Kelly is a longtime client. We started working together when she was a young analyst at a Fortune 500 insurance company. Kelly made decent money but didn’t have the time to focus on her finances. Soon enough, she was promoted to vice president, then to senior vice president overseeing the entire East region. Today, 25 years later, we are sitting at her house, reviewing her retirement cash flow projections, and the reality sinks in that she can finally retire — or, as she says, “not have to get up in the morning.”
Kelly earned it — she put in the time — but she also acknowledges she couldn’t have done it alone. Together, we had several conversations on how to maximize the plans her company offered. Those plans turned out to be the cornerstone of her retirement nest egg. If you’re like Kelly, working in Corporate America and wondering how to get the most out of what your company offers, here are some of the things that worked for Kelly and may work for you, too.
401(k)/403(b) retirement plans
Workplace retirement plans like 401(k)s or 403(b)s are great places to save. There are many advantages, such as tax-deferred investment earnings, and there may be a company match, which sweetens the deal even more. For 2024, you can contribute $23,000 per year to a 401(k), with an additional $7,500 if you are older than 50, for a total of $30,000.
We advised Kelly to make pre-tax contributions since the tax deduction is more valuable at higher incomes. We continued with pre-tax contributions for several years. Finally, later in her career, we switched back to all Roth 401(k) contributions. We did this because, over her long career, she built up substantial pre-tax savings in her 401(k), and we wanted to create more tax-free Roth withdrawals in retirement.
We also directed her employer match to go into the Roth account, something new under the SECURE 2.0 Act. There is no tax deduction for Roth 401(k) contributions. However, qualified withdrawals are income tax-free.
Kelly’s plan also allows for an “after-tax” contribution, which is an additional contribution above the $23,000 pre-tax or Roth. The IRS limit for employer and employee contributions to a 401(k) is $66,000, so if your plan allows for it, you may be able to save more than the traditional $23,000 limit, like Kelly. The kicker is “after-tax” contributions can be transferred into a Roth IRA, if the plan allows for it — we call this the “mega-backdoor Roth IRA.” The additional after-tax contributions Kelly made in her later years helped accelerate her Roth savings. It’s best to verify with your 401(k) administrator if after-tax transfers are permissible.
All in all, she finished her career with a healthy balance of Roth and regular contributions. The idea is when she needs money in retirement from her 401(k), she will tap the regular contributions first, which are fully taxable, but stop short of withdrawing more if it pushes her income into the next bracket. At that point, if she needs more money, she will use the Roth accounts.
Deferred compensation
Kelly’s company offered a deferred compensation plan, which is a way to save a part of her bonus before taxes to be paid out later. The advantage is she pays lower income taxes today. The deferred bonus can be invested in mutual funds, and the earnings accumulate tax-deferred, another advantage.
I advised Kelly to participate in her company’s deferred compensation plan with a few caveats. Her plan allows for a lump-sum payment at the time of retirement or in a payment over a number of years. I advised her to schedule a payout of the deferred bonus for not less than 10 years. This was to avoid the state source tax. Generally, deferred compensation is taxed in the state where the wages were earned, unless the payments are made over 10 years or more, then it is taxed in the state of residence. Since Kelly was working in New York and wanted to retire to Florida, this was a no-brainer for her, as Florida has no state income tax, and New York does. Under the not-less-than-10-year rule, the deferred payment is taxed in Florida, not New York.
The lump-sum payment at retirement didn’t really make sense for her either, since that would be included in her final year of compensation and put her in a very high tax bracket. And since she was also retiring two years prior to 65, the deferred compensation payment would negatively affect her Medicare premiums, since they are based on income.
There are risks to using deferred compensation. The money deferred is usually locked up for a certain period of time. The investment is also subject to credit risk — if the company goes bankrupt, it would use the funds to satisfy creditors. These are risks that have to be considered and managed, such as limiting their use or having a meaningful emergency savings fund.
Company stock
Kelly received a part of her bonus in company stock. She received restricted stock (RSUs) that vested over three years. After three years, assuming she was still employed with the company, she could do what she wanted with the stock — keep it, sell it, gift it to charity. I advised her to sell her stock as it vested and diversify into a broader portfolio. But she was reluctant and held on to her stock for many years.
Luckily, the stock did well, but unluckily this created a large tax problem for Kelly if she wanted to sell — there would be a capital gains tax due. A few years prior to her retirement, we devised a three-pronged plan to minimize her company stock exposure, without incurring a tax on the sale.
First, we started an aggressive tax-loss harvesting strategy in her other portfolio positions. We were able to book losses for her in both up and down years in the stock market. The IRS allows us to net our investment gains against our losses. She didn’t need the losses now, but we carried them forward on her federal tax return to be used in the future. The idea is to offset the gains realized from selling her company stock with the losses that we banked from prior years. We would wait till retirement to sell the stock, as she would be in a lower tax bracket then.
Since charity is important to Kelly, there are many ways she can donate her company stock. We started contributing some of her low-basis highly appreciated company stock to a donor-advised fund (DAF), which is an account used to help facilitate donations. While Kelly was working and in a high tax bracket was a good time to make a sizable contribution to the DAF. Gifting stock to a DAF is not a taxable event, so she is able to reduce her exposure in the stock and leave her other cash and diversified investments intact.
Finally, we employed a staged sale, which is a fancy way of saying we delayed selling her employer stock until she is in a lower capital gains tax bracket. There are three different tax rates for capital gains in 2024: 0%, 15% and 20%. Your rate depends on your taxable income.
As a single filer, most years Kelly was paying the 20% capital gains rate. However, some years where she deferred a sizable portion of her bonus into the company deferred compensation plan, she dropped to the 15% cap gains rate. In retirement, she should be in the 15% capital gains bracket more consistently.
The key is to know where you fall on the cap gains rate table and see if there are strategies, like using deferred compensation, charitable contributions or delaying to low-income years, to sell long-term highly appreciated stock.
As you can see, there is much to consider when it comes to maximizing company savings and investment plans. But as Kelly can attest, it is worth the work. Over a long employment, I have seen many retire with large sums in their plans. Each plan is unique, so I suggest starting by reading the plan booklet. I also suggest talking to those already retired at the company to learn from their experience.
Finally, a qualified financial or tax professional with knowledge of company plans and benefits can lend a valuable second set of eyes. As I always tell new clients, you only want to retire once, it’s best to get it right the first time.
To schedule your complimentary company plan review with the author, make an appointment with him here.
Michael Aloi, CFP is an independent financial advisor with 25 years of experience in helping clients achieve their financial goals. He works with clients throughout the United States. For more information, please visit www.michaelaloi.com.
Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666.
This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results.
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