RISE OF THE 401(k)
When I joined the workforce 23 years ago, the average American employee knew more about a 5K running competition than a 401(k) investment plan.
Pensions were still the king of most of the retirement planning world for workers during the 1990s and early 2000s. Many employees didn’t fully utilize 401(k)s, nor did they really understand how the plans worked and what contributions they could (or should) be making.
Even folks who were putting small amounts toward 401(k)s faced limitations on how much they could contribute. When I graduated from college in 1997, the maximum amount a person could save in their 401(k) was $9,500!
While that balance could be boosted by employer contributions, back then it was rare to see workers consistently putting away the six-figure totals that we often see folks doing today.
| Year | Employee Contribution Limit | Limit With Employer Match |
| 1997 | $9,500 | $30,000 |
| 2024 | $23,000 | $69,000 |
As 401(k)s – and similar plans like 403(b)s – have become more popular in recent decades (I’ve utilized a 401(k) throughout my entire career), many wealthy folks on the cusp of retirement or already retired, primarily younger Baby Boomers and older Gen Xers, are seeing 401(k) account balances of $1 million or more.
SOMETIMES, LESS IS MORE
Believe it or not, there’s actually a point where you may have too much saved in your 401(k).
We see some high-net-worth folks come to StrategicPoint for guidance because they’re starting to create a plan for how to spend in retirement. Choosing which account(s) to draw from can be a yearly analysis, as the tax laws change. But what shocks many of these people the most is when we start to project what their Required Minimum Distribution (RMD) could end up being when they finally reach the age of eligibility.
An RMD is the amount of money you must withdraw from your tax-deferred retirements account each year, whether you NEED the money or not. It’s calculated by factoring in your age, 401(k) balance, and the IRS-stated percentage. Since retirement accounts grow tax-deferred, when your RMD kicks in, the distribution will be included in your taxable income, meaning the higher your RMD, the more cash you’re sending to Uncle Sam! (Something often overlooked is the very real possibility that a higher income could lead you to end up paying more to programs like Medicare every year, because Medicare is an income-based program as well. More income, potentially more cost for Medicare.)
For high-net-worth Baby Boomers who may already have over $1 million saved, many realize (once they’re already retired) that they may need to alter their spending course, to adjust for the looming RMD. Twenty years ago, the industry would usually encourage folks to spend down after-tax savings first in retirement. The idea then, being why not enjoy the tax-deferred growth for many more years, even after they retire. However, if a retiree has been a stellar saver in their 401(k) more thought and approach might be needed to try and determine the optimal spending strategy.
On the other hand, I’ve worked with plenty of Gen Xers who are headed into the same situation of having too much saved into a traditional 401(k). These folks are often 10+ years from retirement, and at StrategicPoint we often alert them (and coach them accordingly) about a potential tax problem they might create a decade down the road. The good news is that we’ve advised many of them to successfully use their pre-retirement timeline to tailor their approach, lower their tax bill, and potentially live a wealthier life during their golden years.
Let’s look at an example of how this scenario might play out.
If a retiree at 73 years old takes their first RMD from a $1 million account, the starting rate of 3.78% means they’ll withdraw $37,800 each year. Because an RMD increases each year, by age 80, that person’s RMD will be 4.96% of their account. If the balance was still $1 million – $49,600. That may not seem like a big difference but if both spouses have done a good job saving for retirement, it can mean the difference between staying in a lower tax bracket or jumping into a higher one.
Sure, having an excessive savings for your golden years is a good problem to have, but are there things people should consider to maybe offset this issue?
TAX DIVERSIFICATION
Choosing which account to be your primary funding source for retirement spending can be like whack-a-mole: where one account may solve for a certain issue, it also creates another that pops up to replace the original challenge. Retirees and those nearing retirement really need to game plan for spending needs if they want to try and disinherit Uncle Sam as much as feasibly possible.
The ideal balance sheet for folks in retirement would be one where they have saved for retirement in accounts that have different tax implications when the money is needed.
Imagine a scenario where one couple has $1 million saved for retirement in their 401(k)s, $250,000 saved in a ROTH, and $250,000 in a brokerage account for a total of $1.5 million. Believe it or not, I could make the argument that those people might be better off than a couple who has $2 million saved for retirement, all in their 401(k)s.
Why?
Well, the first couple has much more flexibility when it comes to the tax implications as they need funds. Every time the second couple needs money, it’s taxable income! If the second couple wants to do something big in retirement – like buy a vacation home or even something smaller like pay for wedding or a new car – they are either going to have to bite the bullet with higher taxes or finance it, whereas the second couple can pull from their three different accounts.
Investing in a variety of retirement accounts – including 401(k)s, Roth accounts, joint brokerage accounts, etc. – can create a more valuable end result than nesting all eggs in the same basket. If you have yet to retire, there’s no time like the present to speak with an advisor and learn about strategies that you may want to implement to get more tax diversification!
DON’T LET MONEY MANAGE YOUR FUTURE
During my years here at StrategicPoint, I’ve had the pleasure of partnering with very hard-working people. Many of my clients are dedicated to their trade and have worked well beyond the time they could have retired. They’re keeping their minds sharp, and many of them truly love what they do. Retiring can be daunting to some because they have to figure out what the next stage of their lives will look like.
However, I try to stress to those who continue to work that with each passing year, you’re a year closer to taking your first RMD, and if you are someone who has done a great job of saving for retirement in your 401(k), those extra years of work may come at the expense of losing opportunities to do some tax planning.
When to retire, as well as where and how to retire, are other variables that impact a person’s RMD. At StrategicPoint, we believe that one-on-one personal advising is a reliable way to ensure that a retiree is planning (or has been planning) a financial setup that maximizes potential and utilizes all options that work best for their unique scenario. For example, we advise clients on when to take Social Security, Roth conversions, philanthropic efforts (e.g. Qualified Charitable Distributions), and other financial planning methods.
Our goal is to craft a retirement journey for you that is financially rewarding and well-planned.
If you’re not currently under that level of professional support, Reach out to a StrategicPoint advisor here, and let’s kickstart (or improve) your road to retirement!
Derek Amey serves as Managing Partner and CIO at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail him at damey@strategicpoint.com.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Derek’s opinions and comments expressed on this site are his own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.
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