Saving for Retirement? 7 Ways BP Executives Can Save More in the ESP

They say a watched pot never boils. However, if you apply this idiom to your BP Employee Savings Plan (ESP), you may never reach a boil or quickly boil over. Unlike some 401(K) plans, the BP ESP is NOT a set-it-and-forget-it type of plan. It must be carefully watched and adjusted throughout the year to avoid taxable errors or missed opportunities. These adjustments will differ based on your age, income, and goals and can change yearly. The moral of this story is to pay attention to your BP 401(K) plan. It could mean the difference between retiring early, retiring more comfortably, or leaving your children a considerable legacy. 

As with everything, there are many ways to mess up your BP ESP. Maxing out the ESP contributions and getting the full company match is not easy to get right. More times than not, this is one of the first things we tackle when onboarding new clients. In this article, we'll review some of the opportunities BP employees miss out on and the common mistakes we see them make in the 401(k). Unfortunately, it's not just one type of person making these mistakes. We see errors from the "set it and forget it," the "overachiever," and the "I didn't know BP offered that" camps of employees from BP. 

Meet with One of Our BP Financial Planning Experts 

Identifying where to start to get back on the right path is tough if you fall into any of these categories. But we help clients with this daily. If you're already nervous, reach out to set up a meeting with our team to see how you're doing and, if needed, how to get back on the right track. 

The "Set It and Forget It" – James and Patricia 

James and Patricia are both 50 years old and work at BP. They have four kids, so the last thing on their mind is actively managing their 401ks. 

Max Out 401(K) Contribution Limits for 2023

For 2023, they can each contribute $30,000 between Pre-tax and Roth in their BP ESPs. Additionally, this is the first year they can utilize the catch-up provision for those 50 years and older. If they both neglect to increase their contributions to include this additional $7,500 catch-up, they will miss out on an extra $15,000 total in catch-up contributions! That's $15,000 extra that they can't deduct on their tax return. That's also $15,000 extra that they can't grow on a tax-deferred basis over their career and into their retirement years.   

Let's assume that this missed contribution number stays static for the rest of their careers, and they work until they are 65. That's $225,000 of missed contributions! And we haven't even grazed the surface of the tax efficiencies they're leaving on the table.     

Understand the Tax Impact of Contributions to a 401(K) vs. Brokerage Account

If we want to dig into the nitty-gritty of how much James and Patricia are leaving on the table, let's grab our shovels.   

There are two items we are concerned with as we think about contributions to a 401(k) versus a brokerage account:  

1. What is their tax rate now, and will their tax rate be lower in the future? 
2. How will investment returns differ between a 401(k) and a brokerage account?

Use Your 401(k) Contributions for Tax Arbitrage  

Avoid the Higher Marginal Tax Rate Now, and Pay a Lower Marginal Tax Rate Later 

James and Patricia are in the 32% marginal tax bracket during their working years and expect to be in the 22% bracket once they’ve retired and need to pull funds from their 401(k)s.  

During their working years, if they miss out on the $15,000 annual pre-tax payroll deductions to their 401(k), they will receive $10,200 of that money post-tax annually instead. Why? It’s simply because they are being taxed at their 32% marginal tax bracket.  

What if they had been more vigilant during their high-tax-rate working years and had maxed out their pre-tax ESP contributions? Instead, they'd have $15,000 per year going into the 401(k) pre-tax and growing at 8% per year. The after-tax value of that account when they hit age 75 (when required minimum distributions begin) would be $685,845. If you remember, the after-tax value of this 401(k) looks different once they retire because their marginal tax bracket will be 10% lower than while they were working. That's almost a $90,000 difference! Imagine if they had been under-contributing for their entire careers!   

This strategy only works if James and Patricia will be in a lower tax bracket during retirement than while they are working. This is generally the case, but not always. However, as you can see, there are obvious financial benefits to this strategy, so ensure you max out your 401(k) in your working years so you can take advantage of this future tax arbitrage. 

