Wednesday, November 17, 2010

Ultra-High Earners, How Much Can You Really Defer?

A lot of what we might describe as ultra-high earners (say $500,000 US per year or more) would love to have more tax-favored savings. Physicians, attorneys, and others who are owners of their businesses struggle with this.

In a fairly common design scenario, here is what they can defer into a qualified retirement plan (tax-favored, secure from creditors):

  • $16,500 ($22,000 if they reach age 50 or older during the year) to a 401(k) plan
  • $22,050 in a profit sharing plan. This is 9% of $245,000 (pay cap). We use 9% because by contributing 3% of pay on behalf of nonhighly compensated employees (NHCEs), the owners are usually able to contribute 9% (3 times 3) to their own accounts
  • Perhaps a matching contribution (not more than about $11,000) in the 401(k) plan, but only if they make similar percentage of deferral matches for NHCEs, and the NHCEs participate in the plan to a great enough extent.
Suppose someone told you that by putting aside a little bit more for your NHCEs (generally tax deductible, but you should seek appropriate legal or tax counsel before proceeding), you could quintuple your own deferrals if you are at least age 62 (the numbers are smaller for younger ages, but can triple as early as your 40s). Go through the math, or trust me. Because of the tax deductibility of all these contributions (if you can afford to make them), your income plus deferrals less taxes will often increase ... and you get the benefit of tax-deferred buildup, secure from creditors.

The mechanics aren't that simple, but that's why there are experts. From your standpoint, you just need the willingness to do this, good advisors, and proper counsel.

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