GRD Season 4 Episode 7-What’s the Best Retirement Plan for High Earners_mixdown
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[00:00:00] Hi, I'm Ed Slotttt. And I'm Jeff Levine. And we're two guys who just love to talk about retirement and taxes. Look, our mission is simple to educate you the saver, so that you can make better decisions because better decisions on the whole lead to better outcomes. And here's how we're going to do that. Each week, Jeff and I will debate the pros and the cons of a particular retirement strategy or topic with the goal of helping you keep more of your hard-earned money.

At the end of each debate, there's going to be one clear winner you. A more informed saver who can hopefully apply the merits of each side of the debate to your own personal situation. Decide what's best for you and your family. So here we go. Welcome to the Great Retirement Debate. What's the best retirement plan for high earners?

Hi everyone, and welcome to this episode of The Great Retirement Debate. I'm Ed Slott along with Jeff Levine, and that's exactly what we're going to talk about. That's one of the most common questions we get at our programs from [00:01:00] financial advisors. So Ed, when we're talking about retirement plans, what you're really saying is like, if I am a, a business owner, should I have a, a SEP IRA 401k, a pension plan?

Is that that effectively what we mean by that? Yeah. High earners is people in a top bracket because one of the things they always hear me talking about Roth and they say, well, should I convert or should I, you know, I'm already in a top bracket. Shouldn't I be concerned about tax deductions now because I'm in a tax.

A, a top bracket. Okay. So couple of different things to unpack there. I, I think it would be worth starting though, and saying that, you know, just 'cause you're a high earner doesn't mean you have a choice, right? Ultimately, you might be a high earning employee of a company, in which case. The best plan is the one that they give you, because that's your only option, right?

You don't have that choice. You don't have the luxury of picking the plan with the right provisions just for you or, you know, deciding. I, I don't want a 401k. I'd rather have a step. Well, that's [00:02:00] lovely, but if it's not you, if you're not the business owner or you're not a decision maker for that business, you may not have that option, and the plan that exists is probably better than no plan, right, ed?

Right, but, uh, for example, the Roth 401k, not everybody has one. And this is in, in the secure 2.0 law that, uh, there is a provision. Who knows if it'll go into effect that, uh, if you're a, uh, a high earner, you may be forced into a Roth 401k. Even if you want the deduction, you won't get it. You know, that's supposed to happen in 2026.

But we'll see. For catch-up contributions, right? For the catch-up contributions. Yep. So there, there's, there's a possibility that some people may have to if they're able to do that, but, but let's go and say that you do have a little bit more flexibility, right? Maybe you are a self-employed individual, or you are the primary owner or decision maker for an S corporation or the partnership or whatnot.

If, if you're a high earner in those situations, a high earning [00:03:00] business owner or again, high earning. Executive at a business where you have a, a, a good amount of influence over what that plan should look like, ed, then what becomes the best plan for that individual? Well, it depends who, how they're looking at it.

Let's say you have a group of, uh, doctors, so it's a typical plan where that's more of the kind of plan. Not a big company where you have more, you as the business owner have more input on what's going to be allowed in that plan. So you have a group of doctors, maybe they're making, uh, seven, 800,000 big, big numbers, and all they care about is taking tax deductions to reduce their current taxes.

So they use things like, for example, cash balance plans are coming back in vogue where they can put away, depending on their age, because, uh, the older you are, the better you can do with that. Uh, you could put away two, 300,000 or more a year and get these huge tax deductions, but I don't know if that's great for the long term.

It's great now to reduce current income, but the thought behind that is [00:04:00] maybe after I retire, there will be low years and maybe I'll use those low years to start converting that to a Roth IRA, so I end up in the better place anyway. Alright, so let's take a step back for a second and say you're a high earning business owner at a company and you're trying to figure out what plan is best for you.

We, you said it depends, so let's, let's think about some of the factors that may play in here, right? Like, what are, what are the different elements? So one would be how much money you want to put away, right? Like that would certainly impact you. For instance, you mentioned a a, a cash balance plan. Cash balance plan may allow you to put away more money, let's say, than a 401k plan.

