Most doctors who have learned even a little bit about personal finance know that it’s important to contribute as much as possible to tax-advantaged retirement accounts. Hopefully, most will choose to max out the employee portion of their 401k, especially if it means getting ‘free’ money with an employer match, as this is a tried and true pathway to financial security during retirement. It used to be that contributing to the 401k was a very simple check mark upon being hired, but in 2006, the Roth 401k, or the option to contribute to retirement accounts with post-tax money, became an option. Since then, nearly half of employers have begun offering this option, and accordingly, we often get the question of whether physicians should choose the traditional 401k or the Roth 401k option. This article will go into how to choose between the two options based on your specific situation and financial goals.
As always, you should consult appropriate expertise before taking action based on this content, which is not individualized to your personal situation and can not be guaranteed to be accurate or up to date. While we have attempted to explain this to the best of our ability, we are not accountants or financial advisors and this is complex information that can be misinterpreted or unclear. To learn more, visit our disclaimers and disclosures.
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Introduction
A 401k is a benefit offered by employers to allow employees to contribute a portion of their wages to a tax-advantaged retirement account. As a bonus, the employer often also contributes to the employee’s retirement. It has become the modern day version of a pension program.
Similar to the differences between the traditional IRA and the Roth IRA, the primary difference between a traditional 401k and Roth 401k is in choosing how you want your contributions, growth, and eventual withdrawals to be taxed. But unlike a Roth IRA, there is no income cap restricting eligibility to contribute to a Roth 401k, just a cap on the amount you’re able to contribute.
In 2024, an employee can contribute a total of up to $23,000 into their 401k between traditional 401k and Roth 401k contributions. If you happen to be employed as a W-2 physician with a 401k through a healthcare system or private practice and also self-employed with a side gig and have a solo 401k set up, note that limit is the total amount for employEE contributions across all 401k plans you have (you can, however, max out the employEE contribution at your day job and then contribute to the employER side of your solo401k (more about this in our primer on finances for self employed physicians).
The Traditional 401k
A traditional 401k means that the elective salary deferrals you make are excluded from your taxable income, which will lower your tax burden in the year that you contribute to the account. This money can grow tax free within the account until there are required minimum distributions (RMDs) at retirement age. At that time, the distributions from the original contributions as well as the earnings are counted as taxable income.
The Roth 401k
With a Roth 401k​, you pay taxes up front and your contributions go in as post-tax dollars. The money you put in and its growth are not taxed when distributed in retirement. While Roth 401ks for years had RMD requirements like a traditional 401ks, beginning in 2024, RMDs are no longer required for designated Roth accounts. This is huge for physicians who anticipate having enough income during retirement from other sources that they are not counting on their retirement accounts, and would like for these to continue to grow tax free.
While your employEE contributions can be made into a Roth 401k with post-tax dollars, it’s important to note that employER contributions are made with pre-tax dollars, so they will always go into a traditional 401k.
A Note on Solo 401ks
The traditional 401k or Roth 401k discussion we outline below also applies for solo 401ks managed by self-employed 1099 physicians. The solo 401k designation is simply to classify a plan for a single individual (and their spouse, if applicable).
Many solo 401ks offer both traditional 401k and Roth 401k options as outlined above, just like other employer-sponsored plans. The only difference is that as a self-employed doctor, you will be acting as both the employEE and the employER and making both sets of contributions to your plan.
Learn more about the solo 401k plan for self-employed and side gig physicians.
Evaluating Traditional 401k or Roth 401k
As nobody has a crystal ball and rules and taxes are constantly changing, there is no way to say with confidence whether contributing to a traditional 401k or a Roth 401k will work out better for you. That said, while there is no one clear cut choice, there are general guidelines and considerations when deciding which (or both!) are best for your financial situation and retirement planning.