  
Avoid Tax Drag by Contributing to a 401(k) Instead of a Brokerage Account

 Annual tax payments on a brokerage account eat away at the lifetime value of the account 

Here’s a question I often ask my clients: are returns the same in a 401(k) as they are in a brokerage account if they are invested in the exact same things?  

The short answer is… no. Does that surprise you? Let’s review why that is together. 

We all know that your 401(k) is a tax-deferred, retirement account. This means that any market appreciation (think year-over-year returns), interest, dividends, capital gains, etc, are not taxable to you as they occur. However, the amount you withdraw in your retirement years will be taxable to you when withdrawn at your ordinary income rate. 

A brokerage account is structured a little differently. The brokerage account is comprised of dollars that have already been taxed. However, capital gains, dividends, and interest are all taxable as they occur – Sometimes at your ordinary income rate and other times at a tax-beneficial rate (think long-term capital gains and qualified dividends). 

So how does this affect you and your choice to save in a 401(k) or a brokerage account? We call the taxes that you’re having to pay on an ongoing basis on your brokerage account investments “tax drag.” Tax drag, in essence, is the reduction of a portfolio’s annualized return due to taxes. For our purposes here, let’s say the “tax drag” on James and Patricia’s brokerage account is 2%. You know where I’m going with this… 

If James and Patricia can earn 8% returns in their 401(k) now and 6% returns in their brokerage account (accounting for the 2% tax drag), there’s an obvious winner: the 401(k). But let’s put real numbers to this in case 2% seems like a minimal amount. 

Continuing with our example from above, let’s assume James and Patricia are missing $15,000 total in catch-up contributions from age 50 until they retire at age 65. They don’t plan to pull from their 401(k)s until age 75 when their tax bracket is 22% (it’s 32% now). 

At age 75, those contributions in the 401(k) (taxed at 22%) would have grown to $685,845 after-tax. 

At age 75, those same contributions would have grown to $425,172 in their brokerage account due to the 2% tax drag. 

The result: Over $250,000 of tax drag, and it’s for a relatively short period of time. What if they had been missing contributions during their entire career? 

BP 401(K) Match & Why Frontloading 401(K) Contributions Isn't Always a Good Idea

BP matches up to 7% of your compensation per paycheck, up to $23,100 in 2023, which is 7% of the IRS'415 income limitations for the year. Many BP employees know this, and it might sound so simple that you're wondering why I'm even bothering to mention it to you. What if we look at this from another angle? Suppose James and Patricia max out their contributions, but they do so too early in the year.   

Let's assume James, whose salary is $200,000, wants to max out his $30,000 pre-tax contributions this year. He can contribute 15% of his paycheck evenly throughout the year. The reason for doing this is: BP will match contributions as long as you're also contributing. Therefore, BP will stop their contributions if you max out your 401(K) early in the year, meaning you're missing out on FREE money from BP if you try to frontload your contributions. 

What is the true dollar impact of missing out on those free contributions? Let’s say James finishes up his 401(k) contributions in June of this year. He’s contributed $30,000 by the end of June and cut off his contributions after that because he’s done. That’s exciting, right? Nope! BP matches 7% of each paycheck into his 401(k), so he’s only accumulated $7,000 of matching into his 401(k) by the end of June instead of the full $14,000 401(k) match. 

If James stops contributing to his 401(k), those matching contributions shut off. He’s missing out on six additional months of contributions simply because he didn’t plan his 401(k) contributions properly. $7,000 of missed contributions doesn’t seem like a lot for one year. But most people who make this mistake in one year continue to make it year after year.  

Let’s say that James made this same mistake for ten years in a row. That’s $70,000 of missed BP contributions. Not only that, but it’s also ten years of tax-deferred growth. By the end of the tenth year, those contributions would have grown to over $100,000 (pre-tax) based on an 8% rate of return.  

But, let’s look at this practically since James probably won’t be touching those funds for even ten years after that. With another ten years of tax-deferred growth, those funds look more like $215,000 (pre-tax). So, the moral of the story here is. No, it’s not just $7,000 missed (also known as a nice vacation) for one year. It’s potentially $215,000 or likely more of FREE funds from BP that James (or you) might be missing out on. That’s huge.  

