Regardless of your age, maximizing the benefit of your 401(k) and other retirement accounts now can lead to a more rewarding retirement later in life.
Everyone knows that it’s best to start retirement planning early, though that advice is hard for most people to follow. It can be difficult to live in the present while considering future obstacles that may not materialize for years (or even decades).
Studies show that the struggles of retirement planning aren’t limited to just the middle class; even high net worth individuals face uncertainty when it comes to sustaining their wealth. According to the , more than 40% of investors are delaying their retirement due to financial uncertainty.
One essential component of a high net worth retirement is understanding which options are available and appropriate when it comes to tax-advantaged retirement accounts. High net worth individuals may have more complicated financial situations than the average investor, meaning traditional savings and investment vehicles alone may not be ideal for preserving and growing wealth. Regardless of financial status, many Americans are exploring less traditional investment strategies. Instead of just buying stocks and bonds as they would in years past, they’re turning their attention toward private equity, gold and other precious metals, real estate, bitcoin, and socially responsible impact investments.
Despite changing preferences and the rise of new asset classes, one retirement savings vehicle continues to remain rightfully popular: the 401(k) plan. Contributions to a 401(k) or 403(b) plan are tax deductible and grow in your portfolio over time. For high net worth individuals who are in the highest income tax bracket, the savings can be meaningful.
The preservation and growth of your wealth over time are closely linked to your success in minimizing your tax exposure.
Regardless of age, maximizing the benefit of your 401(k) and other retirement accounts now can lead to a more rewarding retirement later. Download our Retirement Planning Checklist for more help getting started.
Challenges and Misconceptions of Investment Strategies for High Net Worth Individuals
Most 401(k) plans aren’t designed to be one-size-fits-all. There are multiple types of 401(k) plans, and even the most standard version will be administered with its own set of rules and options, depending on the employer.
Every plan is different, and some have a limited investment lineup that can make it difficult to allocate funds optimally. Conventional investment strategies for high net worth individuals — amongst those who select investment options for 401(k) plans — suggest that “less is more.” 401(k) fund options usually include a mixture of five asset classes: money-market funds, core bond funds, large-cap funds, small-cap funds, and international funds. Due to liability and regulatory risks, many 401(k) plans offer only a few options that are limited primarily to target-date funds and passive index funds. This approach is intended to make investment selection easy for plan participants and reduce the legal liability for plan sponsors, but it has some drawbacks.
While the financial press might insist that index mutual funds and exchange-traded funds (ETFs) deserve the hype they receive, excessive interest in passive investment vehicles involves risks that are too often ignored. Low fees might be appealing, but the end goal of any investment should be long-term risk-adjusted returns. Most notably, with everyone involved with 401(k)s moving into the same pool of passive index funds, we’re seeing significant price distortion among certain assets. Picking the right 401(k) portfolio allocation requires thought and an understanding of price, value, and the portfolio holdings and investment strategy of each fund selection.
Moreover, the financial media’s focus on 401(k) plans leads many Americans to the short-sighted belief that a 401(k) is their only savings recourse. In reality, the IRS makes annual caps on 401(k) contributions. For example, 2023 personal contributions can’t exceed $22,500 for the year (or $30,000 if you’re over 50). The limit on combined employee-employer contribution is either 100% of the employee’s salary or $66,000 ($73,500 for workers 50 and over), whichever one occurs first.
That’s not to say that you shouldn’t save in a 401(k), of course. Employer matching contributions to your plan are effectively free money, so take them at every opportunity. Moreover, you should understand the significant tax advantages that a 401(k) can offer at every stage of life. While you’re working, your non-Roth 401(k) contributions below the allowed maximum aren’t taxed. Additionally, your 401(k) investment income (e.g., interest, dividends, and capital gains) isn’t taxed, which allows the account to grow for decades. And if you’re in a lower tax bracket when you begin to make withdrawals from the account, the distributions you receive from your 401(k) in retirement won’t be taxed as heavily as when you contributed to it.
