Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Family Offices Use 401(k) Plans for Principals
Transcript
- Lucas: So Luna, we talk a lot about the exotic side of wealth management — trusts, private placement life insurance, art lending. But today I want to talk about something that might sound almost mundane in comparison. Luna: Mundane? Now I'm curious. What could possibly be mundane in our world of cross-border trusts and structured sales? Lucas: The humble 401. Yes, that retirement account that most Americans associate with middle-class saving. But here's the twist: a growing number of ultra-wealthy families are deliberately keeping 401 plans in their family office structure — not as an afterthought, but as a strategic piece of their tax planning. Luna: Wait, I thought the contribution limits were tiny compared to their net worth. How much can you even put in? Twenty something thousand? Lucas: For 2026, the employee deferral limit is twenty-three thousand five hundred dollars, plus a catch-up for those fifty and older. But that's just the base. When you add employer contributions, profit sharing, and the mega backdoor Roth strategy, a family can push well over sixty-nine thousand dollars a year per person into a Roth environment. Luna: Okay, so you're talking about getting maybe a hundred grand a year into a Roth. Over a decade, that's a million. But for someone worth fifty million, is that really moving the needle? Lucas: That's the classic objection, and it's fair. But the needle isn't just about the absolute number. It's about the quality of the assets. Remember, this is a Roth — tax-free growth forever. For a family that expects their investments to compound at eight or nine percent over a couple of decades, that's a significant amount of tax-free return. Luna: And it also diversifies their tax exposure. If they have a huge taxable estate, having a pool of tax-free money at age seventy-two can be a hedge against future tax rates. Lucas: Exactly. And that's why we're seeing family offices — even those managing several hundred million dollars — maintain a 401 plan for their principals. It's not about the absolute contribution; it's about the tax-free compound growth and the flexibility it provides. Luna: But there are rules, right? You can't just funnel unlimited money into a 401. What are the practical constraints? Lucas: Right. The IRS caps total contributions — employee deferrals plus employer contributions — at sixty-nine thousand dollars for 2025 and twenty-three thousand five hundred for the employee portion. And there's the compensation limit: you can only base contributions on the first three hundred forty-five thousand dollars of compensation. So the math is: you need to set your compensation high enough to maximize the contribution, but not so high that you're paying unnecessary payroll taxes. Luna: That sounds like a delicate balancing act. And what about the mega backdoor Roth? That's not a standard feature. Lucas: No, it requires a plan that allows after-tax contributions and in-plan Roth conversions. Many 401 plans don't have that provision. But for a family office that controls its own plan, you can design it to include those features. That's the secret weapon: a custom-built 401 that acts like a backdoor Roth on steroids. Luna: And you can do that because the family office is the employer, so they have total control over the plan design. That's pretty clever. Lucas: It also helps with retention and compensation. If you have non-family employees in the family office, a generous 401 plan can be a powerful tool to attract and keep top talent. It's not just a tax play; it's a human resources play. Luna: So it's a win-win. But I'm guessing there are pitfalls. What about the required minimum distributions? If you have a large balance, RMDs could force you to take money out that you don't need. Lucas: That's a real consideration. RMDs start at age seventy-three now — that was pushed back a couple of years under SECURE 2.0. The IRS has tables that determine your required withdrawal based on your account balance and life expectancy. For a family with a multi million dollar 401, the RMD could be substantial. But there are strategies to manage that, like rolling the money into a Roth IRA before RMDs kick in, or using Qualified Longevity Annuity Contracts to delay distributions. Luna: And there's also the option of just leaving the money in the plan and taking the RMD — but that defeats the purpose of tax-free growth if you don't need the cash. Lucas: Right. So the planning has to be personalized. Some families might prefer a traditional 401 to get a tax deduction now, betting that their tax rate in retirement will be lower. Others will go all-in on the Roth side. The point is, it's a versatile tool. Luna: I've also heard about something