Rory O’Hara, CFP®, CRPC®, is the founder and senior managing partner at Ausperity Private Wealth.
It’s often easy to fall into the trap of thinking that middle-class Americans require retirement advice the most. But the fact is that even high earners need as much help as anyone when it comes to taking advantage of the entire arsenal of strategies available to maximize retirement savings.
These include maxing out 401(k) plans, moving beyond target-date funds as retirement nears, avoiding the past performance trap and conducting mega-backdoor Roth IRA.
Maxing Out 401(k) Plans
Most people—even high earners, in my experience—do not max out their 401(k) plan contributions. Unfortunately, plan sponsors and their financial institutions don’t do a good job of demonstrating how important it is to do this. So, what ends up happening is that people often only allocate enough to trigger the employer match, which in many cases, is only half the employee’s contribution.
Maxing out a 401(k) is especially important for younger workers. Doing so makes it possible to accumulate enough savings to shave as much as a decade off their working years.
Of course, this may require making lifestyle changes. Yet that’s easier than it sounds. A good place to start is by establishing a realistic budget and sticking to it. By default, that could put a dent in credit card debt, which is another thing that will provide a leg up in retirement.
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Moving Beyond Target-Date Funds Near Retirement
In general, target-date funds are good retirement savings vehicles. There are, however, some caveats. For one, not everyone approaching retirement needs to get ultra-conservative in their portfolio, as such funds tend to do by leaning heavily into bonds.
What if you have other income sources? It could be anything from high-interest savings accounts or a healthy deferred compensation plan. Whatever the case, it would mean your risk profile is a bit higher than the typical pre-retiree, suggesting that a portfolio overloaded with bonds may not be the best approach.
The other thing to remember is that having more than one target-date fund across all your portfolios doesn’t make sense. Sometimes this happens by accident, with people not realizing they have a target-date fund within their 401(k), so they invest in another one in a separate account. However it occurs, because of the fees and the fact that many target-date funds share the same holdings, you only need one.
Avoiding The Past Performance Trap
Some high earners opt against maxing out their 401(k) plan because they want to act as their own portfolio manager using an online brokerage provider. Yet few people, including many financial professionals, can successfully pick stocks over a long period.
One reason is that DIYers often invest using one criterion: recent past performance. But what works for one area of the market during some periods could just as easily produce huge losses during a different cycle.
For example, in the 1980s, value stocks outperformed growth. This trend flipped during the next decade, only for value stocks to retake the lead between 2000 and 2007. Then, after the financial crisis, large-cap growth funds outperformed value funds through 2021—until the rapid successive shocks of the Covid-19 pandemic, war in Ukraine, rampant inflation and Federal Reserve interest rate hikes ended the trend again.
Conducting A Mega-Backdoor Roth 401(k)
Investors already maxing out their 401(k)s can look into mega-backdoor Roth 401(k)s, which get funded with after-tax dollars. Younger investors, who face an annual $22,500 401(k) contribution limit until age 50, have the most to gain. That’s because Roths not only have a more extended period of investment growth, but the returns accumulate tax-free.
High earners with 401(k)s may be able to do a mega-backdoor rollover by placing up to an additional $43,500 of after-tax dollars in their 401(k) and then rolling it into either a Roth IRA or Roth 401(k), with future growth occurring tax-free. First, you should speak with your employer’s 401(k) plan financial representatives to learn whether the plan allows for this and what you need to do to avoid or minimize tax obligations.
Some 401(k) plans have an auto-rollover feature to do this for plan participants after each after-tax contribution. Others allow such rollovers only once per year. And some require participants to wait until two years after their first contribution to conduct a Roth IRA mega-backdoor rollover.
High-income workers of all ages have a wide range of investment strategies to accumulate and retain significant pre-retirement savings. Making this happen calls for proactive planning and the help of a qualified financial professional.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.