend of pre tax and after tax contributions, sort of a 5050 or a 4060 split. But if these are my high earning years, Ralph, shouldn't I be maximizing my pre tax contributions first to reduce my taxes right now?Why would I ever want to contribute after tax dollars when I'm in a higher tax bracket than I'll probably be in retirement? Is there any real reason to keep a high after tax contribution percentage rate? Or is my new thinking the smarter move? What a great question.This is one of those questions I love when I get to because it makes me really dig deep, innocent.And if your tax rate is likely higher today than than it will be in retirement, leaning more heavily into pre tax contribution often makes a lot of sense. But the smartest answer usually comes from tax flexibility, not tax guessing alone. So let's get into today how to make this work.I want to start with this. Your instinct isn't wrong here. What you notice with your dad is exactly the kind of real world observation that should shape your planning.Pre tax contributions do reduce your taxable income now. That's why they're called pre tax.And if you're in a meaningfully higher tax bracket today than you expect to be in retirement, that immediate tax break can be very valuable. I want to break this down in plain language. If you're choosing to pay taxes later when your income may be lower, that's why you're doing this.So your new thinking is reasonable and it's actually pretty smart. A lot of retirement planning comes down to one simple question. When is the dollar least expensive to tax? Is it now or is it once you retire?But you got to know what your pre tax and your after tax are really doing. Pre tax means this. You pay the tax, you get the tax deduction. Now. Then you pay ordinary income tax when you withdraw in retirement.That's what your father is doing as he's collecting his 401k. A little known fact, the Roth IRA is actually from Bill Roth who was a senator from my home state of Delaware. I met him many times.Bill Roth was a kind of a cool guy. He used to have this big old dog that his Saint Bernard that went with him everywhere. But he's actually who came up with this Roth IRA.But let's talk about the Roth IRA. So the Roth or after tax 401k contributions mean you pay taxes on that money now before you put it in.And then when you go to take that money out, it comes out tax free. Now this isn't about one being good and the other being bad. This is about when you believe paying taxes will hurt less.If today's tax hit is heavier than tomorrow's, it's likely that pre tax becomes more attractive. Which is what you're telling me in your particular question.You're in your earnings years, but if you believe your future tax rate could be similar or even higher, then Roth or after tax becomes more attractive. Pre tax helps you when you have a heavy burden. Today, Roth helps you when tomorrow's tax burden may be the bigger burden.But you asked a really interesting question. Why would someone still choose after tax during their higher earning years?And the real reason is to keep some Roth exposure even in the strong earning Years. Why do we do that? First thing, no one knows what the future tax law will be. None of us have a crystal ball.I'm a firm believer that tax rates are probably going to continue to increase. So there may be some value in having some after tax investments. Here's the second thing. Retirement income isn't always as low as people expect.In fact, here's what I've seen in my own practice. I've been practicing accounting for over 30 years.A lot of times people's income in retirement is equal to or hear this, sometimes even higher than what it was when they were working because of those requirement on distributions. Maybe they've got a strong pension, maybe they've got some rental income or other assets to keep that taxable income elevated.Here's the third thing a Roth account does create some flexibility. If you have both a pre tax and an after tax, you get tax free buckets that give yourself more control. You can decide what to take.Here's another thing. Young investors often have a long time horizon and some people like the idea of decades of future growth coming out tax free.So the question isn't, is after tax foolish? The better question is this, how much diversification do I want?Because sometimes the value of the Roth isn't just about tax rates, it's about that flexibility. But you can't ignore the value of the tax break you're getting now, which is really what you're talking about.If you're contributing 22% and you're in your higher earning seasons, pre tax contributions may free up real dollars in your paycheck today. It may actually make the amount of your net paycheck better. That tax savings can help you in three distinct ways.Number one thing it can do, it can increase the total retirement contributions you're able to make. Like you said, you went from 6% to 22%. Another thing it can do is it can strengthen your other priorities.It'll help you build that emergency savings, the debt reduction plan, or maybe meet your family's needs. Because you're reducing your taxable income. It can also reduce the pressure in your monthly cash flow.This strategy isn't just about theoretical math. Decades from now, it has to fit your real life today, which is when, when I work with clients, I always say to them, look at your budget.What can you actually afford to put into the retirement account? Start there because we can talk about, it'd be great to push that much in.It'd be great to put 30% in, be great to put 25% in but you gotta look at the reality on the ground that tax deduction isn't just a number on paper. It can actually create margin in real life. But