Tax-deferred growth makes a difference over time.
A recent client came to us looking for a second opinion on her financial situation with a goal to retire in three years. She is 62 years old, single, with an older son who is on his own. She has done well preparing for retirement over the years and has been able to save approximately $1.5M between her current 401k and IRAs that have been rolled over from previous employment. A key component of her retirement savings will come from her Employee Stock Ownership Plan (ESOP) associated with her current employer. She has been with the company for 10+ years and is 100% vested.
An ESOP is a tax-qualified deferred compensation plan and allows for the ownership of a corporation by its own employees. While the rules and requirements associated with ESOPs can be complicated, an ESOP provides tax savings for the underlying corporation and employee motivation through stock ownership. As the company does well, contributions are made to the plan which will eventually be paid out to the employees within 5 years after retirement based on the ESOP’s distribution policy.
As we do with all of our clients, we went through a detailed data gathering process over the course of a few weeks. Once all information was received, it was analyzed and then entered into our financial planning software, eMoney Advisor. We worked with our client to understand the intricacies of her ESOP plan and agreed on conservative amounts to use for the annual pre-retirement contributions. Once we agreed on a projected ESOP balance at retirement in 2021, we then used our software to run through different what-if scenarios to assess the overall impacts to her financial plan.
We analyzed the difference between taking the ESOP payouts as a lump sum in the year they would be distributed vs. directly rolling the ESOP distributions over to another qualified retirement account. The difference in the amount of wealth created over her lifetime was significant. The tax-deferred growth associated with the direct rollover strategy resulted in over $2M of additional wealth in today’s dollars. We also calculated the total amount of income taxes paid over her lifetime. When applying the direct rollover option, she ends up paying less overall income taxes (even with the additional wealth that would be created).
We provided cash flow projections and analysis that highlighted exactly where her income will be coming from during retirement. We prepared tax projections, which highlighted additional retirement planning opportunities to take advantage of in the future. One key action item we identified during our analysis was to reduce her exposure to equities nearing retirement. As she prepares for her next stage in life, we will be crafting a customized portfolio to her specific situation that considers her future retirement needs. She will have flexibility in retirement with regards to spending and allocating towards her savings. Going forward, we will keep her financial plan up-to-date and revisit it as needed, to help facilitate these types of financial decisions.
If you are looking for financial guidance, whether it be for a one-time financial plan or continuing advice on your investments, we invite you meet with the First and Main Financial advisors for a free consultation. We would be more than happy to sit down with you, assess your current financial situation and review with you our services to help you navigate your own financial future.