By all means, maximize your 401(k) contributions. Furthermore, you should maximize your eligible contributions to your IRA, your Roth IRA, your SEP IRA, and any other qualified retirement vehicle that might apply to you. Just don’t assume you can rely on retirement accounts alone to keep you afloat during retirement. The reality is that everyone should be saving much more annually than what the IRS allows you to accumulate in qualified retirement accounts.
Everyone’s goals and challenges are unique, but in our experience, most high net worth individuals follow a similar path to wealth. In the next section, we’ll discuss how to maximize the benefit of your 401(k) at various stages of your life to ensure you’re ready to retire on your terms.
A Blueprint for Retirement Success
The importance of wealth management doesn’t change over time. No matter your age, developing and executing a financial plan for the future can greatly enhance your quality of life — during retirement and in the present. The peace of mind that a growing retirement savings account provides can be priceless. When you know that your retirement is secure, you can take advantage of opportunities to deploy resources in other fulfilling ways.
Individuals hoping for a financially stable retirement may traverse the life stages outlined below. Throughout each stage, they’ll face unique challenges and seemingly complex decisions. Equipping yourself with the right knowledge can help make the obstacles feel smaller and the decisions easier.
Investment Options for High Net Worth Individuals
Stage 1: Wealth Accumulation
At the beginning of your career, retirement is merely conceptual. Most professionals under the age of 34 are often burdened with student debt and other expenses, which entry-level salaries aren’t always enough to cover.
If you are starting your career, don’t make the mistake of neglecting your retirement. Beginning to save for retirement now can help you later in life: The earlier you start saving, the more your wealth should accumulate due to compound interest. It’s been said that Albert Einstein appreciated the power of compound interest, although you don’t need to have his IQ to understand and take advantage of this power.
Early in your career, you may be in a low tax bracket. This means it may make more sense to make contributions to a Roth 401(k) instead of a traditional 401(k), assuming you have that option. You’ll be contributing after-tax dollars, but those dollars will be taxed at a low rate. As a result, your Roth 401(k) investment will be tax-free throughout your entire life — including the distributions you receive in retirement.
Conduct a tax analysis to figure out whether it makes more sense to contribute to your company’s traditional 401(k) or Roth 401(k). Either way, we generally recommend that you seek to maximize your 401(k) contributions, annual IRA contributions, or any SEP IRA contributions you’ve collected from side gigs. If you aren’t in a financial position to maximize your contributions yet, we would recommend that you at least contribute enough to your 401(k) to receive any matching funds offered by your employer.
The key to high net worth retirement saving is to start small and build good habits. Commit to saving a specific amount from each paycheck, and try to increase your rate of savings over time as your income grows. You may have to follow a budget or defer certain discretionary expenses, but you’ll be thanking yourself down the road when your retirement savings starts to build. If you don’t know whether you are saving enough, you should create a financial plan where you can put together a model of your future savings, spending, and income.
Stage 2: Wealth Preservation and Growth
Middle age poses new and often formidable financial challenges. These could include periods of unemployment; expenses associated with marriage, parenting, and divorce; your children’s college; homeownership; healthcare costs; childcare or eldercare necessitating time out of the workplace; and other scenarios with potentially adverse financial repercussions. Don’t make the mistake of assuming the money you’ve saved for retirement will serve as a safety net should you fall on hard times in your 30s, 40s, or 50s without harming your long-term financial plan. Instead, improve your financial literacy before difficulties arise.
As you grow older, it becomes increasingly critical to develop non-tax-advantaged savings sources. While funding your retirement accounts should remain a savings priority, you should also explore savings and taxable brokerage accounts that allow you to accrue and invest funds that remain liquid and can be withdrawn at any time. Except in some very specific circumstances, the IRS imposes stiff penalties on 401(k) distributions taken before age 59 1/2. The early distribution penalty — and the fact that IRAs are taxed at ordinary income tax rates — makes retirement savings accounts a poor source of pre-retirement liquidity.
