While more and more employers are offering the after-tax savings accounts to their employees, workers have been slow to incorporate them into their retirement plans. However, many savers — physicians included — could greatly benefit from doing so.

Rise of the Roth 401(k)

As the Wall Street Journal reports, a recent Vanguard Group survey found that only 17% of workers with a Roth 401(k) made a contribution to the savings account in the last year. According to the Vanguard Group’s data, savers aged 25–34 were the most likely to make an after-tax contribution to these accounts, while those aged 55 and older were the least likely.

The Roth 401(k) (and the Roth 403(b) for employees of certain nonprofit organizations) have seen a boost in prominence due the rising popularity of after-tax savings among financial experts (and savers who want to enjoy tax-free distributions later in retirement) and a recently delayed tax law that will require older savers to make any catch-up contributions on an after-tax basis. 

According to the Vanguard Group data, roughly 80% of retirement plans allowed some kind of Roth contributions. In 2014, that number was well under 60%.

The Vanguard Group data, however, also suggests that many savers have yet to seriously incorporate this relatively new employer-sponsored savings vehicle into their retirement saving plans. Making contributions to employee-sponsored retirement plans is a primary way of saving for retirement for many physicians, but — as financial planners warn — these savers could be missing out on various benefits by not putting aside at least some after-tax savings for their life after medicine.

Roth vs. Traditional: What’s the difference?

The principal difference between the traditional 401(k)/403(b) and the Roth 401(k)/403(b) is when the saver pays taxes on their savings. For a traditional retirement plan, employees defer part of their salary to the employer-sponsored savings account on a pre-tax basis. In some cases, workers can contribute after-tax money to a traditional 401(k)/403(b) as well. However, pre-tax contributions are most common and since the pre-tax income is considered deferred, high income earners save on their current-year income taxes. Taxes on these savings then have to be paid at the time of withdrawal, presumably in retirement.

Conversely, Roth 401(k)/403(b) accounts hold after-tax contributions, just like a Roth IRA. Because workers pay taxes on the savings before they’re placed in these retirement accounts, they can later make withdrawals without incurring any tax liability. The prospects of investments growing tax-free and making tax-free withdrawals later in life is attractive to many physicians and can help offset other taxes a retiree may have to pay from their pre-tax savings in other retirement accounts.

Another critical difference between these types of accounts is when savers need to start making withdrawals from them. The IRS requires that retirees start taking Required Minimum Distributions (RMDs) from traditional 401(k)/403(b) starting at age 73 (note: this age can change depending on the current year’s tax code). These RMDs are taxable and can complicate a retiree’s finances without proper planning.

Starting in April 2024, Roth 401(k)/403(b) will not be subject to RMD rules. Because taxes on Roth savings are already paid, the IRS allows retirees to withdraw the money at their discretion. This also makes these accounts — and Roth savings in general — easy to pass on to heirs without saddling them with a significant tax bill.  

Other key characteristics between the accounts are identical. For instance, there is no income cap to contribute to either kind of account, which makes the Roth 401(k)/403(b) particularly beneficial for high earning physicians. In contrast, the IRS requires that an individual Roth IRA contributor have a modified adjusted gross income (MAGI) of less than $153,000 in 2023. 

The annual 401(k)/403(b) employee contribution limit ($​​22,500 in 2023) applies collectively to all 401(k)/403(b) accounts a saver might have, including a Roth 401(k)/403(b). Note that employees 50 and older can make an additional $7,500 catch-up contribution. This poses a question for workers who have access to both pre-tax and after-tax retirement plans: How much should they save in a Traditional 401(k)/403(b) vs. how much should they save in a Roth 401(k)/403(b)?

Are you a physician who has been offered a Roth 401(k)/403(b) or is interested in leveraging after-tax savings to maximize your retirement income? If so, the financial advisors at Earned Wealth can help. Our team has decades of combined experience helping physicians set and reach goals to protect and grow their wealth and are ready to assess your best options to ensure comfortable retirement.

Contact our team today to schedule a complimentary consultation.

Where should physicians save?

How you should divide and strategize your pre and after-tax retirement savings depends on a lot of different factors, including the saver’s specific finances and retirement goals. Broadly speaking, two of these pivotal factors are:

• What is the saver’s current tax rate?
  
  
• What will the saver’s tax rate likely be in retirement?

When a physician is in their peak earning years, favoring tax-deferred savings is usually the recommended course. Maxing out traditional 401(k) contributions can provide significant income tax savings for the physician during these peak years when they are subject to higher income tax rates. Then, later in retirement, when their income presumably falls, their 401(k) withdrawals will be taxed at the lower tax rate. Also, physicians may want to consider making Roth conversions early in their retirement when their tax rate is likely lower before Required Minimum Distributions (RMDs) from retirement accounts kick in.

Early career physicians and those in training may want to consider favoring Roth savings while they’re in a lower tax bracket. This means paying the taxes in the current tax year, but more after-tax savings and fewer withdrawal rules to enjoy later in retirement. As mentioned earlier, after-tax withdrawals can help balance retirement income when a retiree is also making RMDs that come with a tax bill. 

Most experts agree that diversifying retirement savings across pre and after-tax accounts over time is the best way to maximize retirement income and hedge against risks and uncertainties. As the WSJ reporting notes, financial research from the University of Arizona determined that once a saver rises out of the 12% tax bracket, it is advantageous to start dividing savings between a Roth and tax-deferred accounts.

This all said, these strategies represent the broad, foundational strokes of a tailored and dynamic retirement savings strategy. Just some of the other factors to take into account include:

• Whether an employer offers employee matching contributions
  
  
• Whether an employer-sponsored plan offers automatic Roth conversions
  
  
• What state a physician may plan to spend retirement
  
  
• Whether the physician wants to execute regular Roth conversions or take advantage of Backdoor Roths
  
  
• What a physician’s spouse’s finances and tax status may be
  
  
• What individual goals the physician may have for retirement (travel, part-time work, etc.)
  

Where Earned Wealth comes in

There’s no one-size-fits-all answer to saving for retirement. At Earned Wealth, we believe that every retirement strategy should be customized to fit a physician’s individual needs, challenges, and long-term financial goals. 

No matter where you might be in your career as a physician, it’s not too late to start making forward-looking, tax-conscious moves to optimize your retirement savings. Our team of financial advisors is well-versed in balancing tax-deferred funds with Roth savings and other assets and investments that aim to best ensure a well-funded retirement for our clients.

Schedule a complimentary consultation with our advisors to learn more about what Earned can do for your financial future today.

‍

‍