called a solo 401 for business owners. Is that relevant for family offices? Lucas: Absolutely. If the family office is structured as a sole proprietorship or a single-member LLC, a solo 401 might be the simplest and most cost-effective option. It allows the owner to wear both hats — employee and employer — and can be set up with minimal administration. But as the family office grows and adds employees, you'll probably need a more traditional plan. Luna: So let me get this straight. A family office can use a 401 not just for tax efficiency, but also as a tool for compensation and retention. And they can customize it to allow mega backdoor Roth conversions. That's a pretty powerful trifecta. Lucas: Exactly. And that's why we're seeing more and more family offices adopt these plans. It's a relatively low-cost, high-flexibility strategy that flies under the radar compared to the exotic structures we usually discuss. Luna: It's funny, we talk about all these complex trusts and offshore structures, and sometimes the simplest tools can be just as effective. Lucas: The thing is, there's no one-size-fits-all. But the 401 is often overlooked because it's so common. People assume it's not for the ultra-wealthy. But as we've seen, that's a misconception. Luna: And I love how it ties into the broader theme of our show: every tool has a place, even the mundane ones. Lucas: Before we go too far down this rabbit hole, I want to mention something that's been on my mind. We've been doing this podcast for a while now, and it's completely ad-free. That's a choice we've made, and it's possible because some of you out there support us. Luna: Yeah, it's genuinely a small donation that makes a big difference. A couple of dollars a month helps us keep the lights on and the microphones recording. Lucas: If you've gotten something out of our money conversations — maybe you've thought about a financial decision differently — consider buying us a coffee. It's buy me a coffee dot com slash fexingo. That's it. No pressure, just a heartfelt thanks. Luna: And now back to the 401 strategy. So, Lucas, what's a concrete example of how a family might structure this? Lucas: Let's say you have a founder who's sold their business for fifty million dollars. They set up a family office. They draw a salary of, say, three hundred forty-five thousand dollars a year — that's the compensation cap. They max out their employee deferral at twenty-three five. The family office as employer can contribute up to the difference, bringing the total to sixty-nine thousand. Plus, if the plan allows after-tax contributions, they can add another chunk and immediately convert it to Roth. Luna: And over time, that becomes a Roth account with tax-free growth. But what about the employer contribution? Is that a tax deduction for the family office? Lucas: Yes, employer contributions are tax-deductible as a business expense. So the family office reduces its taxable income by the amount it contributes, and the owner gets tax-deferred growth. It's a double benefit. Luna: So the family office is essentially paying the owner with pre-tax dollars that also grow tax-free. That's a pretty sweet deal. Lucas: And if they do the Roth conversion, the tax is paid now, but all future growth is tax-free. For a family that expects to be in a higher tax bracket later, or who wants to leave a tax-free inheritance to their heirs, that's a compelling option. Luna: But I assume there are legal limits on who can participate. You can't just have a 401 for the principal and exclude everyone else. Lucas: Right, there are nondiscrimination tests. The plan must be offered to all eligible employees, not just the owner. That's why many family offices do include their staff — it's a requirement, not a choice. But it can actually be a benefit: a well-designed plan can attract and retain key employees. Luna: So it's not just a tax tool; it's a way to align the interests of the family and their employees. Lucas: And that's the key insight. The 401 is a versatile, powerful tool that, when used correctly, can serve multiple purposes. It's not just about the numbers; it's about the strategy. Luna: Well, I think we've just scratched the surface. There are so many nuances — like the rules around loans, hardship withdrawals, and even the recent secure act changes. Lucas: We could do a whole episode on SECURE 2.0 alone. But for now, the takeaway is: don't overlook the 401 just because it's common. For the ultra-wealthy, it can be a strategic asset. Luna: And maybe the most important thing is to work with a qualified advisor who can tailor the plan to your specific situation. There's no one-size-fits-all. Lucas: Agreed. And that's a good note to end on. Thanks for joining us on this deep dive into the humble 401 and its place in high-net-worth planning.