Q. I’m 55 and my wife is 54; like a lot of 50-year-olds, we are playing catch-up with our retirement savings. Unlike a lot of my peers, I’m making more money now than I ever have and can see this continuing for the next 10 or so years. I started my own niche business and it’s going like gangbusters, putting us in a high tax bracket. Our adjusted gross income is now between $150,000 and $180,000. My wife helps me but is not officially on the payroll. For the first time in our lives, we hired a money manager and a CPA. The problem is that we are receiving conflicting advice from each of them concerning retirement savings.
Our money manager set up a solo 401(k) with a Roth 401(k) component, but he thinks we should invest all that we can in the pre-tax 401(k). This would include my personal contribution of $23,000 as an employee and my company matching contribution of around $10,000. Our CPA thinks we should make my employee contribution in the Roth 401(k) since my company match has to go into the pre-tax 401(k). The CPA says that this way when we retire, we will be able to keep ourselves in a low tax bracket by making taxable withdrawals from the pre-tax 401(k) and tax-free withdrawals from the Roth 401(k) to meet expenses. Our money manager argues that with our projected maximum savings in the 401(k), assuming a reasonable rate of return and a 10 percent withdrawal rate in retirement, we will still be in a much lower tax bracket in retirement than our current bracket.
They are both respected professionals, and we can understand both sides, but we are now conflicted as to which type of plan my personal contributions should be made. Is there a problem that our advisers are not on the same page? Any advice would be appreciated.
A. It would be nice if your advisers were in agreement. If you haven’t already, maybe you could encourage them to discuss the matter and explain why they feel the Roth 401(k) or traditional 401(k) is a better fit for your personal employee contributions. There may be some information about your personal situation that one of them is missing. I don’t see where either of them would benefit if you took the advice of one versus the other. You may want to meet with an objective financial adviser or tax professional and get a third opinion. Without knowing your total financial situation; I can only provide some general advice, but it may be helpful when discussing the matter with a third party or your current advisers.
If you don’t already have a lot of retirement savings and you are currently in a higher tax bracket than you expect to be in retirement, I’d tend to agree with your money manager. If you are able to achieve a 10 percent rate of return over the next 10 years and continue to make employee and employer contributions of $33,000 each year, your account value will be just over $525,000. A 10 percent withdrawal would generate a taxable income stream of $52,500. If you add to this amount a maximum Social Security benefit at full retirement age of $2,642 for you and 50 percent of that amount for your wife you will have an additional $47,556 of income of which 85 percent of $40,422 will be subject to tax. Projected total retirement income subject to tax is $92,923. Even before taking deductions and exemptions, this is less than your current taxable income.
Unless your CPA knows something about your situation or future changes to tax rates of which I’m unaware, making the employee contributions into the traditional pre-tax 401(k) makes more sense to me. If cash flow allows, you and your wife should contribute to Roth IRAs in addition to your 401(k) plan. The maximum each of you can contribute is $6,500 ($5,500 plus a $1,000 catch-up for those wage earners and spouses age 50 and over). Assuming a 10 percent rate of return $13,000 invested each year for 10 years, you will have $207,186 in your Roth IRAs.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624