Getting the Most from Your Retirement Plans
Each year about 40% of our clients who open defined benefit plans also open a 401(k). They do so for several reasons:
1. Maximum Contribution
Clients with extremely high income often want to maximize their annual contribution and tax deduction. Often, they can add about $40,000 to the 401(k) on top of their calculated maximum defined benefit contribution.
|Defined Benefit Only|
|2017 Business Contribution:||$186,800|
|Tax Savings @ 38%:||$70,900|
|Defined Benefit + 401(k)|
|2017 Business Contribution:||$227,000|
|Tax Savings @ 38%:||$86,200|
2. Increase Flexibility
Some clients know that their income or cash flow will vary from year to year. While they want the higher limits of a defined benefit plan in some years, they don’t want to commit to it every year. Contributions to 401(k)s are optional each year so when cash flow is required for other purposes, no contributions will be made to the 401(k) that year.
Architect, age 48, has an S-Corp and paid himself $185,000 in W-2 income in 2016. He wants to save as much as possible this year but wants flexibility as his income fluctuates.
In 2017 He’ll contribute $110,000 to the defined benefit plan and another $29,000 to the 401(k). Next year he might not fund the 401(k) at all.
3. Stretch Contributions
The IRS has a limit on the total asset accumulation allowed in a defined plan. For clients who want to continue to get the large tax deductions for a decade or more, we can design their combined DB+401(k) to fill up the 401(k) first.
A physician age 60 has $450,000 in self-employment income and has no plans to retire in the short term. He could maximize his contributions to a defined benefit plan in 2017 at $209,000 but he’d reach his contribution limit in 5 years. He’d prefer to stretch it out over a longer time. So, he funds a 401(k) at $36,000 a year and makes tax-deductible contributions to a DB at $100,000 a year, extending the life of his plan to 10 years.
4. Start Earlier
While most of our clients are age 45+, some fortunate folks are making a lot of money in their 20’s or 30’s and they want to contribute more than a 401(k) alone allows. By combining a defined benefit plan with a 401(k) we can often bring the contribution and deduction up to $100,000+.
A sales rep, age 35, has had consistently high income over the past 3 years, averaging more than $600,000 per year. With a 401(k) alone, she can contribute only $54,000 per year. With a defined benefit plan alone, she can contribute only $78,000. But by combining the DB with a 401(k), this sales rep can contribute $112,500 for an estimated current year tax savings of $42,750, assuming 38% combined federal and state tax rate.
As life expectancies increase, the amount needed for a comfortable retirement also increases. People in their fifties and sixties who are making much more than they did in the past, want to contribute more than they can to a DB alone to catch up for starting to save later. Every $30,000 helps!
An energy consultant, age 50, has been earning $200,000 in W-2 income from his S-Corporation which would qualify him to contribute as much as $128,000 to a defined benefit plan for 2017. He would like to save as much as possible over the next 12 years, but given his long time horizon, wants some leeway around his annual contribution. Instead, he combines a defined benefit plan with a 401(k) and contributes $90,000 to the DB, and with his catch-up contribution, $36,000 to the 401(k).