How the BP Bonus Impacts 401(K) Contributions

You may not realize your BP compensation isn't evenly distributed throughout the year—for example, bonus season. 

Bonus time is when you need to monitor and adjust your contributions to ensure that you don't max out your contributions too early. James and Patricia need to be diligent about tracking their annual compensation (noting salary increases and bonuses) and adjusting their contribution percentages to ensure they don't miss out on the BP match in the ESP.  

The "Overachievers" – Susan 

The overachievers… you know who you are. In this example, there are two types of overachievers: the ones who overcontribute to their 401(k) and those who make too much money and get cut off from contributing to their 401(k).   

What Happens When You Over-Contribute to the 401(K)? 

Susan, 45, just started at BP last year and is making $250,000 (including her bonus of $50,000, which is paid in the first quarter). She's eager to max out her 401(K) to get the BP match. Susan decides to bump up her percentages so she maxes out quickly. As a result, Susan maxed out her pre-tax contributions well before the middle of the year. Wow! She doesn't think any of it and pats herself on the back. If she had spread out her contributions during the year, contributing 9% per paycheck would still allow her to reach the $22,500 limit for her 401(K) contributions.  

Later in the year, Susan notices that her paycheck hasn't increased. "That's weird," she thinks. "I already maxed out my contributions, right?" Little does Susan know that if she doesn't halt her contributions after maxing out her 401(k) pre-tax contributions, BP will continue deducting these contributions under the after-tax bucket in the ESP. After-tax contributions aren't necessarily a bad thing (as we'll discuss in the next section), but Susan may have created another issue for herself, as we will see below.  

Before getting into that issue, let’s rewind and take you back to your childhood. Remember Goldilocks? This is a bear of a situation because the way the BP plan works, you need to get it just right to use all your BP benefits to their full potential. So, let’s talk oatmeal…or was it porridge? 

Too Hot: Frontloading 401(k) contributions to max out before mid-year. Susan thought of her savings strategy more like a sprint than a marathon and contributed way too much, way too quickly. The reason this isn’t a great idea is that if she contributes too much to her ESP (exceeding the $66,000 limit for 2023), she will actually push the money from BP’s matching contributions into a non-qualified plan (the Excess Benefit Plan or EBP). She’s still getting the BP match if she overcontributes, BUT they’re not being contributed into a tax-efficient account. The EBP will be paid out after retirement and will be fully taxable at payout (likely in a very high marginal tax bracket). Because of her high salary and her bonus, she’s likely to max out the ESP by the middle of the year. By doing so, $8,750 of BP’s matching contributions will get pushed into her EBP. If she had known, she could have decreased her contributions to contribute evenly throughout the year to get her full BP match inside her ESP without the non-optimal spillover to the EBP. 

Too Cold: What if Susan had noticed that she was contributing more than she anticipated and decided to shut off her contributions mid-way through the year? Sounds like a pretty great option. But if we remember James’ situation from above, we know it’s not. BP matches on a per-paycheck basis, so if Susan shuts off her contributions during the year, she also shuts off the BP matching contributions. Ouch. She’s now missed out on $8,750 of BP’s contributions this year because she’s maxed out her accounts too early in the year. Because she doesn’t know she’s missing out, she might do this year over year, which can really add up. 

Just Right: So, what can you do to get this right? Well, it takes the most monitoring and work from you (or an advisor well-versed in all the moving parts). If the goal is to contribute just enough per paycheck to max out your ESP AND get the full BP match INSIDE of the ESP, here’s an example of how to get it right if you were structuring Susan’s contributions. 

