Are You Contributing Too Much to Your 401(k)? Key Risks for High-Net-Worth Investors
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Table of Contents
The Risks of Overloading 401(k) and IRA Accounts
The Role of Roth Conversions in Wealth Preservation
The Importance of a Taxable Brokerage Account
Frequently Asked Questions (FAQ)
Conclusion: Striking the Right Balance
For many high-net-worth individuals (HNWIs), maxing out tax-advantaged retirement accounts, such as a 401(k), is considered an essential wealth-building strategy. But some investors question whether they may be overfunding their 401(k) plans.
The potential risks of accumulating large balances in tax-deferred retirement accounts include unexpected tax burdens in retirement, restrictive withdrawal rules, and limited financial flexibility for those who want to retire early or allocate capital differently.
One Long Angle member, for instance, described wrestling with the idea of scaling back their retirement contributions, despite putting away nearly $100,000 annually across 401(k)s and IRAs. With compound growth, the total could easily exceed eight figures, raising critical questions: Will they genuinely want to withdraw from Roth contributions early? And how do they manage the tax impact of sizable Required Minimum Distributions (RMDs)?
That concern highlights an important consideration: just because a retirement account offers tax deferral today does not mean it will be the most efficient wealth-building vehicle in the long run. Future tax liabilities, legislative changes, and estate planning considerations should all factor into deciding how much to contribute to a 401(k) versus alternative accounts.
We will explore the risks of overfunding tax-deferred retirement accounts, the implications of RMDs, strategies for Roth conversions, and the role of taxable brokerage accounts in a well-balanced financial plan.
The Risks of Overloading 401(k) and IRA Accounts
One of the biggest risks of accumulating an oversized 401(k) or IRA balance: the potential tax inefficiencies that arise in retirement. Contributing to a pre-tax 401(k) offers immediate tax savings, but the savings eventually reverse when withdrawals begin. Since traditional 401(k) and IRA withdrawals are taxed as ordinary income, retirees with large balances may find themselves in high tax brackets later in life, negating much of the initial tax benefit.
The Hidden Costs of RMDs and Tax Brackets
The IRS mandates that, under the 2025 IRS rules, individuals must begin taking RMDs from their tax-deferred retirement accounts once they reach age 73. These required withdrawals are based on IRS life expectancy tables, meaning the larger the balance, the larger the required withdrawals. While RMDs were designed to ensure that retirement savings are eventually taxed, for HNWIs, they can become a significant tax burden.
For example, an investor with a $10 million 401(k) balance at age 73 could be required to withdraw over $400,000 annually. That would push them into higher tax brackets and increase their tax liability. Plus, the increased taxable income can lead to higher Medicare premiums through Income-Related Monthly Adjustment Amounts (IRMAA) surcharges. It could cause Social Security benefits to be taxed at a higher rate.
One Long Angle member noted that even if they stopped making traditional contributions today, their 401(k) balance by age 72 would likely exceed $8 million, far more than they anticipate needing. In their view, the real concern isn’t running out of money, but instead being pushed into higher tax brackets purely because of forced withdrawals they don’t need.
Legislative Uncertainty and Future Tax Risks
Another primary concern for VHNW investors is that tax laws are not set in stone.
Future legislative changes could change how retirement accounts are taxed, reducing the benefits of traditional tax-deferral strategies. While Roth IRAs currently offer tax-free withdrawals, some investors worry that the government may impose future restrictions on large Roth accounts, similar to the taxation of Social Security benefits.
One Long Angle member expressed doubt that the government will uphold its current treatment of Roth accounts, especially as federal deficits and entitlement spending increase. They pointed to the example of Social Security, which was originally tax-free but is now taxed, and suggested that Roth accounts could eventually face similar means testing or taxation.
Many members agree that it’s wise to diversify tax strategies rather than rely solely on tax-deferred retirement accounts. Maintaining a mix of taxable brokerage accounts, Roth accounts, and traditional 401(k)/IRA balances provides flexibility in responding to future tax changes.
Liquidity and Early Retirement Limitations
Liquidity is one of the most commonly overlooked risks of overfunding a 401(k). Retirement accounts are structured for long-term savings, and funds generally cannot be accessed before age 59½ without facing penalties, unless specific strategies like the Rule of 55, 72(t) SEPP withdrawals, or a Roth conversion ladder are used.
These workarounds exist but can be complicated and may not offer the same flexibility as a taxable brokerage account. For investors planning early retirement, having too much capital locked up in tax-deferred accounts can limit opportunities to invest in real estate, private equity, or other assets that require liquidity.
