Monthly Archives: February 2019

A Common Mistake High Income Earners Make in 401(K) Savings and How to Avoid it

February 11, 2019

I started working with a new client that completely missed out on maxing out his 401(k) contributions for the 2018 year when he thought he was set up to max it—all due to the 401(a)(17) limitations. He contributed $11,000 instead of the $24,500 maximum he could put in pre-tax in 2018, which cost him a significant amount in tax savings.

Who Misses Maxing Out Their 401(k)?

This particular client was a high income earning corporate executive from Chevron aiming to max out his contribution to the Chevron Employee Savings Investment Plan. He had a long career at Chevron and was grossing over $600,000 annually between base pay and bonus. (I see this same issue with many corporate professionals I work with, including those from Shell, BP, Marathon, BMC and others.)

 

He knew that for the 2018 year the max amount he could put into the 401(k) is $24,500, as he was over age 50. At the beginning of the year, he took that number and divided it by his expected benefit eligible compensation (at Chevron this is cash compensation not including stock); $24,500 / $600,000 = 4%. His assumption was that if he set his pre-tax contribution to his 401(k) to 4%, then he would max out by year-end.

 

It wasn’t until we sat down with him in January of 2019 and showed him his 2018 401(k) statement, that he realized he missed out on additional tax savings he could have had.

 

(For the 2019 year, the maximum pre-tax contribution for someone over age 50 is $25,000.)

What Happened?

There is a fairly unknown rule regarding 401(a)(17) contribution limits that prevented the Chevron saver from fully maxing out his pre-tax contribution to his 401(k). The 401(a)(17) rules set a maximum on compensation that can be used to contribute to a 401(k) and many other types of retirement plans. Specifically, the 401(a)(17) rules only allow the Chevron saver to use the first $275,000 of income to save into a qualified retirement plan. Once the saver started making over $275,000 a year ($280,000 in 2019), he can no longer make contributions to his company’s 401(k) plan.

 

Since this saver set his contribution to 4%, he was only able to put in $11,000 (= $275,000 * 4%) into the plan—missing out on $13,500 of pre-tax contributions he could have made into the plan!

 

(There are exceptions to the 401(a)(17) earnings limit rules whereby a company can allow their employees to consider income past the $275,000 when making contributions to retirement plans, but few allow it, as it regularly messes up anti-discrimination testing, which causes bigger problems.)

How to Ensure You Max Your Contributions

The saver at Chevron could have easily ensured he maxed out his contribution to the 401(k) by slightly adjusting his formula. He should take the max contributions of $24,500 for 2018 and divide it by the income earnings limit of $275,000 for 2018.

 

For 2018 contributions for those over 50, $24,500 / $275,000 = 9%

For 2018 contributions for those under 50, $18,500 / $275,000 = 7%

 

For 2019 contributions for those over 50, $25,000 / $280,000 = 9%

For 2019 contributions for those under 50, $19,000 / $280,000 = 7%

 

Note that both the max contribution and the earnings limit are inflation adjusted annually. Both limits utilize the same cost of living adjustment, so in most cases, the percentage deferral stays the same from year to year.

 

Generally speaking, if you are a high earner and subject to the 401(k) earned income limits, you will not be able to contribute to your 401(k) proportionally throughout the entire year. Often, we see high earners make contributions to their 401(k) over the first half to three quarters of the year. Once they have hit the earnings limit, their net paycheck goes up as they can no longer make contributions to their company 401(k). It’s important to realize that if you are a high earner you will have lumpy take-home pay, with lower earnings at the start of the year than the end.

After-Tax and Roth Contributions are also Affected

Do also note that all employee deferrals are affected by the earnings limits. This includes Roth 401(k) contributions and Non-Roth After-Tax 401(k) contributions.

 

If you are aiming to max out pre-tax and after-tax contributions to the 401(k), it’s important to also ensure are you maxing out contributions to the after-tax source prior to hitting the earnings limit. When doing the math, remember to take the max that you can contribute to the after-tax source and divide by the earnings limits.

 

For example at Chevron, in 2018 the after-tax limit for most employees is $15,500. To ensure you are able to max out your contribution to the after-tax source in your 401(k), you have to defer 6% (= $15,500 / $275,000) in addition to the pre-tax contribution.

Your Employer Contribution is Also Capped

 

The 401(a)(17) limits apply not only to employee contributions but also to employer contributions. Once you earn over the benefit eligible contribution limit ($280,000 for the 2019 year), your employer is no longer able to put money into your 401(k). Many employers will set up non-qualified retirement plans so they can continue making contributions even if they cannot direct them to the 401(k). 

 

At Chevron, the company continues to contribute the 8% but allocates the 8% for every dollar of income earned over and above the $280,000 limit to the Retirement Restoration Plan (RRP). At Shell Oil, they contribute the 10% over the limit to the Provident Fund Benefit Restoration Plan (PF BRP).

 

hese non-qualified retirement plans have additional limitations and restrictions making them a nice benefit, but less attractive than traditional 401(k)’s. If you have a non-qualified plan there are many considerations you should asses leading up to and before electing a retirement date to maximize benefit and minimize taxes.

How We Help

As part of our comprehensive asset management and planning process, we would sit down with you annually and review your compensation and benefit plans, educating you on your options and assisting you in making the changes necessary to optimize your specific situation. We get to know you and formulate a plan to assist with your savings goals taking into account taxes, investments, and your employer’s compensation and benefit options. Things are always changing and we understand that as time goes on, your personal finances get more complex. We believe that if you are not looking at the full picture, then you are likely leaving money on the table. That is why our promise to clients is that we are continuously planning on your behalf. If you would like to meet with one of our advisors or are interested in receiving more information regarding our services, please contact us at (713) 439-1200 or click here to submit a request.

 

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Performance from individual returns may vary substantially from those presented due to differences in the timing of contributions and withdrawals, account start dates, and market results. Past performance may not be indicative of future results.  Therefore, no current or prospective client should assume future performance.

2019 Update – Chevron Phillips Employees Can Save MORE in the 401(k) Savings and Profit Sharing Plan This Year

January 16, 2019

The IRS has recently released the 2019 retirement plan contribution limits.

 

For super-savers at Chevron Phillips, things are looking up. Here are a few of the most noteworthy changes:

 

–> Chevron Phillips employees can now contribute $19,000 (or $25,000 for those over 50 years old) of pre-tax or Roth savings to the Chevron Phillips Savings and Profit Sharing Plan.

 

How Chevron Phillips Employees Can Maximize Their Retirement Plan Contributions

It’s important to ensure that you are contributing at least 6% of your pay every pay period to receive the full 4.5% company match. At Chevron Phillips, it is easy to miss the opportunity to receive the company contributions, so make sure you do the math every year!

 

2019 Annual Compensation Limits and Strategic Saving for Chevron Phillips Employees

The annual compensation limit for 2019 has increased from $275,000 to $280,000. If you make more than $280,000 in base and bonus compensation for 2019, remember to ensure you max out your Chevron Phillips 401(k) contributions prior to earning $280,000 of income. After you earn $280,000 of income, you can no longer contribute to the 401(k).

 

Many Chevron Phillips employees will be able to take advantage of higher contribution limits for backdoor Roths. With the IRA contribution limits now $6,000 (and $7,000 if over age 50), it means super-savers at Chevron Phillips can put away up to $37,600 (or $44,600 if over age 50) between the Chevron Phillips 401(k) and backdoor Roths into tax-preferred retirement accounts. It’s important to keep in mind that these are the maximum numbers and are subject to the income limits outlined in the Chevron Phillips Savings and Profit Sharing Plan.

 

The 2019 limit adjustments will be advantageous for super-savers at Chevron Phillips and it is important to be sure that you make the most of these changes. Willis Johnson & Associates will be working with our clients over the next few months to assist in adjusting contributions to ensure they get the full 4.5% company per paycheck match.

 

In 2019, we will follow up with clients who are eligible to take advantage of backdoor Roth IRAs to ensure they are on track for success. We will help facilitate after-tax rollouts from the 401(k) in the second half of the year once contributions have been maxed.

 

If you have any questions about the 2019 contribution and compensation limits, please contact your advisor, or schedule a free consultation with one of our Chevron Phillips specialists.

 


Jason Mishaw, Associate Wealth Managers,Jason Mishaw, MSF

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As an associate wealth manager at Willis Johnson & Associates, Jason Mishaw is actively involved in both the Financial Planning role and the Investment Management role. On the financial planning side, he helps to implement customized financial plans for WJA clients. On the Investment Management side, under the supervision of a Senior Wealth Manager, he assesses the financial goals of WJA clients and assists in creating a customized strategy to further those goals.

 

Jason received a Master of Science in Finance at the University of Houston C.T. Bauer College of Business, a B.A. in economics and a B.S. in biochemistry and cell biology from Rice University.

 


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