But at the same point, it's a lot more complex. It's probably gonna cost more money to Oh yeah. To, to create and to do the record keeping for, and the testing and all the work that has to go into maintaining the plan. So there's, and so that's another factor, right? Cost. Cost is a factor. So we've got how much you could potentially put away.

In the plan each year for [00:05:00] retirement on a tax preference basis. There's the, the cost of that. What are some other things that a business owner may need to consider when figuring out what the best plan for them would be? Well, as I said, they have taxes today versus taxes in the future now, so potentially whether the plan could have a Roth option or not.

Right. Like Right. If we're thinking about a, a, a pension plan, for instance, there's no Roth pension plan, right? Right. Which, uh, which is kind of what I was talking about there that define, they call it a defined benefit aspect of it. Sure. Let's stick with, with a, a straight 401k versus a, uh, a Roth 401k. So the, the traditional thinking is if you'll be in a lower tax bracket in retirement, and this is the question I get from advisors in almost every program, ed, you always talk about the Roth, but I have a guy making a lot of money, like I said, seven, 800,000 maybe more, and they want a tax deduction.

Because once that big W2 goes away, uh, they'll, their income in retirement is going to be much lower. And [00:06:00] my answer to that is, uh, well, we don't know what future tax rates would be. I still think at some point they may be higher for higher income people, but that's a different issue, even if they stay the same.

I find just from my experience alone, people in top brackets, high earners. Are always in top brackets, high brackets, even when they're retired because as they pile up this money, say in their 401k, uh, you could have a situation where their RMDs in retirement, when they have no W2 anymore are just as high as, uh, what their current wages were.

Absolutely. Yeah, that, that's a huge factor too. And another one to add there would be, what is it going, when we think about cost, not just the cost of maintaining the plan, but what will you have to put away for your other employees? Oh yeah. That's another big factor, right? Like if. If you're, if it's just you and you're either a, a sole proprietor with no employees, or maybe you have an S corporation, you're the only employee of your company, or it's [00:07:00] just you and your spouse, then it's pretty easy because whatever you put away is for you.

But in many other circumstances, the amount of money that you are able to put away. Is going to be tied somehow to the amount of money that is that you put away for your employees. There are what are known as anti-discrimination rules and they basically are there so that somebody can't just say, I'm gonna create a retirement plan for me and forget my employees.

I don't really care about them. Right, right. You can actually do that. You mentioned the husband and wife, solo 401k. That's a perfect place to do something like that because there are no, there are no discrimination or testing rules. That's right. When you don't have any employees, it's really easy because you don't have to worry about it.

But the more you have employees, the more you have to think about this. And depending upon the type of plan you have, it might cost you certain a dollar amounts for your employee contributions in order to be able to put more money away for you. Now, if, if the purpose of creating your [00:08:00] plan is, boy, I am a, a business owner and I've got all these employees and I've gotta attract talent, I need, right?

Being the best people. Then it's not so much about the tax savings, it's about you need to do this as a business owner to create an environment where you can attract the right talent. But in many other instances, it's not that sort of situation. You might have a, a business owner who is primarily concerned about themselves and you know, think about someone who may own a restaurant, right?

Maybe. They are, you know, the, the, the primary purveyor of the restaurant. They've got a lot of, you know, they've got some wait staffs in there, they've got some cooks in there. But effectively, um, they feel at least as though those people are somewhat interchangeable, that if a waiter goes away or waitress goes away, they can hire another one if a a cook goes away. Again, I'm not saying that they're great cooks and amazing wait staff, but let's say this particular business owner feels that those individuals are somewhat interchangeable. They don't really care about creating a retirement plan to attract the best [00:09:00] waiter or waitress. They care about what they can put away for themselves.

But if they also have to put away money for those individuals. It might impact the choice of plan that they decide. So there are different types of plans. Different plans allow you to exclude different types of people to different degrees, but effectively, uh, for the most part, you should think about the fact that if you have a plan and you're putting a my money for yourself as an employer, you're likely going to have to do the same to, not necessarily the same degree, but you'll have to put away some money for your employees.

