Retirement Planning Attorney Andrew H. Hook Discusses Retirement Planning When A 401(k) Is Capped
Virginia Beach, VA (Law Firm Newswire) May 23, 2016 – It can be challenging to find tax-advantaged ways to save for retirement when an individual is highly compensated. Under the general rule, workers can save $18,000 annually in pre-tax income in a 401(k) plan. However, if the worker earns over $120,000 annually, owns in excess of a five percent interest in an employer’s company, or is among the employees who earn the top 20 percent of income at the firm, the IRS considers such a worker to be a highly compensated employee (HCE).
The contributions made by an HCE can be limited if an insufficient number of lower-paid employees contribute to the plan. The IRS performs “non-discrimination” tests to make certain the top earners are not contributing substantially more. High earners can save only about $6,000 in their 401(k) plans.
Andrew H. Hook, a prominent Virginia retirement planning attorney with Hook Law Center with offices in Virginia Beach and northern Suffolk, states, “The choices made with respect to retirement planning can have a great impact on clients and their families for many years. That is why it is best to consult with a retirement planning attorney concerning the variety of options that are available.”
One way to increase a person’s retirement savings is to make catch-up contributions. Thus, a person over age 50 can save another $6,000 a year in a 401(k). In addition, if an individual’s spouse qualifies for a 401(k) or other retirement savings plan through an employer, the spouse should contribute the maximum amount. If the spouse does not have a 401(k), the spouse can make contributions to a deductible IRA and receive a tax break. For 2015, the maximum contribution is $5,500, and if the spouse is over age 50, the maximum contribution is $6,500.
Another option is to contribute to an IRA, but if a couple earns over $118,000 in modified adjusted gross income, and one spouse has a retirement plan through an employer, they are ineligible for the tax break. In lieu of a traditional IRA, they should contribute to a Roth IRA, to which they contribute after-tax dollars, with the funds growing on a tax-free basis. If they invest the money for five years, the withdrawals will also be tax-free. However, there are income limits for making contributions to a Roth IRA. If a married couple earns over $183,000, neither spouse can contribute the full $5,500.
One other strategy is to make a nondeductible cash contribution to a traditional IRA, and afterward, change it to a Roth IRA. This is called a “backdoor Roth.” If the couple has no other IRAs, then this will be a tax-free transaction. But if the couple has other IRAs, then those assets will be taken into account when figuring their tax bill.
Employees may also wish to consider depositing funds into a health savings account (HSA) if their employers offer one. HSAs are associated with health insurance plans that have high deductibles, and allow individuals to save money on a tax-free basis. If a person has individual health coverage, then a maximum contribution of $3,350 is permitted, and if the employee has a family plan, a maximum amount of $6,650 can be contributed.
After using the tax-free or tax-deferred retirement options, an individual can invest in a taxable brokerage account. Investments in a buy-and-hold stock fund or index funds will be taxed at a 15 percent capital gains rate, which is lower than the income tax rate. Fixed-income investments, including bonds, should remain in the IRA or 401(k).