You’ve Maxed Out Your 401(k) Contributions, Now What?: Choosing the Right Investment Vehicles
Saving and investing for the future can be a bit more complex for high-income sales professionals than for the average working professional. Sales professionals are tasked with aligning their savings goals with a potentially fluctuating cash flow and also working their non-cash compensation options into the mix.
Because of the income caps and maximum annual contribution thresholds imposed by most traditional retirement savings vehicles, these accounts are not enough for sales professionals to rely upon alone. Sales professionals must prioritize where they will save their excess income to build the most wealth in their allotted timeline.
How can sales professionals prioritize savings goals?
Taxes are often one of the largest financial burdens high-income earners face. So if you’ve been thinking to yourself, why wouldn’t I just open a brokerage account for my investment needs and call it a day? The answer is that taxes due on assets generated from the sale of your securities could take a huge chunk of income out of your pocket. The US government is not unaware of this concern and offers preferential tax treatment on a handful of retirement accounts that can be mixed and matched to help high-income earners amass the wealth they need for their future.
But with so many investment options to choose from, how can you prioritize one type of savings vehicle over another? Which accounts will allow for maximum growth and minimum liability?
The 3 Types of Tax Breaks on Retirement Accounts
Investment accounts can be classified by the types of tax savings they offer. Some accounts offer no tax breaks while some offer all three (with stipulations, of course). The idea is to combine the ones that work best for your mix of needs and align them to your overall financial plan.
1) Tax-Deductible: Tax-deductible accounts offer tax savings up front in the form of deductions, but are taxed upon withdrawal.
2) Tax-Deferred: Investment growth is allowed to grow tax-free year after year and is either taxed upon distribution from a traditional account or received tax-free from a Roth.
3) Tax-Free: Investments are taxed upon contribution rather than distribution, offering tax savings on the tail end.
Most every account, even brokerage accounts, offer the second tax-break—tax-deferred growth. Any gains accrued in the account that remain invested are not taxed until they are distributed as income. What separates the remaining accounts, then, are whether you will pay tax on the contributions—with what are known as “traditional” accounts--or pay tax on the distributions with what are known as “Roth” accounts. Even though high-income earners earn too much income to open a Roth-style account, they can perform rollovers multiple times over the course of their lifetime to create tax-free investment income.
There is one special account known as an HSA, or Health Savings Account, which offers all three tax-advantages. This account allows investors to make pre-tax contributions, enjoy tax-deferred growth, and use the money tax-free upon withdrawal when the funds are used to cover qualified medical expenses. This is a great option for many individuals, but these are only offered to those who have High-Deductible Health Plans (HDHP).
Keep in mind, the more perks an account offers, the more likely that account is to have strict regulatory stipulations in place about when, how, or in what fashion you are able to access your funds without penalty.
Of course, retirement accounts are not the only way for high-income earners to save and build wealth for the future. Life insurance policies with cash value, taxable brokerage accounts, and trusts can also be great vehicles for saving. Permanent cash value life insurance policies can be used as a tax-deferred vehicle by those who don’t necessarily need the death benefit for their heirs. Brokerage accounts can also be positioned as tax-deferred for long-term growth assets when held long enough to incur long-term capital gains tax rather than ordinary income tax. And for those who have a sizeable legacy to leave, dynasty or grantor trusts can be set up to provide tax-free income for future generations.
A Tax-Wise Approach
One approach sales professional can utilize is maxing out contributions to the most tax-advantaged vehicles first, then moving to the next most tax-advantaged accounts in the hierarchy until all excess funds are allocated. However, each individual will undoubtedly have a combination of different needs and resources available that should be taken into account when making a complete plan. Having the right advisors in place can help sales professionals from leaving too much potential growth on the table or too much tax in the hands of Uncle Sam.
At Meenes Wealth Partners, we specialize in helping high-income sales professionals build a portfolio that targets their own unique goals while also taking into account the risks that threaten their probability of success. If you are interested in learning more about our firm to see if we