WEALTH PRESERVATION INSIGHTS: RETIREMENT STRATEGIES

One of the biggest challenges in growing and preserving wealth lies in being able to separate the distractions from the information that really matters. To get started, you need to know what to include in your retirement strategy by sorting out the relevant items against the backdrop of an increasingly complex wealth management landscape.

From a big-picture point of view, your personal risk management strategy should protect your family, wealth, assets, legacy, health and well-being. This article, however, is meant to facilitate your discussions with a trusted advisor on just one part of that picture: your retirement strategies to protect your wealth.

Value of a goal-based financial investment strategy

Defining goals sets you on a path for better wealth management. Using goals helps you match your time horizon to your asset allocation, which means you take on the optimal amount of risk. With specific goals, you are more likely to achieve them.

Goals allow you to align the cash flow from your various portfolios according to when you will need to make withdrawals. With each goal, a wealth advisor can help you select a portfolio of stocks and bonds customized for the time horizon you set.

The first step would be a “gap analysis,” which assesses your current financial situation, then factors in your goals. The difference between where you are now and where you want to be at a specific time in the future is the “gap.” A goal-based strategy will include a plan to bridge that gap, which is typically an ongoing process based on your changing circumstances. Therefore, each year you should review your progress to compare where you are to where you want to be and adjust the plan accordingly.

Key components in your goal-setting strategy include:

• Current income
• Anticipated growth in income
• Current market value of savings and investments
• Value of your expected Social Security benefits
• Income you will need to support your desired lifestyle in retirement
• Age at which you want to retire (or be financially able to)

Additionally, when it comes to your actual investment portfolio, your asset-allocation strategy will have a significant impact on your success or failure—your mix of stocks, bonds, and cash. You risk a shortfall if your strategy is too timid. You risk a significant loss if your portfolio is too aggressive—a loss that would be difficult to recoup during your anticipated investment timeline.

Provided with this information, an advisor can help determine you are on track to meet your goals—and, if not, what you need to be setting aside to fill the “gap.”

To fill that savings gap, you have a number of tax-efficient savings tools available to you, depending on your employment. While some options for individuals, employees and self-employed overlap, each group has different opportunities for contributing to retirement savings based on their source of income. To maximize your savings potential and reach your retirement goals, you should explore how each option can work for you.

Plans for individuals:

• Deductible IRA - Contributions are made individually to an IRA, and individuals claim a tax deduction for their contributions on their personal returns. Contributions are phased out as incomes increase, so depending on income, you may or may not be able contribute to an individual IRA. Earnings grow tax-deferred and are subject to income taxes when they are withdrawn. You will owe a 10% penalty if you cash out before age 59½. You also must begin withdrawing money by age 72.
• Non-deductible IRA - Contributions are made with after-tax money and earnings grow tax-deferred until they are withdrawn, at which point they are subject to income taxes. There are income eligibility requirements, so depending on income, you may not be eligible. You will owe a 10% penalty if you withdraw money before age 59½. You also must begin withdrawing money by age 72.
• Roth IRA - A better choice for after-tax contributions might be a Roth IRA. The contribution limits are similar to a non-deductible IRA, but the income phase-out thresholds are higher. Also, the gain on investments is not taxed on withdrawal if the money has been retained in the Roth IRA for a long enough period of time. There are no required minimum withdrawal requirements for a Roth.
• Life insurance – Life insurance can be used as a retirement savings vehicle. For most purposes, life insurance is used to create an asset for beneficiaries for specific needs. For those needs that are temporary, term life insurance is the best option. For permanent insurance needs, such as estate planning, you want to purchase permanent insurance at the lowest possible premium cost. Guaranteed death benefit universal life might be a good fit. But life insurance contracts can also be used for their investment potential. To maximize the investment potential of a life insurance contract, you will want to fund a contract with the maximum premium allowed under IRS rules, funding the least amount of death benefit necessary to maintain the tax-qualified status.

One of the key advantages of permanent life insurance is the tax-deferred accumulation of earnings inside the contract. When needed to supplement retirement income, your basis (what you contributed to the contract) can be withdrawn tax-free. To the extent you want to use earnings inside the contract to supplement retirement income, you can borrow the earnings tax-free. If you hold the contract until death, the tax-free death benefit pays off the loans, so you never pay taxes on the contract gains. To the extent you still have cash available in the contract at death, the remaining benefits and net death benefit are paid to your beneficiaries’ income tax-free.

Plans for the self-employed

• SEP IRAs - Simplified Employee Pension IRAs often are used by self-employed or small business owners to set aside money on a tax-deductible basis. The employer can contribute the lesser of 25% of employee compensation or $61,000 (2022 limit). Limits on contributions are announced annually by the IRS. You must wait until you’re 59½ to withdraw from a SEP IRA or you’ll owe a 10% penalty.
• This savings vehicle can be used by business owners and self-employed individuals, sole proprietors or partnerships. Because workers don’t have to receive SEP contributions from their employer until they meet the three-year service requirement, the plans are great for small businesses that want to offer a retirement plan on a cost-effective basis.
• Simple IRA - These plans are ideal for self-employed business owners, including individuals, who want a flexible plan because contribution methods can be selected before the start of each year.
• Solo 401(k) - Contributions are made by sole proprietors with pre-tax dollars and earnings grow tax-deferred. Income taxes on earnings and original contributions are paid when withdrawn. There are no income eligibility requirements. Because this plan has far higher contribution limits than an IRA, the solo 401(k) is good for self-employed individuals with no employees who want to contribute a significant amount of money to a retirement plan.

Plans for employees

• 401(k) - An employer’s 401(k) plan is an effective savings vehicle for most non-highly compensated employees (those with incomes < $135,000 for 2022). In 2022, they can contribute as much as 100% of their income to a maximum of $20,500 per year. Those over age 50 can make an additional $6,500 “catch-up” contribution. For highly compensated employees (those with incomes > $135,000 for 2022), contributions may be capped at less than the $20,500 elective contribution limits due to discrimination testing. If the employer provides a “safe harbor” match or profit-sharing contribution, the highly compensated employees will not be subject to discrimination testing, but their contributions are still limited to the $20,500 statutory elective contribution maximum (plus catch-up contributions if eligible). As incomes go up, the opportunity to use a 401(k) plan to effectively plan for a full retirement declines due to those caps.
• Employer-sponsored nonqualified plans - If your employer offers a nonqualified deferred compensation (NQDC) plan, it will allow you to defer a much larger portion of your compensation, and to defer taxes on the money until the deferral is paid. To get the most benefit out of an NQDC plan, you must give careful thought to your deferral strategy, investment options, and distribution plan. There are additional ways that employers can utilize non-qualified plans to help employees effectively save for retirement. Some can be set up to provide non-taxable income to the participant at retirement. These plans typically require funding participation from employers.

Bottom line

These are just some of the ways you can increase your retirement savings as a high-income earner. A wealth advisor can walk you through the details of each option and help determine which ones will best fit your current income and financial goals.

Learn more about planning for your retirement.