A few general guidelines to start:
The lower your income and thus your tax bracket, the more advantageous it is to pay taxes now and make Roth contributions
The younger you are and the more time your money has to grow, the better a Roth 401k is, as it will increase the number of years you can take advantage of totally tax free growth
The more you are investing and the less likely you are to need to withdraw your 401k contributions during retirement, the better a Roth 401k can be as there are no required minimum distributions with a Roth 401k, and therefore you can benefit from more years of tax free growth.
Given the time and income factors, the Roth 401k option is almost always the better option for residents who have extra money to invest, as statistically, they will almost definitely be in a lower tax bracket now than at future stages of their lives.
Tax Considerations for Traditional 401k or Roth 401k
Before we dive into the fun topic of taxes, we want to point out that the US tax system works on marginal tax brackets since we see a lot of questions and confusion around this topic. With marginal tax brackets, you do not pay the highest tax rate for all of your income, only for the taxable income amount within the thresholds for that bracket.
Learn more on our physicians’ guide to understanding taxes.
Tax Diversification
Having both traditional and Roth contributions mixed within your 401k and IRA accounts can be a great way to diversify your tax strategy. Optimizing tax diversification and income thresholds on capital gains can help minimize your tax burden once you are no longer bringing in a steady income source in retirement.
While the intricacies of tax strategies are more involved than what we want to cover here, there are several options when looking at your 401k, depending on what’s offered and what other investment accounts you have. If you receive a significant match, consider Roth 401k contributions to balance the employer contributions into the traditional 401k side. Other mixes include:
Have a traditional IRA with a Roth 401k
Pair a Backdoor Roth IRAÂ with a traditional 401k
Do a Mega Backdoor Roth within your 401k
The more taxable income you expect to have in retirement, the more a Roth 401k may benefit you to help lower the additional tax burden from required distributions in retirement. For example, the more of the following income streams you’ll have, the better the Roth option becomes:
Social security benefits
An after-tax brokerage account
A defined benefit plan
Active real estate income
Other passive income streams (courses you created, book royalties, etc.)
Additionally, the more income you have coming in during retirement, the less likely you are to need the income from your retirement accounts, allowing you to not take distributions from the Roth 401k (an option you don’t have with the RMDs associated with the traditional 401k) and instead allow that money to continue to grow tax free. For those physicians that reach FIRE early in life with multiple income streams that will persist into retirement, it's worth considering the Roth option.
To come up with a personalized tax strategy plan for retirement, we recommend working with a fiduciary financial advisor. Learn more on our financial advisors database for physicians page.
Federal Tax Rates at Contribution Versus Withdrawal
One of the biggest considerations in the traditional 401k or Roth 401k debate is taxes.
With traditional 401k contributions, you don’t know what tax rate you will pay when it comes time for withdrawal, as it will be determined when you pull the money out based on the tax brackets that exist at that time. High-income earners may expect to have a lower tax bracket in retirement than in their prime earning years, especially if they are working with a financial advisor on a comprehensive tax strategy. In this scenario, a traditional 401k may more attractive as it will lower your taxable income now, while you are paying taxes at a higher tax rate (this of course assumes that tax brackets won’t be significantly higher all around when you retire due to interim changes in our country’s tax brackets). Assuming you use that tax savings to invest, this will also allow you to have more money invested over many years that will be growing your net worth.
Since the gains on your investments are also taxed in traditional accounts, the less time your contributions have to grow before you plan on withdrawing them, the less you reap the benefits of tax free growth in a Roth 401k and the more you may favor taking the tax benefits early.
With a Roth 401k, you’re only taxed at the time of making contributions, making your tax burden known. Depending on your current highest marginal tax bracket, that may or may not be a good thing in your opinion, as you might be locking in taxes at what could be the highest rate you’ll pay throughout your life.
If your marginal tax rate is 32% - 37%, which can be common for physicians (especially dual physician households), consider investing in a traditional 401k to lower your taxes now, especially if you plan on withdrawing an income in retirement that would put you in a 12%-24% tax bracket. The exception is for our FIRE physicians with continued income streams into retirement, who don’t plan on touching their 401k contributions and don’t want to get hit with RMDs that will force a higher tax bill.