The rigidity of retirement accounts can be a drawback for investors focused on financial independence or early retirement. Strategies exist to access funds early, but they come with tax implications and restrictions that may not align with an investor’s long-term goals.
One Long Angle member shared how this rigidity can disrupt careful planning. They noted that while tax-advantaged accounts, such as 401(k)s and Roth IRAs, seem attractive on the surface, RMDs can lead to taxable income later in life, even if actual spending needs are met. Meanwhile, if dividends from a taxable brokerage account already cover living expenses, the forced distributions may add to them, increasing tax liability without providing any additional financial utility.
For investors who value control, optionality, and the ability to tailor withdrawals to lifestyle rather than tax code, overfunding retirement accounts may come with unintended downsides.
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The Role of Roth Conversions in Wealth Preservation
For those who have already accumulated large balances in tax-deferred accounts, Roth conversions can be a powerful tool to mitigate the impact of future RMDs and taxes. A Roth conversion involves transferring funds from a traditional 401(k) or IRA to a Roth IRA, paying taxes upfront. Once converted, the funds grow tax-free and are not subject to RMDs. This strategy is particularly beneficial for individuals in a lower-income year, such as during early retirement before RMDs begin.
One Long Angle member, for instance, described a plan to balance roughly $1 million in traditional retirement accounts and $1 million in Roth accounts before stopping further retirement contributions (aside from the employer match). The goal was to gain more control over future withdrawals and manage taxes more deliberately throughout retirement.
Roth conversions can be a great strategy, but require careful planning. The upfront tax bill can be large, and the best approach is often to convert smaller amounts annually, staying within a manageable tax bracket. For example, filling up the 24% tax bracket with conversions each year may be preferable to making one large conversion that pushes income into the highest tax rates.
The Importance of a Taxable Brokerage Account
A well-balanced investment strategy should include more than just tax-advantaged retirement accounts. A taxable brokerage account provides essential liquidity and allows for more control over capital gains taxes. Unlike 401(k) or IRA withdrawals, which are taxed as ordinary income, long-term capital gains in a taxable account are taxed at preferential rates, currently maxing out at 20% federally.
A Long Angle member emphasized this point, noting that having a mix of traditional, Roth, and taxable brokerage accounts provides far greater flexibility when managing income, withdrawals, and taxes over time.
Another member reminded others that tax laws and retirement account rules can change over time, underscoring the need for flexibility in financial planning.
For optimal tax efficiency, different types of investments should be allocated strategically across account types:
Tax-deferred accounts (401(k)/IRA): Best for income-generating assets like bonds and REITs.
Roth accounts: Ideal for high-growth investments that benefit from tax-free withdrawals.
Taxable brokerage: Best for appreciating assets like stocks and ETFs that qualify for long-term capital gains treatment.
Another member highlighted how large tax-deferred balances can lead to big RMDs and potential tax burdens later in life:
Another Long Angle member shared how running a financial plan projection helped them see just how significant RMDs and future tax burdens could become after age 72. While they still contribute to their 401(k), they shifted most of those contributions to a Roth 401(k) after realizing that the projected RMDs—and the associated taxes—were far higher than expected. The takeaway: It is entirely possible to accumulate too much in traditional tax-deferred retirement accounts, particularly if those balances aren’t balanced with other types of accounts.
Frequently Asked Questions (FAQ)
Should I Prioritize Traditional 401(k) or Roth 401(k)?
Traditional 401(k): Best if you're in a high tax bracket now and expect lower retirement taxes.
Roth 401(k): Best if you expect higher tax rates in the future.
Many VHNWIs split contributions for flexibility.
What Are the Best Strategies for Balancing Tax-Advantaged and Taxable Investments?
Maximize employer-matched 401(k) contributions first.
Fund Roth IRAs via backdoor conversions if income is too high.
Invest excess savings in a taxable brokerage account for flexibility.
Conclusion: Striking the Right Balance
While 401(k)s and IRAs remain powerful retirement savings tools, VHNW investors must proactively balance tax-advantaged accounts with taxable investments. The key to long-term wealth preservation lies in tax diversification, strategic Roth conversions, and estate planning. Investors can optimize their tax situation and better navigate the uncertainties of future tax laws by maintaining flexibility across different types of accounts.
One Long Angle member summed up their approach by emphasizing the value of diversification, not just across asset classes, but across account types. In their view, building diverse “buckets” of capital, including traditional, Roth, and taxable accounts, is the most prudent way to prepare for the future.
If you’re a high-net-worth investor looking for sophisticated financial planning insights, consider joining Long Angle. Our members actively discuss strategies for managing wealth efficiently in light of ever-changing tax laws. Apply today to become part of an exclusive community of financially savvy professionals navigating such challenges together.
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