Be­yond The 401(k): Re­tire­ment Sav­ings For The Rich


Let me start by say­ing that I love the 401(k) plan. It’s the sin­gle best wealth ac­cu­mu­la­tion ve­hi­cle avail­able to the vast ma­jor­ity of Amer­i­cans. At to­day’s con­tri­bu­tion lim­its, you can de­fer $18,000 of in­come—and $24,000 if you’re 50 or older— tax-free.

That’s great for middle-class Amer­i­cans, and many can meet those goals with a lit­tle bit of dis­ci­pline. But if you have an an­nual in­come of $500,000 or more, that amounts to a pal­try sav­ings rate of less than 4%. Any sav­ings above that amount would be sub­ject to pun­ish­ingly high taxes—and even the dreaded Oba­macare sur­charge.

Well, I have good news. If you earn a high in­come and own your own busi­ness (or are paid as a 1099 con­trac­tor), you have vastly su­pe­rior sav­ings op­tions at your dis­posal. If done right, you can save well over $100,000 per year in taxshel­tered ac­counts.

This strat­egy is de­signed for the self-em­ployed, but it can also work if you work for a pay­check but also earn ad­di­tional in­come from a side busi­ness or ad­di­tional con­tract in­come. A lot of doc­tors and con­sul­tants would fall un­der this um­brella.

We all know that the tra­di­tional de­fined ben­e­fit pen­sion is dead. The days when your em­ployer guar­an­teed you an in­come for life are now some­thing we read about in his­tory books.

Well, that might be true for cor­po­rate plans. But there is noth­ing stop­ping you from start­ing your pen­sion for your­self and your spouse.

The One-Man Pen­sion

The best re­tire­ment sav­ings strat­egy is ac­tu­ally a com­bi­na­tion of two sep­a­rate ve­hi­cles:

1. An In­di­vid­ual 401(k) plan with profit shar­ing

2. A cash bal­ance de­fined ben­e­fit pen­sion plan

I’ll tackle the In­di­vid­ual (“Solo”) 401(k) plan first. Most in­vestors con­sider a Solo 401(k) plan to be more or less in­ter­change­able with a SEP IRA.

They’re wrong.

While both plans max out at $53,000 per year in con­tri­bu­tions, the Solo 401(k) al­lows for front­load­ing. I’ll ex­plain with an ex­am­ple. Let’s say your busi­ness earns $100,000. With an SEP IRA, you can con­trib­ute 20%, or $20,000. This is a profit-shar­ing con­tri­bu­tion made on your be­half by your em­ployer—which hap­pens to be you.

With the Solo 401(k), you can make that same profit-shar­ing con­tri­bu­tion of $20,000. But you can also de­fer $18,000 of salary, for a to­tal of $38,000.

Of course, we’re talk­ing about high-in­come earn­ers, and both the Solo 401(k) and the SEP IRA max out at $53,000 on in­comes of $265,000.

So, if you earn $265,000 or more, the SEP IRA and Solo 401(k) are in­ter­change­able, right? Wrong! If you save via a Solo 401(k), you are also el­i­gi­ble to con­trib­ute to a de­fined ben­e­fit plan. If you save via a SEP IRA, you can­not.

This brings me to the se­cond prong of the re­tire­ment plan, the sin­gle-per­son de­fined ben­e­fit plan. Yes, you can ac­tu­ally make a tra­di­tional pen­sion plan—for your­self. There are ad­min­is­tra­tive fees in­volved, and you’ll want to hire a pro­fes­sional to draft the plan doc­u­ments and mon­i­tor com­pli­ance. But do­ing all of this opens the door to mas­sively in­crease your re­tire­ment sav­ings.

Con­tri­bu­tion lev­els here de­pend on your age and other ac­tu­ar­ial as­sump­tions, but this is how they shake out:

2016 Max­i­mum Con­tri­bu­tions To Cash Bal­ance Pen­sion

Putting It All To­gether

Com­bin­ing the Solo 401(k) with the cash bal­ance de­fined ben­e­fit plan is a lit­tle com­pli­cated, so I can’t stress enough the im­por­tance of hir­ing a knowl­edge­able pro to set it up cor­rectly. But here are the ba­sics.

Nor­mally, you can con­trib­ute $18,000 in salary de­fer­ral and 20% of prof­its to a Solo 401(k) plan up to a max­i­mum of $53,000. But if you also con­trib­ute to a cash bal­ance pen­sion plan, your profit-shar­ing per­cent­age gets bumped from 20% to 6%. That ef­fec­tive drops your $53,000 con­tri­bu­tion to $33,900 if you’re un­der 50 and $39,900 if you’re 50 or older.

But here’s where it gets fun. If you’re 65 years old, your com­bined con­tri­bu­tion to the Solo 401(k) and cash bal­ance

pen­sion is a whop­ping $284,400 ($244,500 cash bal­ance + $39,900 401(k) plan). The num­bers get smaller the younger you get, but at age 35 you can still con­trib­ute a not-too-shabby $102,200.

Is There A Down­side?

So, stash­ing away mul­ti­ple hun­dreds of thou­sands of dol­lars per year sounds pretty great, right? What’s the catch?

Be­lieve it or not, there re­ally isn’t one. There are costs, of course. Ex­pect to pay $2,000 to $3,000 in ad­min­is­tra­tive ex­penses. And you need to have a fairly con­sis­tent in­come in or­der to make this work, as there can be penal­ties for fail­ing to make con­tri­bu­tions. So the plan is clearly not for ev­ery­one.

But if you are a high-in­come Amer­i­can des­per­ate to shield some of your sav­ings from the tax man, this is the best com­bi­na­tion I’ve seen.

Source: Ded­i­cated De­fined Ben­e­fit Ser­vices LLC

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