State Tax Considerations
If you live in a state with state income tax, this is another consideration on top of federal taxes. States with high income taxes can make traditional 401k investing more inticing, especially if you plan to move to a lower cost-of-living state in retirement.
State taxes can vary on what is taxed and at what rate. Differences include:
Taxes on retirement income such as social security
Special tax treatment of capital gains income
Flat income tax versus marginal bracket system like federal taxes
The more you pay in state income taxes now and the less you’ll likely pay in retirement, the more advantageous going with a traditional 401k is.
Political Considerations
A lot of people are worried about how politics and economics will play into future tax legislation, at both the federal and state levels. Some fear going the traditional 401k route and having tax rates raised before retirement, which will end up penalizing them heavily for their decision. Others who are considering the Roth 401k route worry that politicians will lower rates, thus penalizing them instead.
The government could also change the rules on the relatively new Roth 401k option. For example, they could decide to bring back RMDs or add an income limit, such as Roth IRAs currently.
The truth is, it’s too hard to predict what may or may not happen with these external factors. In general, we don’t like letting fear fuel your financial decisions. In these situations, a financial advisor can be a great resource to help walk you through realistic expectations and planning.
Estate Planning Considerations
We’ve already mentioned the removal of RMDs for Roth accounts starting in 2024, which is a great option for estate planning for heirs if you don’t plan on touching the money in your 401k. A Roth 401k can be a great legacy to leave your kids or grandchildren, similar to 529 plans and other tax-advantaged college savings plans.
As of 2024, a traditional 401k has the following distribution requirements:
You must take a first distribution by April 1 of the year following your 73rd birthday
You must withdraw a calculated RMD amount (fair market value/life expectancy factor) each year after
Learn more about calculating RMD requirements on the IRS website.
While inherited accounts still have withdrawal requirements for beneficiaries, regardless of Roth status or not, they are much more favorable. As of 2024, your spouse who inherits the Roth account isn’t required to take distributions. A non-spouse beneficiary must take the total payout of the account within 10 years of inheriting. Minor children, however, get an extension on the withdrawal ticking clock until they come of legal age.
Charitable Estate Planning
If you are planning on doing charitable contributions instead of leaving your 401k account to a child, grandchild, or other direct beneficiary, the distributions become tax-free so long as you leave the 401k to the charity itself. In this case, a traditional 401k makes more sense, as neither you nor the charity inheriting the 401k once you pass will be required to pay taxes.
Student Loan Considerations
If you are currently working toward Public Student Loan Forgiveness (PSLF), you may be working to keep your IDR payments as low as possible to maximize the amount of your student loan balance that will be forgiven. Going the traditional 401k route will help lower your taxable income, which can in turn lower your IDR payments.
Make sure you qualify for PSLF and are properly accounting and tracking your forgiveness progress if you are going this route.
Learn more about the PSLF student loan program.
Additional Considerations for Traditional 401k or Roth 401k
As you get deeper into tax strategies, you can find even more complex situations and potential tax advantages depending on your specific income and tax situation. A few additional ones to consider that make a traditional 401k a better option include:
If you can qualify for more QBI tax deduction (aka Section 199A) by lowering your taxable income
You plan on doing future Roth conversions such as a Mega Backdoor Roth
You’re trying to help your kids qualify for financial aid for college
As your situation becomes more and more complex, we recommend consulting with an accountant and/or financial advisor to make sure you are making the best decision for your overall financial planning.
Conclusion
While there’s no direct road map leading you to either a traditional 401k or Roth 401k, we hope the considerations above help you determine what’s best for you. With most 401k plans, you can switch between traditional and Roth contributions at any time as your financial planning changes. As briefly mentioned, there’s also the opportunity for conversions in the future if you find you have too much traditional 401k you’d rather have in a Roth account.
If we didn’t address a specific scenario you’re on the fence about, ask our hive mind in the Physicians Side Gigs Facebook community.
Learn more about other financial planning strategies: