As an AbbVie executive, you have worked hard to earn your place in the business world. Along with financial success comes the responsibility of planning for retirement. One of the best ways to save for retirement is through a 401(k) plan. However, for executives with pre-tax, Roth, and after-tax funding options, deciding the best course of action can be tricky. In this guide, we will explore the different options and help you make informed decisions about your retirement investments.
Understanding the Difference Between Pre-tax, Roth, and After-tax Contributions
Pre-tax contributions are tax-deferred; you pay taxes on the money when you withdraw it in retirement. This can be beneficial if you anticipate being in a lower tax bracket in retirement.
Roth contributions are made with after-tax dollars, but withdrawals in retirement are tax-free. This route can be preferable if you expect to be in the same or a higher tax bracket when you retire.
After-tax contributions are taxed in the year in which they are made, but the earnings on those contributions grow tax deferred. It’s important to keep in mind that after-tax contributions are usually subject to a contribution limit separate from the overall limit on 401(k) contributions.
But should all your money to one of these allotments, split between the three, or alternating based on your circumstances?
The key: PLAN WITH THE END IN MIND.
If you’re reached an executive status (think grade level 20 and above), your total income is multiple six figures. If you have a spouse who works outside the home, or even if you’re single and filing as a single filer, you’re likely finding yourself in the 24%+ tax brackets.
The part to map out is whether you think you’ll be in a tax bracket that is higher than 24%. This can be a guessing game because no-one knows what tax brackets will be in the future. But if you’re participating in the pension plan, you’ll likely start using the DCP (Deferred Compensation Plan) at some point, and your spouse has other retirement savings, you’re income might be similar in retirement. In this case, then it is helpful to get a tax break now by deferring the taxes until later. This way, you now what amount of taxes you’ll be saving versus guessing what they will be in the future.
But hold on… What if you end up in retirement with all tax-deferred sources of income? You have no flexibility should tax rates be substantially higher. What if you want some of your income to be tax-free as well as tax-deferred?
Then I would do a 50/50 split of Traditional and Roth contributions. This split in contributions now will provide flexibility of income streams later in the future. You do need to be aware that you will be foregoing any current tax deduction benefits from money that goes into your Roth account today.
I’ve been funding my 401(k) for a while with tax-deferred contributions, have been able to fund Roth IRAs through back-door contributions, and I still have money left over. What should I do?
This is a common question I address with clients. It’s common given your income situation as you usually have a large excess each month.
Setting aside the DCP, there are two things you can do with your money:
- Taxable Saving / Investing
- After-Tax 401(k) contributions
Taxable investing is taking the money from your checking account each month and buying investments, like those in your 401(k). There are no tax benefits from doing this, but you’ll. Be investing to support your future goals.
By taking this money that would have been going to your checking account, and instead making an after-tax contribution to your 401(k), you’re saving money that you’ve already paid taxes on, it’s growing tax deferred and will then be available at retirement. There are various pros and cons to this, but the large con that doesn’t make me like this approach is the money is tied up until age 59.5. The large pro is that the after-tax contribution can be rolled to a Roth IRA when you retire making it a good way to make Roth IRA-like savings while being ineligible to save to a Roth IRA due to your income.
Where to save depends on your long-term goals, current and projected tax situation, and how you want to use your money in the future. It’s different for everyone!
Seeking Professional Advice
Finally, it’s important to seek the help of a financial advisor who can help you make informed decisions about your 401(k) investments, especially if they are focused on working with AbbVie executives, like myself. Simple mistakes that can be made throughout your career (tax-deferred versus Roth, unwise investment choices, etc.) can lead up to thousands of missed dollars in your account, and therefore your retirement security.
Navigating the world of 401(k) investments can be challenging, but with the right advice and planning, you can build a strong retirement plan as an AbbVie executive. By understanding the different funding options and diversifying your investments, you can be well on your way to a comfortable retirement. Don’t forget to maximize your contributions and plan for required minimum distributions. And lastly, seek the advice of a financial advisor to ensure that your retirement plan is optimized for your specific needs and goals.