401(k)s, Retirement Planning, Employee Benefits and Simple Investing Tips
Does your company’s 401(k) offer an “After-Tax” contribution option? Many larger companies (Google, Apple, Amazon, Meta, etc.) offer this additional savings opportunity which can provide significant, game-changing longterm tax benefits to high earners. Fewer than 20% of companies offer this, but it’s worth checking to see if it is an option available to you.
Most US employees believe you can only contribute $20,500 per year in 2022 ($27K if over age 50) as an employee to “max out” your company retirement plan/401(k).
However, if you have the after-tax contribution option through your company, you can actually put up to $61,000 ($67,500 if over age 50) per year combined with your $20,500 employee contribution + your employer match + the after-tax contributions.
For example, if you save $20,500 to your 401(k) via traditional employee contribution and you receive $5,500 in a company match, you can still put another $35,000 of after-tax contributions (more if over age 50.)
What is unique is that when you leave your employer or retire, you can roll all of these “after-tax” contributions into a ROTH IRA which remains tax exempt for the rest of your life meaning no capital gains or forced mandatory withdrawals in retirement.
If you can save $61,000 per year, you likely earn more than the IRS income threshold ($212,000/year if married and $144,000/year if single) and are unable to contribute money to a Roth IRA. However, you can still contribute to a Roth 401(k) which doesn’t have the income caps.
“a ROTH IRA which remains tax exempt for the rest of your life meaning no capital gains or forced mandatory withdrawals in retirement.”
I am often asked by clients at my firm Old Vine Capital if they should contribute to a 401(k) via Roth or Traditional contributions and there is no uniform answer. Quantitatively, if you are living in a high tax state like California/Massachusetts/etc. and are in your prime earning years, there is definite benefit to contributing to your traditional IRA to reduce your current year tax liabilities and then let the contribution grow tax-deferred until you pull the funds out in retirement.
From a behavioral/qualitative standpoint, I often talk to clients about just doing the Roth 401(k) contribution because any “tax savings” from a traditional 401(k) they see in their paychecks are likely to just be spent on non-returning discretionary items (another trip, new shoes, a boat, etc.) Instead, if they make the Roth 401(k) contribution, they will likely see a smaller auto-deposit from their bi-weekly paycheck and in result they will spend slightly less each year.
Overall, it is beneficial to have multiple sources of income as your plan for your retirement including taxable accounts, Roth IRAs, Traditional IRAs, Real Estate, Business Partnerships, and possibly pensions. When planning for retirement, you will likely want to pull from your taxable savings first, let your traditional IRA grow until the age of 72 when required minimum distributions begin (RMDs), and let your Roth IRA grow your entire lifetime to use as a last resort for income and then pass it onto your estate at your death so your heirs will have an additional 10 years to maintain the tax-exempt status of the Roth assets.
During open enrollment each year, look into the level of life insurance offered by your employer and see if there is an option to pay additional money out of pocket to max out that life insurance policy. Many large companies will pay 1X your annual income, so if you earn $400K/year, they will pay the premium for the $400K life insurance policy. Often, you can select to pay up to 10X your income ($4 million in this case) for a fairly small monthly payment without any brokerage/insurance salesman commissions. If you have a family who depends on your income, max this benefit out as the small premium each month is worth the peace of mind of a large life insurance payment to your family to protect against the impact of your lost income. I also like to max out the Accidental Death & Dismemberment, Accident insurance and Short-term/Long-term disability policies. Again, these are small monthly premiums that can really value to your family if you need to use them (hopefully you don’t!)
Another item I’ll add is that you should always be weary of anyone trying to sell your an insurance product, whole life policy, and/or variable/fixed annuities. These are extremely high commissioned products that pay the person who sold them 5%-10% up front! During market volatility like we are seeing today, we see annuity sales from salespeople increase drastically. Investors tire from the 20% down market of equities and love the appeal of a “guarantee” from an insurance salesperson. Often they will sell an index linked annuity that gets “market upside without the downside” and if this sounds to good to be true it is because it is! Those products often cap your annual upside (if market is up 30%, you may be capped at 15% and often will keep all dividend (~3%/year.) These terms are all hidden in the fine print.
With regard to investment strategy, if you want to “have fun” with crypto trading, hot stock trading, options trading, day trading, etc go ahead, but know it’s basically like Vegas money were the house wins and statistically you will underperform the market. I do feel digital assets/crypto can serve as one of several sub-assets within alternatives (next to private equity, venture, capital, hedge funds, and angel investing) but the exposure should be limited and you should sell when your positions move above your asset allocation guidelines. With regard to equities, the global stock markets are highly efficient and if Goldman Sachs and BlackRock’s billion dollar technology platforms, PhDs, CFAs, and Nobel Laureates cannot beat the broader market, what makes any individual investor think they can beat markets. Using multi-factor tilts in equity markets has proven to be beneficial in providing an enhances Sharpe Ratio over-time, but always be aware of benchmark risk measured via tracking error. Always avoid mutual funds and instead use ETFs if you have a smaller account and need pooled vehicles for diversification. For larger taxable accounts, most investors should use a separately managed account of individual equities designed to track a specific equity benchmark with ongoing tax-loss harvesting.
Be aware of investor psychology and the powerful impact it has on investors to make bad decisions, especially during volatile market periods. The average investor drastically underperforms the market because they often jump out when it feels scary and then get back in at the top of the market when it feels “better.” Woman are better investors statically than men and some professions (certain types of engineers, surgeons, and others) tend to over-engineer portfolios and make emotional decisions their brain masks as “logic.”
If you can’t tell, I am passionate about defending clients from all these types of conflicts, helping them navigate the ever-changing investment landscape and serving as a fiduciary investment advisor. If you are sorting through these type of decisions for yourself and/or your family members, feel free to reach out — I am always happy to be a resource.
“Focus on what you can control. You cannot control daily market volatility, you cannot control geopolitical events or macro-economics, but you can control your future by building an effective financial plan, prudently saving, and investing wisely.” — Neil Kay, Managing Partner of Old Vine Capital