Key Takeaways
Cutting taxes today is good; planning for taxes over time is better.
Pre-tax savings reduce AGI now but can create a future tax liability.
Tax diversification is as important as investment diversification.
AGI control is wealth control. The more flexibility you have, the easier it is to manage brackets, surcharges, and credits.
Wealth Building in Your 30s and 40s: Taxes Matter
When many people think about building wealth, they focus on making more and saving more. But, if you aren’t strategic about taxes while you’re building wealth in your 30s and 40s, you may be setting yourself up for a higher tax bill during retirement. Even if you nail the “earn more, save more” part, smart tax planning can compound for decades and give you more control later.
Case Study: Mark & Lisa: Age 40, Household Income $200,000
Like many professionals, Mark and Lisa pride themselves on maxing out their workplace 401(k) plans and they try to pay the least amount of taxes possible.
Their Current Plan: Mostly Pre-Tax
- Each defers $23,500 into a 401(k) in 2025 (under age 50 limit).
- Employer each match: 4% (= $8,000 combined annually)
- Starting at age 50, each adds the $7,500 catch-up contribution.
- Together, they save over $60,000 per year into retirement accounts, all pre-tax.
By doing this, they reduce their Adjusted Gross Income (AGI) from $200,000 to about $153,000. (Remember, employer matches don’t reduce AGI.) After applying the standard deduction, their taxable income falls even further, keeping them in the 22% bracket.
They feel great—they’re saving on taxes now and building a large nest egg. Fast-forward to retirement at age 65. Using a simple assumption of 7% growth, after 25 years of saving their all-pre-tax nest egg grows to $4.36 million
The Hidden Tax Trap
To keep it simple, we’ll assume no withdrawals between age 65 and RMD age, and no account growth.
- At age 73, Required Minimum Distributions (RMDs) begin.
- RMDs on $4.36 million start at over $160,000 annually and grow each year.
- Add in Social Security benefits, and Mark and Lisa’s AGI in retirement jumps well over $200,000.
- After deductions, their taxable income pushes them into the 24% (or higher) bracket. This means they’re paying more in taxes later than they saved during their working years.
What felt smart in their 40s turned into a tax trap in their 70s.
A Smoother Path: The Balanced Strategy
Instead of putting everything into pre-tax accounts, what if Mark and Lisa diversified their savings?
Pre-Tax → grows tax-deferred, taxable later
Roth → grows tax-free, no RMDs, tax-free withdrawals
Taxable → flexible, with favorable long-term capital gains rates
Revised Plan: Three Balanced Tax Buckets
- Mark continues pre-tax 401(k) contributions: $23,500 + catch-up after 50.
- Lisa directs her $23,500 (+ catch-up after 50) into a Roth 401(k).
- Employers still match 4% pre-tax ($8,000).
- They add $5,000 per year into a taxable brokerage account.
Results at Retirement – Age 65
- Pre-Tax Balance: $2.69M
- Roth Balance: $1.67M (tax-free)
- Taxable Balance: $316k (favorable capital gains treatment)
- Total: $4.68M
Following a diversified, balanced tax strategy, they could end up with more money in retirement, and far better control over how withdrawals hit their tax return.
Why Controlling AGI Matters
AGI influences:
- Your tax bracket
- How your Social Security income is taxed
- Medicare premiums (IRMAA surcharges)
By balancing pre-tax and Roth contributions, you can choose where to pull money from – Roth and taxable. In our example, instead of being forced into six-figure RMDs, Mark and Lisa can supplement withdrawals with Roth and taxable assets, helping keep their AGI lower and their lifetime tax bill smaller.
Practical Tax Strategy for Ages 30-40
- Split contributions at work: Consider a mix of pre-tax and Roth; revisit yearly as income changes.
- Add a taxable account: Extra flexibility, plus favorable long-term capital gains treatment.
- Don’t forget about RMDs: Small adjustments now can prevent big headaches when you start having to take a Required Minimum Distribution.
- Align your tax strategy with your life plans
- Annual bracket check: Revisit your pre-tax/Roth split and contribution levels annually and as income and deductions change.
- Calculate your estimated tax payments: To avoid paying penalties for underpayment of estimated income taxes, many computer tax programs automatically assume your income tax liability is the same as the prior year. That might not be correct, especially if it was an unusual income tax year due to the sale of a business, unusual capital gains, the exercise of stock options, etc. A qualified tax professional should be able to help you with a tax projection for the year.
Tax Planning Isn’t a One-Time Task
Tax rules shift, income changes, markets move, and life happens. That’s why tax planning for wealth in your 30s and 40s isn’t a single decision, it’s a rhythm you build into your financial plan. Mark and Lisa’s story is common. Many hardworking families focus on “saving taxes today” but forget to ask, at what cost tomorrow? Tax strategy coordinated with your overall financial plan and small, regular adjustments can keep more of your growth working for you over decades.
Already a Cornerstone client?
Our advisors work with you throughout the year to build tax-smart strategies into your Cornerstone plan, so the coordinated pieces of your financial plan align seamlessly. Reach out to us any time with questions.
Not a client yet?
No one wants tax surprises in retirement. Schedule your Tax-Smart Comprehensive Retirement Review today and get clarity on how taxes fit into your long-term financial plan.
Call: Sioux Falls – 605-357-8553 or Huron – 605-352-9490
Email: cfsteam@mycfsgroup.com
This hypothetical case study is for illustrative purposes only. Individual cases will vary. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Prior to making any investment decision, you should consult with your financial advisor about your individual situation. Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
This information has been obtained from sources considered to be reliable, but Raymond James Financial Services, Inc. does not guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Any opinions are those of the author and not necessarily those of Raymond James.
Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.
RMDs are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Roth 401(k) plans are long-term retirement savings vehicles. Contributions to a Roth 401(k) are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. Unlike Roth IRAs, Roth 401(k) participants are subject to required minimum distributions at age 72 (70 ½ if you reach 70 ½ before January 1, 2020). Matching contributions from your employer may be subject to a vesting schedule. Please consult with your financial advisor for more information.
