Building a $2 Million IRA Some Simple Steps to Securing an Adequate Retirement Fund

The goal for most people is to maintain their current standard of living in retirement. While your mortgage may be paid off and the kids out of the house, other expenses can add up quickly, especially if you have a second home or want to travel. If you would like to maintain a standard of living of $80,000 per year or more after taxes and do not have a pension, a $2 million IRA is a realistic target.

Traditional individual retirement accounts (IRAs) provide income-tax deferral on contributions and earnings. Money withdrawn from traditional IRAs in retirement is taxed as income. The tax deferral allows retirement savings to grow in your high-income-earning years without the drag of annual taxes. In addition, you may be in a lower income-tax bracket after retirement. Tax deferral is a key strategy to building wealth for retirement.

In the past few months, there have been many news stories about Mitt Romney accumulating more than $20 million in his IRA. How is that possible when the maximum annual contribution is $5,000 or $6,000, depending on whether you are over 50 years of age or not? While we don’t know for sure about Romney’s strategy, he definitely rolled over employment-related retirement plans into his IRA. This is a strategy that is available to everyone, and can allow people to accumulate substantial IRA balances. It is not uncommon for physicians nearing retirement to have IRAs worth $2 million or more.

Retirement Plans at Work

Like businesses in most other industries, health care organizations are moving away from ’defined-benefit’ retirement plans and toward ’defined-contribution’ plans. Many doctors, nurses, and other health care professionals may be grandfathered into a defined benefit plan that provides a regular monthly pension income in retirement. However, new employees will likely only have the option of contributing to defined-contribution plans such a 401(k), 403(b), and perhaps a deferred compensation 457 plan. Employers may also contribute to employees’ retirement plans; 3{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} to 7{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of salary is common.

For 2012, each participant in a 401(k) or 403(b) plan can contribute $17,000 per year, and once you reach age 50, you can contribute an additional $5,500 per year. By contributing the maximum amount to a 401(k) for 30 years, your savings could grow to $1.3 million, assuming a 5{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} rate of return. Most people can’t contribute the maximum amount to their 401(k) plan, but everyone should try to contribute 10{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} to 15{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of their gross wages to retirement. For physicians who earn $170,000 per year or more, $17,000 may not be enough to reach the 10{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} threshold, which means they need to look for additional opportunities to save on a tax-deferred basis.

Some local government and nonprofit institutions also offer the ability to save in 457 deferred-compensation plans in addition to 403(b) plans. A 457 plan allows you to defer compensation until a future date. Contribution limits for 457 plans are also $17,000 per year and an additional $5,500 if you are over age 50. One caveat of a 457 plan, however, is that it remains an asset of the organization until you withdrawal the funds after separation, making it subject to creditors if the entity goes bankrupt.

Physicians who own their own practices have the option of creating a defined-contribution, profit-sharing plan. In such a plan, the combination of the employee and employer contributions can be $50,000 per year. An extra $5,000 can be contributed for employees who are over age 50. In special situations, some practices may find it advantageous to utilize a defined-benefit plan, which allows very aggressive savings for older, highly compensated employees.

Some physicians who work at local hospitals may earn outside income from a variety of sources such as honoraria or speaking fees. This is self-employment income. You may be eligible to contribute up to 25{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of your self-employment compensation, or $50,000, whichever is less, to a SEP IRA. There are limitations to eligibility that you should discuss with a qualified tax professional.

All retirement plans can be rolled over into an IRA when you move to a new job, retire, or, in some cases reach age 59½. For physicians worried about liability, you may want to review the creditor-protection rules for IRAs in Massachusetts and Connecticut before rolling over your retirement plan.

IRA contributions

Many people don’t realize that, even if you maximize your contributions to your 401(k) plan, you can also make a $5,000 contribution to your IRA or Roth IRA. Your spouse is also eligible to make a contribution to his or her IRA or Roth IRA. There is, however, a phaseout of the tax deductibility of IRA contributions based on your income, whether you are married, your tax status, and if you are covered by a retirement plan at work (like a 401(k) plan).

For example, a married couple filing jointly and covered by a retirement plan at work starts having tax deductibility of IRA contributions phased out at $92,000 of modified adjusted gross income. There is also an income limitation on eligibility for contributing to a Roth IRA.

There are other options for saving in tax-deferred accounts. One of these options is an annuity. Once all of your other tax-deferred savings options are exhausted, a tax-deferred annuity may be worth considering. But annuities may come with high fees and surrender charges, so investors need to be careful about their choices.

Certainly, not everyone needs or will have a $2 million IRA at retirement. The lower your expenses are, the more likely that Social Security will cover a greater percentage of your needs, and the lower the amount of savings you will need. But if you are a high-income earner with high living expenses, a key component to maintaining your lifestyle in retirement is to build a substantial IRA. v

Doug Wheat, CFP, is director of Family Wealth Management in Holyoke;www.fwmgt.com