I was working with a client family recently and we took a moment to appreciate the fact that because they started saving in Roth IRAs and Roth 401(k)s at an early age, and accomplished smart Roth conversions along the way, there was a real chance that the vast majority of their retirement income could be tax-free.
Can you imagine it? Picture yourself in retirement and the only income taxes you may owe are from Social Security income! That would be incredible from a tax savings perspective, not to mention the potential peace of mind knowing that you could be protected from future income-tax rate increases regardless of what politicians decide to do.
Granted, this may be considerably more challenging for many folks that are late to the “Roth” game, but there is hope for you and if you’re a youngish professional pilot, this low-tax environment could be your retirement reality.
First, a little background. Roth accounts, whether Roth 401k, Roth Thrift Savings Plan, Roth IRA, etc., are all funded with after-tax, non-tax-deductible contributions. This means the Roth IRA distributions, if all IRS requirements are met, will be tax-free.
So why am I writing about something so simple? Because there is a price to pay to get money into Roth accounts and it’s not easy to know if, and when the cost is worth it. To be more specific, the price you pay is oftentimes a forgone tax deduction at your current income tax rate. Furthermore, accumulating Roth may also mean saving significantly more than you already do in order to take advantage of the back-door Roth IRA strategy.
Eventually, paying income taxes at the highest airline income pay rates becomes so painful most pilots will do almost anything, legal or even borderline legal, to reduce their current taxable income. This may make sense for some periods of the airline pilot's financial lifecycle. But eventually if this all-or-nothing-reduce-my-income-taxes-NOW approach is not balanced with a reasonable consideration for future taxes in retirement, there may be a “tax bomb” waiting to go off when required minimum distributions (RMDs) kick in at age 73 or 75, depending on birth year.
Do your homework, or hire someone that does their homework, to make great decisions to balance the income tax burden now versus the potential retirement income tax bomb. As we sometimes say, it may be simple, but it’s not easy!
Below are six strategies for effectively utilizing Roth accounts and thus working smartly towards the goal of a lower tax liability over the entirety of your life, not just while you're a senior captain at a major airline.
1. A Backdoor Roth IRA conversion is a strategy that allows high-income earners to contribute to a Roth IRA, even if their income exceeds the Roth IRA income limits. Here's how it works:
- First, you contribute to an after-tax, non-deductible traditional IRA, which has no income limits. In other words, anyone can contribute to an after-tax IRA regardless of their income.
- Second, convert to a Roth IRA: After making the contribution, you convert the funds from the traditional IRA to a Roth IRA. Since you made the traditional IRA contributions with after-tax money (as long as you don’t deduct the contribution), you may pay little to no tax on the conversion if there’s minimal growth between the two steps.
The Back Door Roth IRA strategy is especially useful for those who earn too much to contribute directly to a Roth IRA, but it requires careful planning due to tax implications, especially if you have other traditional IRAs that have any pre-tax contributions.
If you currently have a pre-tax rollover IRA from a previous employer’s 401k, you may be able to “roll-in” this pre-tax IRA to your current employer’s 401k retirement plan. Due to the IRS IRA aggregation rule, rolling in any pre-tax IRAs could potentially clear the path for future after-tax IRA contributions to be converted to your Roth IRA tax-free. Important reminder: Any investment gains will be taxable at your marginal income tax rate but not your contributions. For those interested in learning more about the IRS Roth IRA aggregation rule, please click here.
2. Roth 401k. Unlike Roth IRAs, Roth 401(k)s do not have income limits. So, even if you earn a high income, you can still contribute directly to a Roth 401(k) if it's available through your employer. The downside to contributing to your Roth 401(k) is that you will potentially forgo a significant income tax deduction and voluntarily choose to pay taxes at your current marginal income tax rate. There are multiple factors that should be considered when deciding to utilize your Roth 401k. Here are just a few:
- Your time horizon. For example, it’s almost a no-brainer for a brand new first officer to take advantage of the Roth 401k feature. It’s a much more personalized and nuanced decision if you are older.
- Do you have a military pension? If so, this may change the amount of your required minimum distributions (RMD) that you actually need for retirement spending. I can attest that it makes people very angry to have to withdraw from their pre-tax 401(k)s and IRAs and pay taxes whether they need the income or not. Roth contributions or conversions reduce the RMDs since there are potentially less pre-tax savings.
