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Most people have heard of Roth IRAs. Those who qualify typically contribute and those who do not qualify can sometimes find a way to do so, as we explain here. In either case, you can do MORE.

Take a Step Back and Understand Plan Types and Limits

2021 Retirement Plan Limits
Account Type 2021 Limits
IRA $6,000
50+ Catch-Up Limit $1,000
Simple IRA $13,500
50+ Catch-Up Limit $3,000
SEP IRA $58,000
401(k) $19,500
50+ Catch-Up Limit $6,500
Profit Sharing Plan $58,000
Defined Benefit Plan (Annual Limit) $230,000

Depending on your current occupational status and business structure, you may or may not be able to open any of the accounts noted above. For starters, any individual can open an IRA (with certain age/income requirements). All other plans must be company sponsored. An optimal retirement plan design permits annual savings of $58,000/year if you are under the age of 50 or $64,500/year if you are age 50 and above. What’s more, it can all be Roth!

How is This Possible?

Formula = 401(k) + Profit Sharing + After Tax Contribution + Roth Conversion

An individual can contribute up to $19,500/year (under 50 years old) or $26,000/year (50+ years old) to a Traditional 401(K), or Roth 401(k). You can fund the remaining balance of $38,500 through any of the following ways:

  • EMPLOYER can contribute via matching or profit sharing
  • EMPLOYEE can contribute with after-tax dollars

You can then convert any traditional dollars (past or present) to Roth. It is that simple.

Why Doesn’t Everyone Do This?

Frankly, most people do not know how to do this. It also depends on how your business and income is structured (C-Corp versus Sole Proprietor or whether you file 1099 versus W2, for example), among other things. That said, if you are an employee, your company must draft the retirement plan document to allow for these features. The Department of Labor also deploys plan discrimination testing which can alter the amount highly compensated/key employees can contribute. If you are a business owner and you are not doing this, you may be missing out.

The Optimal Plan Design

You can also add a cash balance plan on top. A cash balance plan is a pension plan in which an employer credits a participant’s account with a set percentage of his or her yearly compensation plus interest. There is a complex calculation that takes your age and income into consideration, among other things, to determine your maximum annual contribution.

An example of an optimal plan design:

Participant Age Cash Balance Contribution 401(k) Deferral Profit Sharing Contribution After-Tax Contribution Total Contribution
Owner 40 $101,578 $19,500 $17,400 $21,000 $159,618
Participant Age Cash Balance Contribution 401(k) Deferral Profit Sharing Contribution After-Tax Contribution Total Contribution
Owner 50 $166,905 $26,000 $17,400 $21,100 $231,455
Participant Age Cash Balance Contribution 401(k) Deferral Profit Sharing Contribution After-Tax Contribution Total Contribution
Owner 60 $274,000 $26,000 $12,000 $26,500 $338,560
*Assuming Net Schedule C Income of $500,000

Step Up Your Game

Modern problems require modern solutions. There are many planning strategies at your disposal if you get creative. It is definitely worth a conversation with your financial advisor to go over the options.

 

Wealthspire Advisors LLC is a registered investment adviser and subsidiary company of NFP Corp.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, Certified Financial Planner, and CFP® (with plaque design) in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. © 2021 Wealthspire Advisors

Kevin Couper, CFP®

Kevin is an advisor based in the Los Angeles, CA area.