• Pre-tax contribution for 2023: Max of $22,500 -- 10% contributions with a change after 5/15/23 to 8% 
• BP Matching for 2023: Max of $17,500  -- Constant, contributed by BP 
• After-Tax Contributions for 2023: $26,000 -- 11% with a change after 5/15/23 to 10% 

Triggering the BP Non-Qualified Plans

Excess Benefit Plan (EBP)

One of the lesser-known plans at BP is the one Susan faced in the example above – the Excess Benefit Plan (or the EBP for short). Having money spill into the EBP and other non-qualified plans is less tax-efficient than a 401(k) or other tax-preferred accounts. 14 months after retirement, these plans are paid out in full at your ordinary income tax rates! If Susan already has money in the EBP, she can look at modifying her elections from the default 14 months after retirement to elect to push the payout 74 or more months so she’s in a lower tax rate when she gets it. How she proceeds and makes changes for the upcoming year to avoid the EBP isn't cut and dry. It will depend on her cash flow needs, retirement goals, and her increases in compensation. That's a lot to keep track of and calculate by herself.  

Excess Compensation Plan (ECP) for High-Income Earners  

Let's fast forward a few years. Susan understands the plan better and contributes to the ESP more evenly over the year. She's gotten a few increases in compensation, and her income is now above the IRS income limits in section 415 (for 2023, this number is $330,000).   

Susan's compensation exceeded this limitation in August of that year. Once her income hits the IRS 415 threshold, all future BP matching contributions go to a BP Non-Qualified Savings Plan known as the Excess Compensation Plan. This is good news and bad news for Susan.  

The good news: she's still getting matching contributions.  

The bad news: these contributions will go in a non-qualified plan, so they are not as tax-advantaged and will be fully taxable when they pay out to her after retirement.   

The "I Didn't Know BP Offered That" - Parker 

When Parker, 40, started at BP, they threw a lot of information at him, and he didn't have time to read it before diving into his busy role. What are some of the key things he might be missing about the BP ESP? 

After-Tax Contributions in the 401(K) & the Mega Backdoor Roth Strategy

Unlike some companies, BP offers Pre-Tax and Roth contributions (up to 22,500 for those under 50) and after-tax contributions for current employees. The amount of after-tax contributions Parker can make will depend on his compensation and his other contributions. If we remember above, the IRS limitation for 2023 for Defined Compensation plan contributions is $66,000.  

For example, let's assume Parker makes $200,000 and maxes out his BP ESP pre-tax contributions at $22,500. Because BP matches 7% of his compensation ($14,000), Parker can contribute up to $29,500 in after-tax dollars to the ESP for 2023.   

After-Tax vs. Brokerage Account Contributions: Which Is Best? 

So Parker can make after-tax contributions. What's special about that? Is after-tax in the ESP better than after-tax in a brokerage account? You're asking all the right questions. Something else that Parker needs to know is that the BP plan allows for in-plan Roth conversions. Meaning he can roll his after-tax ESP contributions out to Roth tax-free. Not only can he move them to Roth, but these contributions will continue to grow tax-free and can be withdrawn tax-free later. That will always trump growth and distributions from a brokerage account because it eliminates tax drag on an account, like what we saw with James and Patricia in our earlier example. 

Roth IRA Income Limits

Now, you may say: Parker is a highly compensated individual, so I thought Roth IRAs were off limits. Not quite. Parker's compensation will not preclude him from doing these conversions, which, in the industry, are referred to as Mega Backdoor Roth Contributions. Why not, you may ask? Despite his high income, Parker's Roth conversion takes place from within the 401(K), which he can contribute to up to the $66,000 limit until he reaches the 415 income limit of $330,000 in 2023. By converting his after-tax dollars within the 401(K), he can get additional Roth savings that he'd otherwise be unable to get outside the 401(K). 

Working with a Fiduciary Financial Advisor with BP Benefits Expertise

These are just a handful of examples of things to consider while trying to maximize your BP ESP benefits. While the BP ESP can be confusing, at Willis Johnson & Associates, getting the most from the BP 401(K) is a conversation we regularly have with our BP clients. BP's ESP is more complex than setting and forgetting contributions. If you need additional guidance, you can take advantage of a complimentary meeting with our team to discover how to get more savings into the plan each year. Rather than waiting to see if the pot will spill over or fail to boil, I hope these examples have motivated you to hop off the couch, log in to your NetBenefits, and see how your ESP is doing. Or, if you want someone to give you a step-by-step plan, call us, and we'll help you get it right for the years to come.