Alex Coppola for the Wall St Journal writes: For almost a decade, the client and his wife scaled back their retirement savings while they put their children through college. Now, in their early 50s, their youngest had finished school and they found themselves behind in their retirement savings. The client's first impulse was to increase his contributions to his 401(k). He was only contributing a little over $8,000 a year, which represented just 3% of his $250,000 salary and was less than half of the allowed annual contribution for an individual. But his adviser, Pat Burke, asked to take a look at the details of the company plan first.
"Conventional wisdom says that investors should always make the maximum contribution to their 401(k), but each plan works differently," says Mr. Burke, managing director at Mill Creek Capital Advisors in Conshohocken, Pa., which manages $3.2 billion for 250 clients. "You have to consider the fine print before you can develop a strategy."
In this case, that fine print revealed a flaw in the client's plan. If he increased his 401(k) contributions, he would actually lose the advantage of a very generous employer match--14% of salary up to the Social Security wage base, and 19.7% of salary above that wage base.
What the client hadn't considered was the $51,000 total limit on 401(k) contributions. If the man's combined contributions exceeded that amount, his employer would be forced to reduce its contributions dollar-for-dollar.
Instead, Mr. Burke suggested that the client contribute only enough to his 401(k) to maximize the employer match, and then focus on saving additional money in personal retirement accounts.
First, the adviser started by calculating how much the client could contribute before affecting his employer match. Based on his salary, the client's employer was contributing close to $43,000 annually to his 401(k), which meant that the client could contribute only $8,000 of his own money before exceeding the $51,000 total annual limit. So as it turned out, the client was already making the maximum contribution.
The $8,000 "seems almost trivial until you remember the plan rules and our goal," says Mr. Burke. "We wanted to be sure the client wasn't leaving any free money on the table."
Still, Mr. Burke had calculated that the couple needed an additional $13,000 in yearly savings to meet their retirement goals. Since the client's income level disqualified him for deductible contributions to a traditional IRA, Mr. Burke suggested using Roth IRAs to save that money.
"If we couldn't help the client save taxes on his contributions, we'd at least allow his money to grow tax-free going forward," Mr. Burke explains.
And while the client's income also disqualified him from making direct contributions to a Roth IRA, Mr. Burke explained that there were no limitations on account conversions. So he advised the client and his wife to contribute $6,500 each to traditional IRAs, which they would immediately convert to Roths. They couple will use the same strategy each year until their retirement.
The result: A portfolio of tax-free assets to supplement the retirement savings in his 401(k) that were largely funded by his employer.
"It's about making the most of the opportunities available," says Mr. Burke. "When the client and his wife make that final IRA conversion in a few years, they'll have what they need to meet their goals in the future."
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