Beyond the 401(k): 3 Tax-Efficiency Strategies for High-Income A&D Professionals

If you are a senior program manager or executive in the Aerospace & Defense sector, you may face unique financial planning considerations. You may have maximized your pre-tax 401(k), paid off high-interest debt, and established an emergency fund. You might still have excess cash flow and face a significant tax burden.

Once your household income reaches a certain threshold, standard financial advice may need adjustments. Maximizing your 401(k) may be a starting point, but not a comprehensive strategy. To potentially improve your tax efficiency, consider these strategies that are sometimes overlooked.

The Mega Backdoor Roth

Some A&D 401(k) plans may offer features that allow for this strategy, but it might not be widely used.

The Concept

The IRS limit for total 401(k) contributions (Employee + Employer) is higher than the pre-tax limit. If your plan allows After-Tax Contributions (not to be confused with Roth 401k) and In-Plan Conversions, you can potentially contribute additional capital into your 401(k) and convert it to Roth.

Considerations

• There is no initial tax deduction, as contributions are made with after-tax money.
• However, potential growth is tax-free, and withdrawals in retirement may also be tax-free, subject to IRS rules and regulations.
• This can increase your tax-free savings beyond standard Roth IRA limits.

Note: This requires coordination with your payroll department. Consult with a qualified tax professional to avoid potential tax issues.

The HSA

Many people use their Health Savings Account (HSA) for current medical expenses.

An Alternative Approach: Consider preserving these funds. If you can afford to pay for your medical expenses out-of-pocket today, you might consider leaving the HSA funds untouched.

Potential Advantages:

• Tax Deduction: Contributions may be tax-deductible.
• Tax-Free Growth: The HSA balance can be invested.
• Tax-Free Withdrawal: When used for qualified medical expenses, withdrawals may be tax-free, subject to IRS rules and regulations.

Important Note: There is no strict deadline for reimbursement. You could pay for medical expenses today in cash, save the receipts, allow the HSA funds to grow, and reimburse yourself in the future for those expenses, assuming you follow all applicable IRS rules.

Asset Location

Asset Allocation involves the mix of investments (e.g., Stocks vs. Bonds). Asset Location focuses on where you hold those assets to potentially reduce tax impact.

Considerations

Bonds and Real Estate Investment Trusts may generate interest and dividends taxed at ordinary income tax rates. Growth stocks may be taxed at capital gains rates.

A Possible Approach

Consider strategically placing assets in different account types.

• Tax-Deferred Accounts (Traditional IRA/401k): These accounts may be suitable for assets that generate taxable income, such as Bonds or REITs.
• Taxable Brokerage Accounts: These accounts may be suitable for assets that generate minimal dividends and primarily long-term capital gains, such as broad-market ETFs or Municipal Bonds.
• Roth Accounts: These accounts may be suitable for assets with high growth potential.

Summary

Managing a high income effectively includes considering tax-efficient strategies. By optimizing where you save (Mega Backdoor Roth), how you use benefits (HSA), and where you place investments (Asset Location), you may potentially improve your overall tax situation.

These strategies require careful planning. If you want to review your 401(k) Summary Plan Description to see if you are eligible for the Mega Backdoor Roth, schedule a consultation.