Why the Wealthy Don’t Rely on a 401(k)

It is a common belief that wealthy individuals do not use 401(k) plans, but the role of the 401(k) in their financial strategy is different. High-net-worth individuals often contribute to their 401(k) enough to receive the full employer match, as this represents an immediate, guaranteed return on investment. However, the 401(k) is rarely the primary tool for their wealth accumulation. Its inherent limitations for high earners diminish its impact compared to other financial tools.

The reason the 401(k) is not a central wealth-building tool for the affluent is that its benefits are constrained. For high-income individuals, strategies outside of an employer-sponsored plan offer greater potential for tax-efficient growth and control. Consequently, the 401(k) serves more as a supplementary account rather than the foundation of their financial future.

The Limitations of a 401(k) for High Earners

A drawback of a 401(k) for high earners is the annual contribution limit set by the IRS. For 2025, this limit is $23,500. While substantial for an average earner, it represents a small fraction of a high-income individual’s earnings. For instance, a $23,500 contribution is over 15% of a $150,000 salary, but it is just over 1% of a $2,000,000 salary, making it a less significant savings vehicle for wealth growth.

Another restriction is the limited menu of investment options. Most 401(k) plans offer a list of mutual funds and ETFs, but do not provide the breadth of opportunities sought by sophisticated investors. High-net-worth individuals seek to allocate capital to alternative investments like private equity, hedge funds, or direct real estate for higher returns and diversification. These investments are unavailable within a standard 401(k) plan, which must adhere to guidelines under the Employee Retirement Income Security Act of 1974 (ERISA).

The rules for Required Minimum Distributions (RMDs) can create tax inefficiencies for the wealthy. Beginning at age 73, or 75 for those born in 1960 or later, individuals must start taking taxable withdrawals from their traditional 401(k)s. For an affluent individual with a large balance, these forced distributions can be substantial, potentially pushing them into a higher tax bracket during retirement. This conflicts with the goal of controlling the timing of taxable income to minimize lifetime tax liability.

Advanced Retirement Savings Vehicles

To overcome 401(k) limitations, high earners turn to other tax-advantaged retirement plans like the Mega Backdoor Roth IRA. This technique is available if a 401(k) plan allows for both after-tax contributions and in-service conversions. The process involves contributing the maximum to the pre-tax or Roth 401(k) ($23,500 in 2025), then making additional after-tax contributions up to the overall plan limit of $70,000 in 2025. These after-tax funds can then be converted to a Roth IRA, allowing all future growth and withdrawals to be tax-free.

The tax code also provides for catch-up contributions for those nearing retirement. Individuals age 50 and over can contribute an extra $7,500 per year. A provision of the SECURE 2.0 Act provides a greater opportunity for a specific age group. Beginning in 2025, individuals aged 60, 61, 62, and 63 can make a higher catch-up contribution of up to $11,250, allowing for an acceleration of tax-deferred savings before retirement.

For business owners and high-income professionals, another tool is a Defined Benefit Plan or a Cash Balance Plan. These are a form of pension plan where the employer promises a specific benefit to the employee at retirement. The advantage is that contribution amounts are not limited to standard 401(k) caps. Instead, they are determined by an actuary based on the employee’s age, compensation, and desired retirement benefit.

These actuarially determined contributions are tax-deductible to the business and can exceed $100,000 annually for a single individual. This allows for large, tax-deferred savings that dwarf what is possible in a 401(k). The funds grow tax-deferred until retirement, at which point they can be paid out as an annuity or rolled over into an IRA. This provides a mechanism for accelerating retirement savings and reducing current taxable income.

Non-Qualified Plans and Compensation Strategies

Beyond qualified retirement plans, wealthy executives build wealth through specialized compensation arrangements like Non-Qualified Deferred Compensation (NQDC) plans. These are contractual agreements between an employer and an employee to pay compensation at a future date. NQDCs allow high earners to defer income, such as salary and bonuses, far beyond 401(k) limits. This reduces their current income tax burden.

A distinction from a 401(k) is that assets in an NQDC plan are not held in a trust for the employee. They remain on the company’s books and are subject to the claims of the company’s creditors until paid out. This means the employee is an unsecured creditor of the company, introducing a risk not present in a qualified plan. This risk-reward tradeoff is a feature of NQDC plans, which are governed by rules that dictate the timing of deferrals and distributions.

A portion of an affluent individual’s wealth is built through equity compensation rather than salary deferrals. Instruments like Incentive Stock Options (ISOs), Non-Qualified Stock Options (NSOs), and Restricted Stock Units (RSUs) are designed to align the interests of executives with shareholders. While the tax treatment varies, they provide the opportunity for wealth creation tied to the company’s performance. This path is separate from and can be more lucrative than saving in a retirement plan.

Taxable Investment and Estate Planning Strategies

For the wealthy, a taxable brokerage account is a foundation of their financial plan, offering flexibility and control that a 401(k) cannot match. To maximize efficiency, they employ strategies to manage the tax impact. One strategy is tax-loss harvesting, which involves selling investments that have decreased in value to realize a loss. These capital losses can offset capital gains and up to $3,000 of ordinary income annually, reducing the tax bill.

Another technique is asset location, which involves placing different types of assets across various accounts to minimize taxes. For example, tax-inefficient investments that generate high ordinary income, like corporate bonds, might be held in tax-deferred accounts like an IRA. Conversely, tax-efficient assets like growth stocks are held in taxable brokerage accounts to take advantage of lower long-term capital gains tax rates.

Permanent life insurance, such as Indexed Universal Life (IUL) or Variable Universal Life (VUL), is used as a multipurpose financial tool. These policies offer a combination of tax benefits. The internal cash value grows tax-deferred, the policyholder can access this cash value through tax-free loans, and the policy pays a tax-free death benefit. This makes it a vehicle for supplemental retirement income and wealth transfer.

Trusts are important to the estate planning of high-net-worth individuals. A trust is a legal entity that holds assets on behalf of beneficiaries. They are used for objectives beyond a 401(k), such as minimizing estate taxes, protecting assets from creditors, and establishing rules for distributing wealth to future generations. These structures are used for managing and preserving wealth across generations.