If you are a personal injury attorney trying to plan for your future retirement, you have a unique opportunity that is available to almost no other profession — and that is the ability to determine when you receive your income from a particular fee for a case by using deferred compensation plans.
How Does Using a Deferred Compensation Plan to Plan for One’s Retirement Work?
Here’s an example: Let’s say you plan to work for 20 more years before you retire, and you are presented with the option each year to invest $300,000 pre-tax versus taking $300,000, being taxed on it, and then investing what’s left. What your nest egg will look like after the 20 years of investing will depend on which option you choose.
If you take $300,000 each year, pay tax, and then invest the after-tax amount in a taxable account, you’ll pay tax on the growth of your investment each year. At the end of the 20 year period, your account value would be approximately $5.3 million after 20 years.
On the other hand, if you take $300,000 each year and defer your fees — and as a result, invest the full $300,000 on a pre-tax basis — your nest egg will have grown to about $13.1 million over the course of 20 years.
The reason why you are getting a much better return on your investment with pre-tax money is that it is growing tax-deferred. In other words, you are not paying taxes on the growth of your pre-tax money every single year, which then allows your money to grow more in 20 years than if you had gone the after-tax route.
With that being said, take note that because the $13.1 million has not been taxed yet, you are going to have to pay taxes as you receive that income. However, even if you were to pay all the taxes that were due in year 21, you are still going to be way ahead of the after-tax projection.
What are the Contribution Limits of Deferred Compensation Plans?
Think of the pre-tax investing using a deferred compensation plan as a supercharged 401(k). However, unlike a 401(k), in a deferred compensation plan, you can contribute as much money as you want in any year. There are no contribution limits. There are no required minimum distributions. You do not even have to include other members of the firm or your staff.
Using a deferred compensation plan to invest on a pre-tax and tax-deferred basis is a powerful way to save on your current year income taxes and to save for the future in a tax-efficient manner.
If you are interested in learning more about how this can be a viable retirement plan strategy for you, give us a call. As financial planners and fellow attorneys, we love talking about this option and helping other attorneys create custom solutions to maximize their retirement.