5 things W-2 Earners should do to Maximize Retirement Income

It’s no secret that employees get the short end of the stick when it comes to taxes and saving for retirement. Below are 5 things that I wish someone told me about when I started working a corporate job. Time is your friend when it comes to saving for retirement so start early!!!

#1: Contribute the Maximum Allowable amount to your 401k

The 401k is one of the most powerful savings tools that employees have to build wealth over the long term. For 2022 the IRS allows employees to contribute up to $20,500 pre-tax to a 401k with an additional $6,500 allowed for employees over 50 years old.

401k contributions reduce your taxable income and are generally matched to some extent by your employer (for example, my employer matches 100% of my contributions up to 6% of my income).

Employees will pay taxes on these funds upon withdrawal in retirement. Some employers also offer a ROTH 401k option where funds go in after tax and gains grow tax free.

#2: Contribute the Maximum Allowable amount to a ROTH IRA

For 2022 the IRS allows single employees to contribute up to $6,000 to a ROTH IRA. The ROTH IRA is a very powerful savings tool since contributions (made on an after-tax basis) grow tax free.

One key limitation of the ROTH is that the IRS limits contributions for people earning $129,000+ for single taxpayers and heads of household.

Saavy high income retirement savers use the “backdoor ROTH” to get around IRS income limits. Setting up a backdoor ROTH is very easy. All you need to do is setup a Traditional IRA and make after-tax contributions to that account then transfer those contributions into the ROTH up to the $6,000 limit.

Ending the backdoor ROTH was a hot topic in Biden’s Build Back Better bill so it is very possible that this loophole won’t be available for much longer!

#3: Consider a Health Savings Account (HSA)

The HSA is one of the less well known retirement accounts available to employees.

For 2022 the IRS allows single employees to save $3,650 and families to save $7,300 pre-tax to an HSA. Withdrawals used toward qualified medical expenses will be tax free and contributions will reduce the employee’s taxable income.

In order to contribute to an HSA the employee must be enrolled in a high deductible plan which typically means lower premiums in exchange for agreeing to a higher deductible. This type of plan is ideal for a healthy person who doesn’t expect to have recurring medical expenses.

I think of the HSA as a supplemental 401k plan and a great way for someone to supercharge their retirement savings.

#4: After Tax 401k Contributions / Mega backdoor ROTH

The mega backdoor ROTH is a great tool for high income earners to really maximize their retirement savings.

Most people don’t realize that the IRS allows total 401k contributions of up to $61,000 including the employer match and as a result leave a lot of money on the table when in comes to their retirement savings.

For example if you are making $100,000 and you are contributing to your 401k up to the $20,500 IRS max and getting a 6% ($6,000) employer match, you are only at $26,500 of your $61,000 allowable contributions.

The remaining amount can be topped up by making after-tax contributions to your 401k assuming they are allowed by your employer (my employer caps these at 5% of income).

Making additional after-tax contributions is slightly exciting, but what I REALLY get excited about is the ability to immediately convert these after-tax contributions into ROTH contributions, allowing those funds to grow tax free for the future.

In order to set this type of plan up you will need to call your 401k provider and ask them to setup in plan conversions. I personally have Fidelity and found the process to be very easy.

#5: Employee Stock Purchase Plans (ESPP)

My old employer was a public company that had an ESPP which allowed employees to use up to 10% of their income to buy company stock at a discount. I regret not doing this every day since the stock increased 4x in value.

This type of plan won’t be available to everyone but it is worth looking into especially if you feel good about the long term growth prospects of your company.

Note: This post is strictly based on my own experience and is not meant to be financial advice (solely for entertainment purposes!!).