Retirement Strategies for High Income Earners: The 3 Bucket Strategy

In this episode of the Retire Early Retire Now podcast, host Hunter Kelly from Palm Valley Wealth Management discusses retirement strategies tailored for high-income earners. The discussion focuses on the 'three buckets' strategy, which involves utilizing taxable, Roth, and pre-tax accounts to effectively manage taxes and savings. Key points include understanding the challenges unique to high-income earners, benchmarks for savings, the importance of diversifying investments, and various tax-advantaged accounts such as HSAs and non-qualified deferred compensation plans. The episode also highlights common pitfalls to avoid, the importance of regular plan reviews, and ends with advice on charitable giving strategies. Listeners are encouraged to seek professional help if needed and to stay educated on best practices for financial planning.

Check out the Palm Valley Wealth Management Website
PalmValleywm.com

Check us out on
Instagram
LinkedIn
Facebook
Listen to the Podcast Here!
Apple
Spotify

Transcript

0:00

And welcome to the retire early retire now podcast. I'm your host hunter Kelly owner of Palm valley wealth management. And today we're going to talk about a retirement strategies for high income earners using the three buckets Chaterjee. And so a high income earners have a unique retirement planning challenge. as far as taxes and how to best go about, deferring those or paying them up front. What should we do? How should we invest? and so we're going to talk about all those things to today. With a structure of what a three bucket strategy is. And so hopefully at the end of this episode today, you'll have a better understanding on. Maybe where you should be putting your money, some questions to ask. and if you should hire somebody to help answer those questions, or can you continue doing that on your own? the first thing we want to do is we want to understand the landscape for higher earners. One, what is a high earner, and two. what is, some different needs at these types of income earners have, from, other people, right. The first thing, a high-income earner. What I consider a high-income earner is kinda, anything north of that threshold where you start. to hit the Roth income limits where you can't just put it into a Roth, you can't just max it out. Can't make contributions. You have to do special things for that Roth to get that money in which we'll talk about here in a little bit. that's when we start. scene. special. strategies. That are all within the scope of IRS guidelines and things of that nature, but things you have to consider so that we can. mitigate those taxes because taxes will be the biggest expense over your lifetime. We talk about, keeping your debt low. not spending more than you earn things of that nature, but really where you can make a ginormous impact on, your wealth over time is avoiding taxes where you can obviously legal. We don't want to evade taxes. That's illegal. but we want to avoid them as we, as we should, through the IRS tax code and things of that nature. the other challenge is that social security will replace only a very small portion of your income need. So some people, if you want to put your tinfoil hat on. Some people don't even think we'll have social security or we'll be pushed back at such an age that you really not going to realize the benefit of it. for me, And for some of my younger clients, yes, we do project for their social security, but if you project out those 20, 30 years, that's going to be such a small portion. The income that you actually need. That you may not even want to plan for it and just be extra right. or if you're much closer to retirement must say, or to full retirement age for social security, let's say 10 years out, 15 years out. obviously you'll want to plan for it, but again, it still may be a very small portion of what, the actual income need that, that you have. We want to see. Okay. what do we need to save? And then how can we, play unfortunately security as well? The other challenge that we'll talk about today is that, your savings rate may be higher than what you can actually put into retirement accounts. Let's say you max out a Roth IRA, you maxed out your 401k, your spouse does the same thing, and maybe your income is such that, the savings rate that you need to meet your goals. You're not able to meet it through those retirement accounts or do you go after that? Right. And we'll talk about that today as well. First thing I want to jump into is, well, what are some benchmarks that we want to look out for? And so I've talked about this in previous podcasts before. But we want to make sure that we're hitting some baselines and some benchmarks. before anything else, and then we can start getting into the nitty-gritty of the strategy, these more complex strategies, tax, saving strategies, things of that nature. And so the first thing is. Let's at least get the baseline of getting our match at our employer. and then getting maybe to 10% of our income saving and various accounts. whether that'd be your 401k for three, B four 50 sevens IRAs, things of that nature. We should at least be getting somewhere around 10 to 15% of our income going to some sort of long-term savings. Now, if you're a person that wants to retire early, or you have some more large purchase goals. before retirement age, maybe not all of that needs to go into a retirement based account, but we want to make sure that we're saving somewhere between that 10, 15%. and you'll be well ahead of most of your peers. and you'll be on a good path to saving a substantial amount of money. Whether you're a high income earner or not. Right. So those are some very basic, baseline things that we want to get