Your firm’s retirement plan is probably the most effective tax shelter available. However, maximizing all the benefits of your retirement plans requires an understanding of income tax, investments and estate planning.
How much should you contribute? What impact will it have on your income tax bill?
In 2021, most law firm partners are eligible to contribute up to $58,000 ($64,500 for individuals age 50 and up) to their firm’s qualified plans. If your firm offers a cash balance plan, your eligible contribution could be well above $100,000. Usually every dollar contributed is tax deductible, so the after-tax cost could be as little as 50% of the total contribution.
But what is the right contribution amount for you? It is important to balance the tradeoffs from a financial planning and tax perspective. What can you afford in the short term? Are you able to save after-tax dollars into an investment account? The most successful balance of assets at retirement usually includes a mix of retirement assets and after-tax assets, which provides income tax flexibility in retirement.
How should you invest the money?
Smart investment planning isn’t just about returns. You need to consider your risk profile, time horizon, diversification strategy, fund management cost and tax consequences.
We recently met with a law firm partner who appeared to be doing a good job maximizing the benefits of his firm’s plan. However, in researching his investments, we learned that he owned some of the highest cost investment funds available in his plan. Moving out of these high cost mutual funds and into less expensive Exchange-Traded Funds (ETFs) saved him thousands of dollars annually.
What about estate planning and the interplay with your retirement plans and your estate planning documents?
Your retirement plans often represent a significant piece of what you provide to your loved ones in the event something happens to you. Retirement plan beneficiaries are far too often an afterthought in estate planning. Mistakes here can cause assets to be distributed to the wrong people and/or can create unnecessary taxes. One classic example is when you spend thousands of dollars to update your estate planning documents, but forget to update the beneficiary designations on your firm’s retirement plans. This mistake could undo all the benefits and time you spent updating your will, revocable trust, etc.
When can you take the money out?
We often help clients think through different tax planning scenarios so they can maximize what they keep, minimize their tax bills, and achieve their long term financial goals. The old rule of thumb was to wait until you are 72 to begin taking your required minimum distributions (RMDs). However, there could be plenty of opportunities to implement tax planning strategies well before you reach the age of 72.
There are no simple answers to these questions. But with proper guidance tailored to your personal situation, your team can help you can take advantage of the all the benefits of your firm’s retirement plans.