Advanced Tax Deferral Options In Retirement Plans
There are retirement plan options that could potentially allow for far more in tax deferrals than many people realize.
Before we get into the advanced strategies, let’s quickly review the basic options:
Contribute at least the employer matching level. Many 401K and 403B plans match at least some of the contribution. When available, it is a very nice benefit and people should take advantage of it when their finances allow.
Defer the maximum? This is a more complicated question as it depends on each person’s financial situation, upcoming needs, and liquid assets readily available vs. illiquid assets not easily accessible. But for those in the right financial position, deferring the maximum every year can provide substantial benefits over time.
Traditional vs. Roth contributions. Traditional plans allow contributions pre-tax, meaning you lower your taxable income by increasing your contributions. Some plans allow Roth contributions, which are after-tax, meaning no immediate tax deferral, but contributions grow tax free and you can withdraw tax free after 59½. Which option makes more sense depends on your financial situation and needs, including factors like whether your tax bracket is likely to increase or decrease after retirement, and your contributions to other plans.
IRAs and Roth IRAs. Although these are relatively small dollar amounts compared to employer-sponsored plans, they can add up over several years. Depending on your finances and ability to save, these can be a nice supplement to your savings. Roth IRA contributions are possible even if you exceed the income limit through a so-called “Backdoor Roth” contribution. This involves an after-tax contribution to a traditional IRA, which is then rolled over into a Roth IRA.
Beyond the basics, there are additional advanced strategies that many people are not aware of. Some of these include:
Super Roth contributions. Some plans allow additional contributions above the regular employee contribution limit of $22,500, which can be automatically rolled over into a Roth. This could potentially increase the deferral to $66,000 a year or more by combining the employee and employer contribution limit. Please note that not all plans allow this, but it is an option in some cases.
Self-employed plans also have high limits. If you run your own business, you could also potentially contribute up to $66,000 a year or more through plans such as a Solo 401K or a SEP IRA.
Defined benefit plans can supercharge your tax deferrals. Many people think of defined benefit pension plans or traditional pensions as being something mainly found in government agencies or old industrial companies. But they can be very useful in certain situations, such as a small practice with older partners and a small number of junior employees. Examples of businesses that could benefit include small legal practices, consulting firms, dental and doctor offices, etc. That is because contribution limits are based on age and income level. It is possible, for instance, for a partner in the 50s to defer over $300,000 a year in taxable income in a defined benefit plan.
These are some examples of tax efficient investing strategies available. There are options for everyone, but small practices where the owners or partners earn a large share of the income have the most flexibility.
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Please note, changes in tax laws or regulations may occur at any time and could substantially impact your situation. While we are familiar with the tax provisions of the issues presented herein, as ...
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