in the end you gotta aim for a wise balance, not some false certainty.The honest answer to your question today is is that none of us knows the future perfectly. We just don't. The current logic. You have me point to a stronger pre tax emphasis right now because this is what we're looking at now.We are assuming that when we go to retire we're going to be a lower tax bracket. Which means it might shift away from that 5050 plan that you're talking about now into more being pre taxed during your earning years.That it doesn't mean you have to abandon the Roth completely. There's one postural approach.Do I want enough Roth money later to give me options while still maximizing my pre tax lower taxes during my highest earning years? That's one things I tell a lot of clients to do.Put the maximum amount you can in that pre tax money, but maybe still put some money into the Roth so you get some flexibility. Kind of what I call middle ground thinking. But in the end you don't need perfect prediction, you just need a thoughtful strategy.The goal isn't to win the tax argument. The goal is to build a retirement strategy that serves your life faithfully.So if I was in your shoes, I'd review fewer things before making this shift. Look at your current federal and state marginal tax rates. Now you might be saying Ralph, you lost me. What's a marginal tax rate?That's the tax rate on the next dollar of income. It's basically what is your highest tax rate you're paying based on your income.Another thing you've got to look at, and we've talked about this on the show before, if your employer offers a match, then make sure you're at least doing that much. Another thing I want you to look at is your expected retirement income sources, Social Security, pension income, other investments.You might be somebody that you know your parents are leaving you a huge nest egg. You might have a ton of income in retirement. That's when that pre tax might not be as beneficial.But you also got to look at your tax savings from pre tax contributions and will that help you strengthen other parts of your financial life?And if those numbers point clearly towards a higher tax burden today than later, it's a no brainer increase the pre tax side making a very sound move, but I want to take this a little deep. Part of what you're really asking is not just what saves me the most money.What you're really asking, underneath the surface is, Ralph, how do I make a wise decision today when I can't fully see the future? Hey, none of us can see the future. But that's where stewardship becomes spiritual. Faithful. Money management is really about having perfect certainty.We just don't have that. But it is about using the information we have right now to make the wisest decision we can at this point.And also refusing to let fear run the process. God never asks you to control every future outcome, but he does ask you to be faithful what you know now.So if your current income, your current tax bracket and your current responsibilities all point towards a stronger pre tax strategy, there's nothing unspiritual about that. That's not fear, that's stewardship. Because in the end, you don't need a crystal ball seeing the future to make a faithful financial decision.So here's your win for today. I want you to look at your last pay stub and your recent tax return and identify your current marginal tax bracket.And next thing I want you to do is estimate your likely retirement income sources and replace those vague assumptions with actual numbers. Put numbers on the paper, then you'll be able to make a more informed decision. Let's get to our Bible verse today.It's from Romans chapter 12, verse 11. Never be lacking in zeal, but keep your spiritual fervor serving the Lord. Retirement planning is part of faithful stewardship.And that kind of diligence isn't just about money. It's about serving God wisely. But what he's entrusted to you, and he's entrusted all of us with so much. How about we pray together?Heavenly Father, thank you for giving us the opportunity to plan, Lord, and to think and to steward the resources you've given us wisely. And right now. I pray for the person who's trying to make a smart decision about retirement. And they feel that weight of wanting to get it right.Give them wisdom as they evaluate their options. Help them think clearly about taxes and their future needs and even their present responsibilities.Protect them from fear, Lord, and from pride and from that pressure to chase certainty they can't fully have. But instead help them to be diligent. Help them to be faithful. And mostly help them to be at peace as they make those adjustments.And remind them that wise stewardship is not about controlling the future. It's about honoring you in the decisions they make today. And we ask this in Jesus name. Amen, friend Your question shows maturity.And that's what I love about your question. You're not just contributing more, you're thinking more deeply about how to do it wisely.So again, if you're in a high tax bracket today and expect a lower one later, that stronger tax pre tax approach may be the better fit. But maybe some Roth can still help you build flexibility. And maybe you're wrestling with a financial decision like this one. I want to hear from you.You can send us a voicemail by going to financiallyconfidentchristian.com/voicemail we'll put a link in the show notes. It's super simple. Click on the link and record your message because I want to hear from you.Financiallyconfidentchristian.com/Voicemail thank you so much for today's question. Thank you for joining me. I want to always encourage you to stay financially savvy. May God bless you and you have a great day.