first, if you're not there yet. I always say, take baby steps. Right? Gets your match first. Like get that free money. Uh, no one can really guarantee a hundred percent return on your money other than your employer. based off their match. So go ahead and get that. And then incrementally increase that. As maybe your income increases or you start cutting expenses, like paying off debt, things of that nature. this can be. Very helpful to helping you grow your net worth over time. And then if you're really killing it, if you want to exceed that baseline, save 20% of your income. Right. one of the studies that I've talked about in previous podcasts is a fidelity study that they come out with and say, okay, if you want to retire by 67, what's a good guideline or baseline of things that you should, how much you have. How much you should aim to have saved at certain ages. They say by 30 years old, you should at least have one times your salary. So again, you're making a hundred thousand dollars. You would want, do you have a hundred thousand dollars saved up in various accounts? Right? By the time you're 40. You want three times that by the time you're 50. You want six times that by the time you're 60 you on eight times, that by the time you're 67, you would want 10 times your salary. Right. And so a couple of things to consider there. One. Interests. This is going to start compounding over time. so while the first. like when you get to 30, that first one time, your salary may take much longer than you getting to three times your salary. because now you have that money working for years invested. and so hopefully you're gaining enough interest and growth off of those investments that, you don't have to contribute. basically 200% of your salary to that to get to that number. Those are some good guidelines on, Hey. Am I saving well, my doing well compared to my peers. and then am I. On tractors to hire by, let's say 8 67. But as the title of my podcast says, we want to retire early. And so we need to run calculations to say, okay, well, if I want to retire at 60 or 55 or 50, what do I need by that time? To retire. And so one, you may need a little bit higher rate of return to, you may need a high. A little bit higher savings rate than let's say the 10% baseline that I mentioned previously. And so once we've determined how much we need to save what our rate of return. Needs to be. Well, now we can start getting into the nitty-gritty of, well, how do I best maximize that money that I'm saving from a tax standpoint? Right. And so this is where you want to start taking advantage of your 401k is for three BS, 4 57. Things of that nature. And if your income allows it, we want to start maxing these things out. So if your savings rate. from a dollar standpoint, needs to be, let's say a hundred thousand dollars a year. well, you're going to hit that max pretty easily. Right. So we would want to make sure that they were doing that because one, that'll start growing tax deferred. So you're not going to pay taxes on it. Theoretically until you take it out, depending on how you voted in. and then two. You're going to be getting that match as well. we want to take advantage of those employer plans. and then consider. Whether we want to do Roth or traditional. So as my income. tax bracket going to be higher now or will it be higher later? And then based off. Kind of some. Estimated guesses. that'll allow us to determine we'll shut up at Roth. Or pre-tax money into these accounts. The next thing you'll want to do. is consider a backdoor off. So what does a backdoor Roth. A backdoor Roth IRA contribution is just a fancy way for someone making over that income threshold for. Roth IRAs to be able to put into a Roth IRA. And so, um, there's a lot of nuance to this. I have some other podcasts that goes more in detail, but essentially is if you don't have any money in IRAs, anywhere then you can put a non-deductible contribution into an IRA. You can convert it directly to a Roth IRA. You will not pay taxes because it's a non-deductible contribution because you've already paid taxes on that income. That you use to contribute to the IRA and then once you convert it, Well, now I can grow that money inside the Roth IRA. It'll grow tax deferred and be tax-free later on down the road for retirement. The other side of that. And again, I want to preface or say again, There's a lot of nuance to that. Make sure you do that correctly. If you have IRA money, then you're going to be subject to what's called the pro-rata rule. And this includes SEP IRAs, simple IRAs, things of that nature of it is titled as IRA. And you have money in it. You need to be careful about what you're doing. So Sikhi tax professional or a financial advisor. If you have any hesitation about what you're doing. do your research. before we start doing these backdoor ROS. And then there is a one other version of this and it's called a mega backdoor Roth. Sometimes your employer will let you put in those non-deductible, After tax dollars. to your employer plan. So you could theoretically have tens of thousands of dollars and then convert that. Uh, to a Roth IRA or Roth 401k. and then kind of the same principles you would have all that money in their author. IRA. Growing tax deferred tax free later on down the road. The next tax advantage account you should consider is using an HSA. HSA is a triple tax advantage account. So what does the HSA is a health savings account? And if you have a high deductible health plan, You can contribute.