Below is an article that FEG’s Joe Clark was recently quoted in for the USA Today, discussing retirement planning strategies.
The rich, it bears repeating, are different from you and me. They, for instance, get to learn about little-known, but highly effective ways to boost their savings for retirement from high-end financial advisers.
But that information isn’t necessarily a secret; it’s just hard to find. Or at least it was. We asked advisers who are familiar with these little-known tactics and strategies to share what average (and not-so average) Americans should consider when saving for or living in retirement. Here’s what they had to say.
Deposit and withdraw
Are you over age 59½ and able to contribute to a 401(k) or similar retirement plan where your employer matches your contribution, say 50 cents on the dollar up to 6%? Are you contributing enough to get the employer’s full match? If so, great.
If not, you might be missing out an “unexploited arbitrage opportunity,” according to a recent paper by James Choi, a Yale University professor.
Because employees over 59½ can often withdraw their 401(k) balances without restrictions or penalties, it makes sense to contribute enough to get the company match and then immediately withdraw some of that money if you need it, Choi wrote in his paper, “Contributions to Defined Contribution Pension Plans.” You’ll pay taxes on the withdrawal, but you’ve increased your after-tax current income courtesy of your company’s match.
But many older plan participants don’t take advantage this arbitrage opportunity, Choi wrote.
Consider: According to one study, some 36% of match-eligible employees over 59½ left arbitrage profits on the table, often because they fail to contribute anything at all to the 401(k), wrote Choi. And another study found that practically none of the customers in their experiment executed a similar “deposit-and-immediately-withdraw” strategy.
Of course, clients of advisers are aware of this strategy and are using it. “That one is on my checklist,” said Joseph Clark, a managing partner with the Financial Enhancement Group, which has offices in Anderson and Lafayette, Ind. “Most of my clients are astute enough to always take the match. The key is knowing the plan document to find out when you are eligible for in-service non-hardship distributions. It is usually at 60 but can be as early as 50.”
Use the 60-day rollover strategy
Most advisers typically don’t recommend using what’s called the 60-day IRA rollover strategy. Usually, when moving money from a 401(k) to an IRA or from one IRA to another you would use a direct trustee-to-trustee transfer.
But you can take the money out of your IRA and, in some cases, your 401(k). And if you put the money back into the account by the 60th day following the day on which you received the distribution you won’t have to pay a tax or penalty on the distribution.
When might you do this? When you need a short-term loan. “There are weird times when a person can transfer from the 401(k) to an IRA and then use the 60-day provision,” says Clark. “It is a workaround when the 401(k) plan doesn’t allow for loans.”
To make this tactic work, first read your plan’s “Summary Plan Descriptions” or SPD. That document should detail what’s allowed and not allowed in your plan. “People presume that if the Labor Department says it can be in a plan that it is, and that is far from the case,” says Clark. “The Labor Department provides the big picture, and the plan has to exist inside the lines.”
The rich and even not-so rich would benefit greatly from having many different types of retirement accounts in place, including a traditional IRA and Roth IRA, a traditional 401(k) and Roth 401(k) and taxable accounts.
But not everyone can open a Roth IRA. For instance, high-income taxpayers — those married filing jointly with modified adjusted gross income (MAGI) of $193,000 or more and individuals with MAGI of $131,000 or more — can’t contribute to a Roth IRA.
But they can contribute after-tax money into non-deductible IRA. “And then, with the stroke of a pen, they can convert the (non-deductible) IRA to a Roth IRA,” says Hal Rogers, a senior adviser with Gold Tree Financial in Jacksonville. “Since the original contribution was non-deductible and there have been no earnings yet, there is no tax on the conversion. They have ‘in effect’ contributed to their Roth IRA, all perfectly legal, no raised eyebrows at the IRS.”
Others like this strategy, too, especially if taxpayers might find themselves in a higher tax bracket in retirement. “I am really concerned that taxes will be going up in the future, so I am a big proponent of tax-efficient investment strategies,” says Phillis Sax Pilvinis, president of PSP Financial Services in Surprise, Ariz.
A version of the backdoor Roth IRA is the mega-backdoor Roth IRA. Instead of funding a non-deductible IRA, contribute after-tax money to your 401(k). Then transfer that money (the after-tax money) into a Roth IRA and any earnings on that money into a traditional IRA.
For this to work, three conditions must be met, according to Christian Koch, the founder and owner of KAM South in Atlanta. One, your plan must allow you to make after-tax contributions to the plan; two, you must have enough disposable income to make an after-tax contribution to your plan; and three, your plan must allow for periodic in-service distributions for your after-tax money and your earnings.
“All these pieces have to fall into place for this strategy to work,” says Koch, who added one note of a caution to this tactic. Some plans won’t let you make after-tax contributions or won’t let you take in-service distributions.
Fund a no-lapse last-to-die insurance policy
Another trick of the trade is for those who own an IRA and are required to take minimum distributions (RMD), but don’t need that income. Take the RMD and pay the taxes due as you would anyway. Then, take the after-tax amount and systematically fund a no-lapse last-to-die life insurance policy. You would do this even if you don’t need a traditional “widows and orphans” life insurance policy, says Rogers.
“Then, at second death of the two spouses, the life insurance will pay the (beneficiaries) the death benefit, tax-free, no probate, guaranteed,” he says.
Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Email Bob at firstname.lastname@example.org.
Disclaimer: This article was written by Robert Powell and FEG does not necessarily endorse or recommend what is written is suitable for all readers. Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.