As you develop a larger portfolio of retirement accounts and taxable accounts, it makes sense to establish a tax minimization strategy for your retirement plan that also allows you to continue deferring taxes. Some investments, like taxable bond investments, should be more heavily weighted in retirement accounts so that the interest payments on those bonds are not taxed at ordinary income tax rates.
Stage 3: Retirement
By the time you reach age 72, your qualified retirement accounts, including your 401(k) and your IRA, will be subject to rules and regulations governing account withdrawals. These distributions from your retirement accounts might be an essential source of funds (along with Social Security) as you progress into retirement. If the money in these accounts isn’t enough to cover living expenses, you’ll have to rely on other sources — or you may need to keep working to generate income.
On the other hand, putting too much money into these accounts can force you to receive required minimum distributions, or RMDs, that are far more than you need. Those RMDs also include a hefty tax bill. If your RMDs are larger than you need, we would advise taking only the minimum required amount, paying the necessary taxes, and then depositing the proceeds into a taxable investment account where they can continue to grow. Charitably-minded investors might also consider making qualified charitable distributions (QCDs) from their 401(k)s to meet donation goals and satisfy RMD requirements in a highly tax-efficient manner.
Additionally, if you expect to have excess income in retirement once your RMDs kick in, you could consider a conversion of your qualified retirement accounts to Roth IRA accounts. Particularly if you retire before the age of 72 and find yourself in a lower tax bracket, you may want to convert pre-tax money into post-tax money strategically by converting your 401(k)s or IRAs to Roth 401(k)s and Roth IRAs.
Stage 4: Wealth Transfer
Managing taxes and planning for long-term illness or death are essential parts of financial planning. If you leave behind a 401(k) account when you die, your beneficiaries will be responsible for handling the account. The beneficiary of an inherited 401(k) may be faced with a taxable event upon inheriting a 401(k), and the options that a beneficiary has concerning the distribution of an inherited plan depend entirely on the plan itself. In almost all cases, rolling your 401(k) into an IRA as part of your estate planning process can provide your beneficiaries with more flexibility in how they take distributions from the account.
Furthermore, any distribution a beneficiary receives from an inherited 401(k) or inherited IRA is taxable in the year it is paid. Under the SECURE Act 2.0, which originally went into effect at the end of 2019 and was updated to version 2.0 in 2022, all retirement accounts must be liquidated within 10 years of the original owner’s death. Heirs of high net worth individuals with large inherited retirement accounts could face a significant tax liability in this event, which is why any beneficiary of a 401(k) or IRA should seek advice from a tax planner.
If you are a spousal beneficiary of a 401(k) or IRA account, you have options that other types of beneficiaries don’t have. In this case, you should consider rolling an inherited 401(k) into an IRA to maintain the tax advantages of the account. If the deceased account owner was older than 72 and had started taking the mandatory minimum distributions, a spouse can roll over the account into his or her own IRA and halt the mandatory distributions until he or she reaches 72.
State Tax Considerations
Because the Federal government establishes and maintains 401(k) regulations, U.S. investors are subject to the same rules, regardless of their state of residence. However, tax rules can differ from one state to another. For example, Illinois does not tax retirement plan distributions, which is a benefit for retirees with large retirement accounts. A good financial advisor will take into account all of the circumstances impacting your financial situation — including where you live and work — when helping you plan for the future.
If you think you could be doing more to optimize your 401(k) — or any other retirement plan — or if you have questions about planning for retirement, we’re here to help. Give us a call, or visit Pekin Hardy Strauss Wealth Management online to schedule a consultation today.
Want to make sure you are saving enough? Download our “Retirement Planning Checklist” to learn more.
This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy,” dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business. The information and data in this article do not constitute legal, tax, accounting, investment, or other professional advice. The views expressed are those of the author(s) as of the date of publication of this report, and they are subject to change at any time due to changes in market or economic conditions. Pekin Hardy cannot assure that the strategies discussed herein will outperform any other investment strategy in the future; there are no assurances that any predicted results will actually occur.