$8,300 for a family in a given year. That should go up each year with inflation. And then a little bit less. If you're a single individual. And so from there we want to contribute to that. if you can max that out and especially if you're trying to eliminate taxes and if you can do that, and if you're a person that doesn't have. A lot of, health needs like prescriptions and surgeries and doctor visits and things of that nature that would drive up the cost of your medical expenses in general. Then you can start to contribute to this. And most custodians of these HSEs will let you invest this money. And so one of two things will happen. One, if you can do this over and over and over for a handful of years. Who are longer than you're going to have a large sum of money that theoretically you'll be self-insured outside of your premiums. Um, theoretically for the rest of your life. Right. And so, um, if you've been saving and you have$40,000 in there and your out of pocket max each years, maybe 10 to 15,000, well, you have several years. Of potentially. Not having necessarily come out of pocket. because you already kind of save for that. And then let's say you don't need that money for an extended period of time and you invest that. And you get to age 65, you know, you won't need that money. There's just so much in there that you're never going to use it for health expenses because you've saved well, and that account invested well, you can start taking that out for, um, retirement. Now you'll pay income taxes on that, but it would have grown taxed of her. You would have put an in tax freeze or you would have saved taxes up front. so. Great opportunity. One to save and plan for health costs, but to potentially have an added retirement account later on down the road. The next thing that, is not quite talked about as often as not always offered. Through your employer, but that would be a non-qualified deferred compensation plan. these are cool plans because you can defer more money. You'll pay taxes upfront, but that money will grow tax deferred over time. And you'll own a little bit taxes on the growth. as you take it out, but it is going to save you from the time that you put in until the time that you take out any capital gains taxes. interests, things of that nature. You can trade however you want, because you're not going to be taxes on any given year. so that does help over time. With those accounts, but. They're not as common. but if you do, or you, if you are. Offered those accounts, it would be something to look into. because generally you can put a substantial amount of money into those accounts as well. Now. We want to start to diversify, especially if our income is such that our savings rate is going to exceed. The limits of these retirement accounts that I just mentioned, we want to start diversifying outside of that. And one of the most underrated things that I see. Especially in the 30 to 40 year old. A high-income earners. So they're not utilizing brokerage accounts enough. And so this is a good way to supplement. To get to the savings rate that you need, but also prepare for larger expenses or larger. financial goals down the road that may not necessarily be, retirement related. Right. And so opening up a brokerage account. contributing to that. Purchasing, mutual funds, stocks, bonds, whatever. Fits your needs. Now you can start to grow that money versus sitting in a savings account. Not earning much interest at all. Now interest rates have gone up over the last couple of years. So you certainly have a little bit more bang for your buck there, but if you're in the market and if your risk tolerance called for. more equity. Heavy type portfolio, you would have exceeded that, call it three to 5% that a high-yield savings account would have given you. Right. we want to maximize those dollars and start to realize. The potential of what the compounding interests can give us. And one way to do that is to take that extra money that we have each month, because we need to save it based off our savings rate needs or goals. that we have and start to invest that so that we can. grow it and maximize that. Toward our goals. the role of the brokerage account would be to one build retirement wealth. But also provide flexibility. You build this thing to a few hundred thousand dollars, and let's say you're working for an employer that you're not very happy with anymore, or maybe you want to start a business. And you have several years. Worth of cash in there, or investments in there where you can leave your job. Take a couple of ones off and search for something. that you would enjoy more or start a business and get that up and running. It gives you a ton of flexibility because you're not tied to the 59 and a half rules as you would be in your IRAs and your 401ks, things of that nature. Your, you have the flexibility to, to sell out of your positions. Yeah. Maybe you'll pay a little bit capital gains. or something of that nature. but you can sell out of those positions, assuming that you're in. a daily trade at fun, like ETF stocks. Mutual funds, things of that nature. and be able to use those funds to bridge gaps. between employment. Maybe take a year off just cause maybe you're burnt out. whatever that is. It gives you the ultimate flexibility. And then there are some tax efficient ways to mitigate those taxes. Like I said, you would pay some. Some long-term capital gains, generally a better rate than your income rate. so you can do things like tax loss, harvesting. to help mitigate taxes over time. but the biggest kicker to this account. This brokerage account would be the flexibility that we'll give to you. Now it's not a magic pill. You're not going to get the flexibility overnight. Or the first year or the first couple of years, you're going to have to contribute to this account, like any other account for a handful of years, multiple years, to start to see the interest in the growth in these accounts. A build up. Over time. So once you've determined your savings