If you're an attorney or similar high-end professional earning $400,000+/year, let's face it: Your basic tax-advantaged retirement contribution limits won't cut it. If you max out your 401(k) contributions at the allowable $19,000 in 2019 ($25,000 if you're over 50), you're only setting aside 4.75% (6.25%) of your total annual income for future spending.
That's not nearly enough. If you are pulling in admirable income during your career years, it's highly unlikely you'll be ready to dramatically downshift your spending or your lifestyle in retirement.
"No problem," you think, "I'm setting aside tons of money in my taxable accounts."
That's certainly a lot better than spending everything you earn! But of course, these investments are subject to ongoing income taxes, which creates an ongoing headwind against their long-term growth.
Strategic Tax and Retirement Planning
Fortunately, there may be a way to enhance your tax-advantaged investments by going in the backdoor. Backdoor Roth IRA contributions - and now Mega Backdoor Roth contributions - may let high-earning attorneys stash away far more tax-advantaged investments for their retirement years.
In particular, we are now seeing firms offer employees a way to defer more than the maximum allowable annual retirement plan contributions by adding options to contribute after-tax dollars.
Imagine you are an attorney working for a good-sized law firm that offers these retirement plan options:
- A traditional 401(k). Pre-tax, you can defer up to $19,000 into your 401(k) account - not including any matching contributions your employer makes. (If you're 50 or older, remember, your personal contribution limit increases to $25,000.)
- A Roth 401(k). If you are in a higher tax bracket, you should opt to contribute to the pre-tax option, but you may be able to also make use of the Roth 401(k). Hold tight and we will explain how below.
- An after-tax contributions bucket: Once you max out your personal contributions, you have the opportunity to contribute additional funds after taxes. In 2019, your maximum contribution is the annual maximum retirement plan limit of $56,000, less employer and employee contributions.
Now we're talking ... or at least starting to.
Long-Term Tax Planning
If you're a high-income earner, you'd likely want to first contribute the maximum $19,000 into the traditional, pre-tax 401(k) (or $25,000 if you're over 50), ensuring maximum employer-matching contributions there as well.
You can then take proactive steps to lower your overall lifetime taxes by contributing any remaining dollars into the after-tax bucket in your plan, which can eventually be converted into a Roth IRA. If you're under 50, with no employer contributions to account for, that's $37,000/year as of 2019.
Before you assume there's no benefit to be had by contributing after-tax dollars to your company retirement plan, remember how this can lower your overall lifetime tax burden. In a tax-advantaged Roth 401(k), your investments can grow tax-free during your career years. In contrast, if you put the same after-tax dollars into a taxable account, they're subject to annual taxable capital gains. As a bonus, after age 59.5, you'll be able to withdraw the after-tax contributions you made (albeit not the growth on them) without paying any taxes at the time!
If you take it one step further, you can take advantage of the Mega Backdoor Roth. You can promptly convert your after-tax 401(k) contributions to the Roth 401(k) bucket of your plan. Or, if your plan allows in-service withdrawals, you can convert the after-tax contributions to a personal Roth IRA.
Use a Seasoned Tax Professional
Especially if you go for the Mega Backdoor Roth (if your firm offers it), this gets quite complicated and must be executed correctly. We don't suggest you try this without a seasoned tax professional to guide the way. That said, we've seen this strategy serve as a great opportunity for helping attorneys and other high-end professionals simultaneously capture excess income, invest it for the future, and reduce their overall tax liability.
Are You Ready for a Cogent Conversation? To help you benefit from this, and many other tax-wise wealth strategies, Cogent Strategic Wealth can review your income sources, your firm's existing retirement plans, and more. We can leverage our seasoned team of professionals to suggest a course toward minimizing your lifetime tax burden to maximize your overall wealth.
To learn more about backdoor and Mega Backdoor Roth opportunities in particular, and strategic wealth planning in general, we invite you to sit down with us today for a Cogent Conversation. We'll listen to what success looks like for you, build a plan tailored to you, and help you execute that plan every step of the way. Managing your wealth can be a daunting task and doesn't need to be done alone. Book your Cogent Conversation today.