Right, because there's testing In the old days, years ago when we, uh, defined benefit plans in the eighties, came really big and had a lot of doctor clients. They used to tell me what's the best plan? And I said, well, the best plan is if you five were all age 60 and all your administrators were 15. That's right.

Well, legally, one of the reasons right, and one of the reasons for that right, is there's, there's different methods of testing. Again, when we, when Ed and [00:10:00] I say the word testing, what we're really referring to is. Does this pass muster of those so-called anti-discrimination rules that the IRS has? In other words, are you putting away enough for your employees that you're following in the context of the rules that give you the tax treatment that we're talking about and different plans?

There's different sorts of testing. Sometimes it's purely a matter of, Hey, uh, you have to put in 3% of this person's salary, or something like that. Some plans work along those lines. Other plans you may be able to say hey, depending upon this person's age and how much they make and how much they would be projected to get from Social Security, how much more, and the more complex your testing is, the more it often costs you to administer the plan, etc..

So there's all of these factors. You know, again, we just mentioned a few of them so far, which is. You know, what does it cost you to create and maintain? What is it gonna take in terms of your employee contributions? What, uh, sort [00:11:00] of Roth options do you need or not? How much money are you looking to put away?

And there's even other things beyond that, such as, you know, what sort of investment flexibility do you need or want in these accounts? Uh, what sort of. Uh, what sort of other provisions, such as access to the funds do you want at different ages and what would you like individuals to have? So every, everyone is gonna have a different set of facts and circumstances, but I think for the most part, Ed, if we're talking about high income individuals.

Who, um, who, who are simply looking to put away, let's say, the maximum amount that can be put into a defined contribution plan this year. So that's, uh, for 2025, it's about $70,000 for this year. Right, right. So, uh, you know, with, with, uh, with the added contributions, not just, that's right. With your employer contributions, what, what, what's the easiest plan that someone can get?

Well, let's again say high income. What, what's the simplest option for them? Well, uh, obviously, uh, you know, a [00:12:00] 401k or, you know, the, the o the profit sharing plan. We can go up to the 70,000, but I wanna say go back to what you said about costs. There's two kinds of costs. One is a cost, I don't think one is you talked about the cost to administer the plan and the cost of the employees.

The cost to the administer of the plan. That's an expense of running it. The cost to, uh. Maintaining good employees. I think that's more of an investment, uh, than a cost to attract good talent and keep it. So that's a, that's a different kind of cost. I wouldn't lump them in together. There's going to be a cost to administer the plan, and that's a pure expense, which you get a tax deduction for anyway.

And, uh. The additional amounts you, that's up to you how much you wanna put in for your employees. And maybe a small business doesn't have, actually a smaller business, probably has more people they want to keep because every person is, is, uh, more integral to the operation. If they only have five or six or seven people, [00:13:00] losing one of them could be a big deal.

So, uh, you know that I wouldn't consider a cost that might be a good investment. So the question is, how much do you wanna do for those people so you can do it for yourself? Yeah, that's, that's fair. Now, in the simplest of, of, of situations, I would say, where an individual only has to worry about themselves if they're a high income individual, uh, instead of a 401k or instead of a profit sharing plan.

I think for, for those individuals, the, the simplest plan is probably a, a SEP IRA. A SEP IRA, you can make a single contribution from the employer side. $70,000 goes in and, and you're done. And you don't have to worry. Now, a, a SEP IRA doesn't necessarily, but you have to, you do have to put in for your employees outta your pocket.

So. That's right. So if you have other employees, absolutely. Right. But if it's just you or you and your spouse or whatnot, yeah. That's probably the, the simplest of those options. Now, if you're someone who's looking to put away as much money for you as you can, [00:14:00] but you do have employees and you don't wanna put as much money away from them, that's where, as you mentioned, like a 401k may be a, a decent option.

You might be able to implement what is known as a safe harbor plan where you put away some. More nominal amount for your employees or offer to, if they contribute on their own. There are some different ways of doing it, and in exchange for that, you're able to put away your salary deferral for the year, which is still north of $20,000 without any sort of other issues whatsoever.