rate. You've said, Hey, I need to be putting into my 401k, my IRA, my taxable account. This is how much I'm going to put in each. This is how I'm investing in each. Then comes once you get to retirement. How do we start with drawling from, these retirement accounts? Right. And so if you're still, Let's say 10 years out, 15 years out, 20 years out. Yes. The conversation of withdrawal strategies may not pique your interest, or you're like, Hey hunter, that's so far away. But it is good to think about this. Occasionally, maybe once a year. Once every other year. Every five years, something like that. to make sure that you're funding the right accounts to set yourself up for tax. Flexibility. And what I mean by that is utilizing that three buckets strategy that I mentioned in the title. I've talked about and a couple other podcasts episodes. And so we want to make sure that we have our taxable accounts filled up, where we can use that when we need to. We want to make sure that we have a good rock bucket. When we, retire and we want to make sure that we have a good deferred. tax bucket, right. Or a pre-tax bucket, a traditional bucket. And the reason why is that's going to give us flexibility. You may be asking yourself, hunter, why don't we just put it in raw the whole time? We'll pay a little bit of taxes up front and then we'll have no taxes ever again. Right. Well, maybe. Your tax situation was such that your tax bracket was so high early on. Or, 10 years previously, because you were making so much money. That it actually made more sense for you to defer. Those taxes till later, right? And so this is where that taxable account comes in. So ideally. What would happen, especially if you're going to retire early. You have that taxable account. To bridge the gap between let's say 55, 60 or 50 and 60. And then you would have your pre-tax where you can start looking at well, can we do some. What's called Roth conversions. So my income was$500,000 a year. My effective tax rate was close to 30%. And so now that I've retired, it's much lower. What can I start? Converting some of this pre-tax money that I had been putting away in my 401k. It may be a 15% tax rate or a 20% tax rate. And now that spread I'm basically making up. 10 to 15%. On this money over time and I'm getting that money into her Roth or that money continued can continue to grow. And so the downside to leaving it in the pre-tax accounts. Could be that when you get to age 75 and the government says, Hey, I need to, start giving them what's called the required. Minimum distribution. I may not need that income. And now I'm paying more income taxes than I need because as I pull that money out, my pre-taxed account. I have to pay taxes on it. again, to kind of reinforce that point, if I have. Let's say a million dollars in my 401k at age 55. and I could have done rotten versions and I just decided not to, for whatever reason. Well, that gives an, I don't pull that money out until I'm age 75. As 20 more years of growth that I'm going to have on that account. So let's just say, theoretically, you're invested to the point where it only doubles once, right? So that's$2 million. Well, now I have a requirement. Minimum distribution on a portfolio. That's$2 million and it's going to start. You'll take that first distribution out in each year. That percentage of that withdrawal will have to continue to increase. So I might have a hundred,$150,000,$200,000 that I have to take off this portfolio at some point. And late in life where I'm paying a much higher tax rate. Circling back. I may want to go ahead and control my tax rate and keep it flat over time where I can convert that at 55 when I retired. Right. And I convert that. So I'm taking out of that million dollar account. Maybe I'm taking.$50,000 here,$50,000 there. And I'm converting it to my Roth and I'm keeping an even, let's say 20% tax rate over that time versus having a smaller tax rate until I'm 75 and then it ballooning to 30% or something like that. And so you run those rejections and it may be that. your overall tax impact over your lifetime would be much less. With you converting or you do it and you say, oh, we'll actually make sense to wait. And I won't do this conversions right. Long winded way to say, Hey, well you could, if you retire early, you should consider Roth conversions. Right? Um, and you should have three buckets. the taxable account. The Roth account. And a pre-taxed account so that you can be flexible with your taxes. In retirement. And then one thing I do want to mention. Kind of help with taxes as well. His charitable giving. There are a few things that you can do. for Chevrolet giving, a lot of my clients that are more cheerly inclined can utilize we'll utilize things like QCD. So qualified, charitable distributions. So let's say you do get to that age 75. You're having to take her requirement required minimum distribution, where you can actually designate that to go to a charity. Then you can avoid, those income taxes that you would incur for that. RMD. The other thing. Would be in a donor advised fund where you can open up. Have fun. this is a very shrewd and simple way of saying it. So obviously do more research. this is kind of off the cuff, then plan on talking about this, but donor advise fund, essentially. creating like a trust and then it is funded and, and to what we call the donor advised fund. And you can put money in that and that would be designated to a charity. The good thing why you would do that, let's say you plan on giving your church or. Specific charity. Let's say$200,000 over a five-year period. Well, you can. Go ahead and put that money. Into, the donor advised fund, the 200,000 you can take a$200,000 deduction. in that given year, and then that would lower your