April 15, 2025
When most people think about their 401(k), the obvious benefits that come to mind are: building retirement savings through investments, employer matching (if available), and tax deferral. But there’s a lesser-known advantage that high earners and business owners should be aware of to ensure they are maximizing the benefit—the marginal tax bracket opportunity that comes with 401(k) contributions. This article is simply referring to the 401k salary deferral option. There are many benefits for the appropriate situation that include profit sharing as well as potentially a Defined Benefit plan. For this strategy, we are simply talking about 401k deferrals.
This strategy isn’t just about saving for the future. It’s about a way to fully understand why you are contributing and realizing the most from the benefit by taking advantage of today’s tax code to maximize wealth efficiently.
Marginal Tax Brackets: The Key to Strategic Deferrals
Given the publishing date of this blog, it’s probably more apparent than usual, but the U.S. federal income tax system is marginal, meaning you pay different tax rates on different portions of your income. The more you earn, the higher the rate as you work your way up the taxable income brackets. For 2025, the top federal marginal tax rate remains at 37% for high earners. If your income puts you in that bracket, every dollar you contribute to your 401(k) isn’t just deferred—it’s deferred at the highest tax rate you are currently subject to.
Here’s why that matters:
Let’s say you are fortunate enough to earn an income that puts you in the 37% bracket; If you contribute the maximum allowable amount of $23,000 to your 401(k), that contribution is deducted at 37%, saving you $8,510 in federal taxes today. That’s real, immediate tax relief. Comparing this to someone in the 22% bracket — the same contribution only saves them $5,060 in taxes (40% less beneficial). The higher your bracket, the more powerful the deduction becomes in the year you make the 401(k) salary deferral.
The Hidden Advantage: Withdrawals in Lower Tax Brackets
The benefit during the deferral stage is apparent, but how does this translate when it comes time to withdraw these funds from your 401(k) in retirement? Well, this is where the long-term strategy shines.
Most retirees don’t draw down their savings in one lump sum. Withdrawals are typically spread across many years—and often taxed at lower marginal rates. For example, in retirement, if you are able to retire prior to starting Social Security, you may actually be in a situation where you have $0 income. That means you have to decide where you will take your income from – Will it come from a Brokerage account (that is subject to Capital Gains), will it come from a Roth based account (that will come out tax free) or will you pull funds from a 401k or Traditional IRA (that is subject to income taxes)?
In this example, we are assuming this is your only reportable income and you pull $100,000 from your 401k or Traditional IRA. Let’s break down how your income will be taxed. We will use the 2025 Tax brackets and income thresholds to show this example. First you will, at minimum, receive a standard deduction. In 2025 the standard deduction for a married couple is $30,000. This means that your first $30,000 of income is not taxed. So, of the $100,000 we will pull from your 401k, only $70,000 will hit the marginal tax brackets. See below for the specifics of how the $100,000 of income will hit your tax return.
Here’s a simple chart showing what would be owed based on each tax bracket:
| Tax Bracket | Income Impacted | Tax Owed | Deducted at | Value of Deduction |
| Standard Deduction | $30,000 | $0 | 37% | $11,100 |
| 10% | $0 – $11,000 | $1,100 | 37% | $4,070 |
| 12% | $11,001 – $44,725 | $4,047 | 37% | $12,478 |
| 22% | $44,726 – $70,000 | $5,561 | 37% | $9,352 |
| Total | $100,000 Income | $10,708 | 37% | $37,000 |
In this scenario, the $100,000 distribution is taxed just 10.7%. Compare that to the 37% savings you locked in when contributing—and the benefit becomes clear: you’ve deferred income at the highest rate and are withdrawing it at a much lower rate. The thing that is missed most in this scenario is that many don’t count the value of “filling up” the lower brackets. I typically hear, in a scenario like the one illustrated above, that the money was distributed at the 22% bracket. While that verbiage is technically correct, the reality is that the income was distributed at a tax rate of 10.7%, not at 22%, yielding a huge strategic tax win of the difference between $37,000 and $10,708 of $26,292.
It’s Not Just About Retirement—It’s About Tax Arbitrage
This isn’t just deferral—it’s tax arbitrage. I talk about this all the time in meetings with clients. You are using the tax code to your advantage as much as possible. You’re legally shifting income from your highest earning (and highest taxed) years into your lower income retirement years. This spread between your contribution tax rate and your withdrawal tax rate is one of the most overlooked but powerful planning tools available.
For high-income earners, especially business owners and professionals, this strategy can be even more effective when combined with proactive tax planning. This is done by considering Roth conversions in low-income years, blending traditional 401(k) and Roth strategies, and coordinating withdrawals with Social Security and required minimum distributions (RMDs) to optimize outcomes. Best part, the answer isn’t the same for everyone. This isn’t a one size fits all strategy.
Blue Rock’s Perspective: Planning Beyond the Obvious
At Blue Rock Financial Group, we don’t just look at the mechanics of saving, we look at the strategy behind it. Wealth isn’t just accumulated; it’s strategically constructed. How, by understanding and taking advantage of the marginal tax system, we help clients defer income in peak-earning years and design smart withdrawal strategies that keep more money in their pockets over time. The goal here is to minimize higher paying years and actually increase years where you may be subject to much lesser rates of tax. This is what comprehensive planning looks like: aligning cash flow, tax strategy, and retirement income to build lasting financial freedom.
Plan with Confidence.