- Your viewpoint on the potential for higher tax rates in the future is important. Some people feel very strongly that tax rates in the future will be higher than they are now. Admittedly, no one can be sure what future tax rates will be, but most reliable prognosticators believe they will be higher.
3. After-Tax Contributions to 401(k), aka Mega Back Door Roth IRA. This is an awesome opportunity to go above and beyond normal Roth savings opportunities. Here are the steps and variables to consider when evaluating the Mega Back Door Roth IRA.
- First make after-tax contributions to your 401(k) (above the standard pre-tax or Roth contribution limits). Several airlines currently allow this option: including Delta, United, American, Fed Ex and UPS. In 2025, the total 401(k) contribution limit (employee + employer + after-tax) is $70,000, not including catch-up contributions.
- Once the after-tax contributions are made, you can convert those funds into a Roth 401(k) or roll them over into a Roth IRA. The conversion or rollover happens without triggering taxes on the principal amount (since it was after-tax), but any investment gains will be taxable if you do not move quickly. The Mega Back Door Roth allows you to bypass the Roth IRA income limits, giving you a way to contribute much larger amounts to a Roth account.
4. Utilize the tax savings in your airline's Market Based Cash Balance Plan (Delta), HRA/RHA (United), Non-Qualified salary deferral plans (Southwest) to add more to your Roth 401k.
For example, if your airline has a retirement plan that accepts 401(k) excess spill cash or allows for salary deferral, consider offsetting the tax savings by contributing a larger portion of your 401k contributions to Roth. Yes, you could just get the larger tax deduction and go with it. However, the tax savings may allow you to benefit now as well as prepare for potentially higher future income tax rates by saving more Roth.
5. Convert potential inheritance to a Roth IRA.
Be sure to consider the tax consequences of potential future inheritances. We’ve seen several clients recognize that their aging parents are in a much lower income tax bracket than their own.
Imagine a scenario where a high-income airline captain in the 32% marginal tax bracket inherits one million dollars from their deceased parents. Because of the SECURE Act regulations Congress passed in December 2019, the pilot will be required to withdrawal all one million dollars within ten years.
This means Uncle Sam will potentially receive 35%-37% of the inheritance instead of 22%-24% had the parents converted their pre-tax wealth to Roth prior to their deaths. I realize this is slightly morbid planning, but there’s no reason for Uncle Sam to receive ten to fifteen percent more ($100,000 to $150,000 in this example) of your money than they otherwise would have by executing smart tax planning.
6. Consider executing Roth IRA conversions once you retire or during any year (disability) where your income may be significantly lower than your normal airline income.
Clearly, anytime your income is lower, and you convert pre-tax IRA or 401(k) monies to Roth, you will pay a lower tax rate on the conversion. This is because the taxable portion of the Roth conversion will be taxed at your marginal income tax rate. Here are some pros and cons for Roth conversions upon retirement, especially if your income is lower than pre-retirement.
- Lower Required Minimum Distributions (RMDs): Traditional IRAs require RMDs starting at age 73 (for most retirees). Roth IRAs do not have RMDs during your lifetime.
- Tax Diversification: Building a pool of tax-free money can give you more control over your tax bracket in later years.
- As stated before, heirs benefit: Roth IRAs passed to heirs can grow tax-free, and withdrawals may be more favorable for them.
- Use caution and be sure to understand that converting too much can push you into a higher tax bracket or increase Medicare premiums (via IRMAA surcharges).
- Strategic conversions over multiple years (a “conversion ladder”) can spread out the tax hit.
- Ideal time: Early retirement (before RMDs and Social Security kicks in) when income may be low.
- It is best to pay the tax with money outside the IRA to maximize tax-free growth inside the Roth. Using IRA funds to pay the tax reduces the benefit of the conversion.
Hopefully, you found this article interesting and helpful. If you have any questions, contact us at 865-240-2292 or [email protected].
Charles Mattingly, MBA, CFP® | CEO & Lead Planner
Leading Edge Financial Planning
865-240-2292 Office
865-328-4969 Cell/Text
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