income right now over that next five years, you would have to give the$40,000 to the specific charity. that you determined that you want to give it to. But you would be able to take that. That income deduction up front. So maybe that would allow you to do more Roth conversions. Things of that nature. there's charitable, charitable trust strategies as well. Um, other types of trusts, charitable remainder, remainder trust, things of that nature. So just some things to consider or maybe look into. Let's jump into some common, Pitfalls to avoid. And that would be, one, I kind of talked about this, but over-reliance a one type of account or another, and the biggest thing I want to mention here again. Is if you were just slamming pre-tax money, you're maxing out your 401k. maybe your position, you have the ability to contribute to a 4 57 as well. And you just have a massive amount of money going into, your 401k and 4 57. And you get to retirement age and this. This account is exponentially larger than all your other accounts. You could be at risk for some RMD issues. Talked about. Which is where you would want to start, can start to consider those Roth conversions. Things of that nature. And that's why you would want the three buckets strategy of the brokerage account Roth account and a break tax account. you want to make sure that you understand what you're spending and how much you need to save to continue to sustain that spending. I talked about this lot last week, my previous episode of lifestyle creep. We just want to make sure that our retirement savings. Whether it be. Early retirement or a normal retirement. We want to make sure that we're saving enough to sustain that lifestyle. So have you continued to get increases in substantial increases in your income and you're not also, Increasing your savings along with that. Then you're at risk of not being able to save enough and continuing that same lifestyle. so just keep that in mind when making your plans. The last thing you would want to, consider and make sure that you don't fall into this. Pitfall as a lot of people will make a plan. and they won't revisit that plan for 5, 6, 10 years. a lot is a lot has changed, especially in your thirties and forties. You're getting married. You're buying homes. You're having kids. Your kids are getting older. They're becoming more independent. They're going to college. a lot changes in that 20 year period. And you should be revisiting your plan at least one to two times a year. and if you're more complex on the tax side, Potentially even more than that, so that you're planning to help save on taxes. But not adjusting. Your plan is the biggest failure. adviser I used to listen to for technical expertise and things of that nature. he once said that. As soon as you make a plan. You present it to the client. And the next day that plan is incorrect because things change so quickly. So the best thing you can do. Is stay on top of that plan and adjust as needed. So you can be less and less wrong and over time you'll meet those goals. Right. make sure that you're revisiting your plan regularly, whether that's with a financial advisor or yourself and your family. So that you can make those adjustments. Again, You get a great new promotion at your job. You're making a substantial amount more in income. And you fell to adjust your savings rate due to that. that's a big failure because now you're saving for that lower income and not a higher income. And you may not be able to retire when you thought you were originally because your lifestyle has changed and you have not saved to support that lifestyle. So some final tips, again, stay diversified. Use that three buckets strategy. You're a brokerage account. So your after tax dollars, your auth dollars and your pre-tax dollars. and then if you're struggling to make a plan and understand these tax strategies on, should I put in a Roth or pre-taxed or what is tax loss harvesting? How do I maximize, saving on taxes over my lifetime? Because a hundred yard, correct taxes. Is going to be, disproportionately the largest thing. Or expense that I have over my lifetime. I just don't understand how to minimize that. Go find a financial advisor again. That's what I do in my day job. I run a mill wealth management company, Palm valley wealth management. Would love to sit down and talk to you. You can go to my website, Palm valley wm.com. And, go ahead, check it out. Look at my process. Schedule a phone call. that first phone call is no cost to you. We just talk. Answer questions that you have. See if we're a good fit. and help you get to that retirement. and other financial goals that you have. hope this was helpful. high-income earners have unique challenges with taxes and saving and making sure that they're saving in the correct spot. I'm here to help. I want to educate you guys on those different things and also we'll continue the tax talk for next week, where we'll talk about them in a year. tax saving strategies that you can hopefully implement. And your life with some expert help as well. So, we will see you in the next one. If you liked this podcast, go ahead and leave a five star review on your favorite podcasting app and share this with a friend that you think would find this episode valuable. I would love to continue to educate more and more people about how to minimize taxes, plan to retire early and meet their financial goals. Again, go ahead and share that and leave a five star review. And as always, this is for educational purposes only. It is not meant to be financial or investment advice. Please seek a tax legal, financial or insurance professional when considering your own. Specific situation and please consider Palm valley wealth management when making those considerations.