Yeah, that's true. Uh, you mentioned the simplest plan is the SEP, which I agree with. The most complicated plan is the one that's called simple. Yeah, we would agree on that. Yep. Yep. I was thinking about the same thing. Absolutely. You know, Jeff has, has to be the biggest misnomer in the tax code for sure. I know.

Yeah. That's another thing I would get rid of in that other show. You know, the whole complicated, you, you are familiar with this chart, which we've been producing for 20 years, our green chart. I remember that chart. Yes. Right. Alright. This is the green chart that covers all the planned [00:15:00] contribution limits this year for the first year.

I don't know if you noticed when you were at our meeting, it's a two page chart. You know why? Because of the simple catch-up contributions. Oh yeah. For catch up and the tiers and the number of employees. There's nothing simple about simple plans and I don't even know that many people that do them 'cause they can't figure them out.

Yeah, they're, I, I, I have to say I, you know, certainly not advice because everybody's situation is different. Yeah. But they are generally at the bottom of my list of things I turn to because they are anything but simple Congress has absolutely turned them into a monstrosity. And in general, because they're an IRA based plan, you don't typically have an administrator like you would with let's say a 401k.

So not only is it more complicated than everything else, but it's more complicated and it's up to you to figure out which, uh, you know, which is a really, really difficult thing. So yeah, look, at the end of the day, we're looking at a business owner who has [00:16:00] a lot of other things going on in their life, and they've got a balance.

Putting aside money today versus investing money in the business for the future. And, and even beyond that, you know, today as we sit here, ed, there's that QBI deduction, the qualified business income Oh, yes. Based on profits of a business. Right? Well, when you make a retirement account contribution from the business to, let's say, a SEP IRA for yourself or your employees, or to a profit sharing plan, or to a defined benefit plan, whenever your business.

Makes a contribution, it will lower your profits because your business just spent money on the retirement contributions that can lower your qualified business income tax deduction and effectively give you only a partial deduction now for your contribution. So there's, there's no single answer for everyone.

Everyone's situation is so different and, and that's why, as we always say, it's important to get specific advice from a professional, whether that be a. A CPA, [00:17:00] a plan administrator, a financial advisor in many cases, it's all three of those individuals working together collaboratively to figure out what is the best plan for this high income individual in front of me today?

Well, I think it comes down to how much of a tax deduction they want. A lot of people are enamored with the tax deduction when somebody tells them. Like I said before, you can put away and deduct 200, 300,000 off your income. They jump at that and maybe there's something to that, but to me, looking long term, so now you'll have 5 million in your 401k, eventually in your IRA in your RMDs.

We'll still keep you in the top bracket, which may be a higher bracket later on. So that's something to consider. When do you want the tax benefit now? And that's, that's a lot of fun having tax deductions up front. But, but, uh, you gotta look long term. It may not be best for everyone unless they can find, like I said before, some kind of valley where [00:18:00] income is low for a short time to.

Push some of that into our Roth at low rates. And like you said, you have to consider not only how much you wanna put away your disposable income, which you said before is really integral. Uh, for somebody who's in a business, I have, uh, a certain amount of disposable income to spend. Do I wanna build the business or dump it into a retirement account?

I think that's a big consideration. They may wanna expand, imagine. I would never tell a client, oh, don't expand. Put money in your 401k instead. I wouldn't say that. I think that's a big consideration. The employees is a big consideration. If they're important to attract and retain talent, that's a big consideration.

But I think the biggest item is the, the amount you have, the disposable income that you can put in. Assuming all these, I wouldn't call 'em costs, but they are money out in the form of. Putting money in a plan, paying for the plan, administration and the employees. Yeah. I, I think if we lump [00:19:00] these plans into, to groups and, and you know, uh, again, everything, every situation is different, but effectively for high earners, right there, there, there'd be different rules here for lower earners, but for high earners, there's sort of group number one, which sort of has a simple IRA in and of itself where the limit there, the maximum amount that could go in would be somewhat smaller.

Then you'd have your SEP IRA, your 401k, etc., where you'd have about $70,000 in 2025, maybe a little bit higher for those who are 50 or older by the end of the year. But effectively, that's like our, our tier two type of plans where it's more. But still a defined contribution based plan, so not into the hundreds of thousands.

