By Victoria Jung, CFP®
December 1, 2023 – Retiring comfortably requires careful planning and preparation. Making the most of your post-work years is an exercise in flexibility and deliberation that begins long before you start to settle down and unwind; for many, the process continues well into retirement itself. Fortunately for high-income earners, there is an array of options and resources available for maximizing one’s retirement finances. Even so, there is no one-size-fits-all path to retirement, and there are plenty of pitfalls that ought to be avoided along the way.
High earners who contribute the maximum amount allowed to their employer’s retirement plan may find that they are not fully optimizing their savings potential due to the limitations of the plan. Depending on the type of plan, the maximum allowable contributions to most qualified accounts can range anywhere from $6,500 to $66,000. Additionally, because each type of plan carries its own set of idiosyncrasies, high earners should stop to take stock and sort out which plan best suits their needs. This includes the income phase-outs, which restrict affluent individuals from making direct contributions to Roth IRA accounts.
Highly compensated individuals — often regarded as those earning more than $200k — need retirement plans that can maximize their savings potential. For business owners, this might mean making substantial tax-deductible contributions and building significant savings on a tax-deferred basis by utilizing a Cash Balance plan. Likewise, individuals whose employer-sponsored 401(k) plans permit Roth rollovers may explore tax-shelter strategies such as the one provided through the mega backdoor Roth. Executives and high-earning individuals can also arrange to defer compensation and taxes through a Nonqualified Deferred Compensation plan.
Cash Balance Plan
A Cash Balance plan is a Defined Benefit Pension plan where the employer contributes a set, predetermined benefit for each employee. The contribution amounts are determined based on the employee’s age and income, and business owners can make tax-deductible contributions of up to $398k in 2023. Unlike other pension plans, the Cash Balance plan must offer a guaranteed rate of return. Furthermore, it can be easily integrated alongside existing business or workplace retirement plans such as a 401(k) to generate a larger amount of retirement savings.
Mega Backdoor Roth
A mega backdoor Roth is a strategy that high earners can use to contribute to a Roth account. Depending on plan eligibility, individuals can make after-tax contributions to their workplace retirement plan and subsequently convert these contributions into a Roth account. Instead of being capped to the $22,500 pre-tax contribution in 2023, this strategy enables high earners to boost their total savings to $66,000 by using the after-tax 401(k) limit. It’s worth noting that after-tax contributions may not be eligible for employer matching. Roth 401(k) funds grow tax free and withdrawals also tax free. It’s important to understand the mechanics and compatibility of the mega backdoor Roth with existing employer plans before funding the strategy.
Non-Qualified Deferred Compensation
An NQDC plan enables individuals with high income to delay a significant portion of their earnings to a future date, resulting in a postponement of income taxes due. While federal and state income taxes are deferred proportionate to the deferred compensation, individuals must still pay Social Security and Medicare taxes. The advantage lies in the tax-deferred growth of the funds and the potential to shield income from being exposed to high tax rates.
NQDC plans are only available to select individuals, such as executives and highly compensated individuals. Additionally, the funds held within NQDC plans are maintained in a trust within the employer’s overall assets, which means that employee funds are not protected from the employer’s creditors.
A few other considerations
- After retirement plans and Roth accounts are fully funded, affluent clients may consider tax-deferred accounts, such as Permanent Life Insurance, Annuities, and Private Placement Life Insurance.
- High income earners may also benefit from the triple tax advantages of a Health Savings Account. Individuals may further optimize their contributions by covering their qualified expenses out of pocket and allowing the funds in the account to accrue over time.
The strategies detailed here can be powerful mechanisms in the retirement planning toolkit, but there are many other considerations to weigh before settling on a singular strategy. If any of the plans outlined above seem like a good fit for your financial situation and needs, be sure to contact your Robertson Stephens advisor to discuss incorporating them into your retirement planning.
Disclosures
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. Registration does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. This material is for general informational purposes only and should not be construed as investment, tax or legal advice. Please consult with your Advisor prior to making any investment decisions. The information contained herein was compiled from sources believed to be reliable, but Robertson Stephens does not guarantee its accuracy or completeness. Investing entails risks, including possible loss of principal. Past performance does not guarantee future results. This material is an investment advisory publication intended for investment advisory clients and prospective clients only. Robertson Stephens only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Robertson Stephens’ current written disclosure brochure filed with the SEC which discusses, among other things, Robertson Stephens’ business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. © 2023 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.