HIGHER INCOME RETIREMENT PLANNING CHALLENGES

Posted on by Jerome.Pfeffer

Blogimage2Planning for retirement is an individual journey. The company-sponsored retirement plan (401(k), 403(b), 457, TSP, et al) offers an accessible way for you and your employees to save for the future. We can’t force your employees to save, but we can give them an opportunity.

In this blog article, we are specifically focusing on the retirement planning challenges of higher income employees.  Let’s look at a hypothetical company example and examine the challenges that higher income earners face when they are saving for retirement.

For our example, let’s say the company’s employees are scientists, doctors, and engineers. These white-collar professionals earn incomes above $120,000 per year. Now, that may sound like a great job and a sufficient level of income to save for retirement– yet, these employees do face some obstacles, and today’s article highlights some of the challenges that high-earning employees might encounter.

Three hurdles that high income earners face include:

  1. Saving Caps
  2. Replacement Ratio
  3. Taxes

The first hurdle is savings caps — the higher the income the more savings ceilings. If your company’s retirement plan does not have a Safe Harbor provision, you may max out your annual deferral well below the 2016 annual 402(g)(1) limit of $18,000.[1] If you have a Roth IRA and earn more than the AGI limit, your annual contribution amounts will phase-out as your income increases. Then, with the proposed bill to cap aggregate tax-deferred saving in 401(k) and Individual Retirement Accounts at about $3.4 million, the accounts become less tax-friendly as you earn more income.[2]

The next hurdle is an adequate income replacement ratio. We define income replacement as 80% of pre-retirement gross wages. With higher your incomes, the larger your nest egg needs to be which, presents a savings challenge. Let’s say you earn $250,000 per year and you retire. To replace 80% of your income[3] – including expected Social Security benefit payments of $2,640 per month – you would need to withdraw approximately $8,000 per month.[4] To have sufficient funds in retirement for 20 years, your nest egg needs to start out at approximately $2M.[5]

Whereas, according to an Aon study, Social Security replaces a larger portion of pre-retirement income at the lower wage levels of lower income earners. However, higher income earners are responsible for the larger margin of separation.
For your approximate Social Security benefit calculator, click here.
Lastly, the third area: taxes. We don’t want to belabor the point, so one quick question: do you think taxes are going up or down in the next 10 years?
If you are a high income earner, what can you do today to save and prepare for your retirement?
We recommend that you speak with your employer about the plan contribution limits and how you can take advantage of saving through your company’s retirement plan. Next, talk to a financial professional about calculating your retirement replacement index and see how you score for preparedness. As we said, retirement planning is a journey, and it’s helpful to check-in with a map every once in a while. Taxes are here to stay, so talk with your tax professional about strategies to efficiently save for a happy retirement.
Thank you for reading, and feel free to contact us with any questions or for more information.

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Securities and Advisory Services Offered Through LPL Financial A Registered Investment Adviser. Member FINRA / SIPC.

[1] IRS Announces 2015 Pension Plan Limitations; Taxpayers May Contribute up to $18,000 to their 401(k) plans in 2015.  IRS.  October 23, 2014. http://www.irs.gov/uac/Newsroom/IRS-Announces-2015-Pension-Plan-Limitations-1

[2] Schrager, Allison. “The Problem with Obama’s Plan to Limit Retirement Savings.” Bloomberg Business. Feb 2, 2015. http://www.bloomberg.com/news/articles/2015-02-02/the-problem-with-obama-s-plan-to-limit-retirement-savings

[3] Scholz, John Karl, and Ananth Seshadri. 2009. “What Replacement Rates Should Households Use?” MRRC Research Paper No. 2009-214. Ann Arbor, MI: University of Michigan Retirement Research Center. http://www.mrrc.isr.umich.edu/publications/papers/pdf/wp214.pdf

[4] Annual income of $250,000 minus taxes ADP Tax Calculator divided by 12 months ($13,416) minus Social Security benefit ($2,640) equals approximately $10,000.  Then with an 80% retirement income replacement that is approximately $8,000 per month.

[5] $8,000 per month times 12 months times 20 years is $1.92M

[6] The scenario above is for illustrative purposes only. Your individual situation will         vary.

 

 

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