Then you get into the pension plans, the money purchase plans, these defined benefit plans, right? Where those deductions can potentially be hundreds of thousands of dollars a year. But the other thing I would caution, you know, so those are kind of like our three tiers, if you will, right? The defined benefit.[00:20:00]

The main defined contributions, SEP IRAs 4 0 1 Ks, and then simple IRA, being at sort of the lowest tier. But it's also worth noting that depending upon what type of plan you implement, it also may lock you into certain decisions for the foreseeable future, right? So when we're talking about. A, uh, a SEP IRA.

You have the ability each and every year to determine how much, if you structure your plan that way, of how much you want to contribute. It can be very small amount, it could be nothing. It could be more in a good year. When you implement a pension plan, you are generally going to be required to continue that plan.

And even if you have a bad year, you are still in general going to have to make contributions for yourself or your employees. You don't get to just pick and choose. There are, there's a lot more rigidity there. So even understanding the nature of your business, is it. You know, are the incomes relatively stable from year to year or do you fluctuate?

These are all factors that high income individuals should consider when picking [00:21:00] the best plan for them. In addition, uh, we were talking about business owners, but what about a straight employee? Somebody works for a company, a big executive, uh, they're not a business owner, but they make a million dollars a year.

Still high. Well, I mean, yeah. I mean, oftentimes the best that they can do is make the most of their plan, right? Right. So if it's a pension plan, which very few private employers today offer, then great. Your employee or your employer is taking care of all of that for you. But if you have a 401k. Then, which is often the more common option, then it's really matter about, okay, am I going to max out my deferral?

Which I would say in most cases a high income individual should be doing. Should you be looking at the Roth option, if there's one, or the traditional IRA, making sure you get your match, but then also beyond that, it's what else should I be thinking about? If you've already maxed out your regular 401k, does your employer, if you're a high income individual.

Offer something like a SERP, a [00:22:00] supplemental executive retirement plan, or a non-qualified retirement plan. If they do, that may be something you wanna explore. Different rules, different set of strengths and weaknesses associated with those things, but that is another way. To potentially get even more tax deductions, or a better way to say it, is to lower your income.

You don't actually get a deduction 'cause they don't pay you it. But it's another way to keep your income lower today if that's no good. Are you able to make just your regular IRA contributions? You probably won't get a deduction for it, but you can use the backdoor Roth to get another couple of thousand of dollars each year for you, maybe your spouse into tax deferred accounts and beyond that.

If you are so fortunate to have even more income, then that's where you can look at things like low cost, uh, annuity wrappers to help defer your income for the long term to take advantage of tax deferral beyond what is offered in a tax preference retirement account. All sorts of [00:23:00] options available for folks.

Just a matter of figuring out what's best for you based on your situation. Right, right. Ultimately, Ed. For you, the best plan is always knowledge, right? Knowing the options. And you know, the other point you made with how, how far you have to continue these plans. A lot of businesses are in flux now. Things go up and down and economic and market conditions change.

Uh, it may not be a good idea at this time, but who knows of getting locked into anything long term. Absolutely, and, and you know, we've been talking about a plan like the thing, but ultimately there is the plan that you should have, which is what you should be doing for yourself, right? For your family, for your business, etc..

And there. Pretty much always the right plan is the one that you're going to stick with, right? The plan that you believe that you could stick with for the long period of time, because ultimately it's about the [00:24:00] long-term success that matters the most. And to that extent, ed, you know, that's the purpose of the Great Retirement Debate and the great retirement debate.

There's meant to be one winner of every debate, and that is you, the listener. Who is armed with more information and more education so that you can make a better and more informed decision for you and your family and those around you. So that's our hope for this episode as is is for all of them. Thanks for joining us for this episode of The Great Retirement Debate.

And Ed, thanks so much. We'll see you all real soon. Okay. Jeffrey Levine is Chief Planning Officer at Focus Partners. This podcast is for informational and educational purposes only, and should not be construed as specific investment accounting, legal or tax advice. Certain information mentioned may be based on third party information, which may become outdated or otherwise superseded without notice.

Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. The topic discussed and corresponding arguments are those of the speakers and may not accurately reflect those of focus partners.