High income earners often find themselves in a bit of a quandary when it comes to retirement planning. Individuals making over $132,000 and married couples making over $194,000 are not eligible to contribute to a Roth IRA.1
For 401(k)s, the annual contribution limit of $18,000 ($24,000 for those over 50)2 is simply not enough for someone who made, say, $250,000 per year during their working years. Saving $18,000 a year is probably not sufficient for someone at that income level to maintain the same standard of living in retirement.
Of course, this does not mean that high income earners should shy away from contributing to 401(k)s or other employer-sponsored retirement plans. The more a person can contribute to a tax-deferred plan, the better. But for high income earners, saving enough so that you can replace your income in retirement means turning to other methods and savings vehicles to reach your goals. Here are three potential options.
Retirement and financial planning can essentially be broken down into three phases:
- Taxable Brokerage Account – Capital gains tax rates may change over time and from administration to administration, but one feature is not likely to ever change: no contribution limits. You can contribute as much as you’d like to a taxable brokerage account in any given year or throughout your lifetime, and you can invest that money for growth as you would a 401(k). The key to managing a taxable brokerage account is to seek ways from year to year to offset your capital gains with losses, which you can do dollar for dollar under the current laws. In some cases, you can also use capital losses in your brokerage account against ordinary income.
- Backdoor Roth IRAs – Since 2010, anyone regardless of income can convert a traditional IRA into a Roth IRA.3 This works particularly if you do not have an existing traditional IRA or IRA rollover from a previous employer, in which case you can fund a ‘nondeductible traditional IRA’ and then convert it immediately to a Roth IRA. In many cases, you can make this conversion with little or no tax upon conversion. If you’re converting an existing traditional IRA or have an IRA rollover from a previous employer, there will likely be a tax implication.
- Explore an After-Tax 401(k) Plan with Your Employer – Certain 401(k) plans allow participants to contribute after-tax dollars up to $53,000 or 100% of compensation. After-tax contributions to a 401(k) work a lot like non-deductible contributions to an IRA – your contributions are after-tax dollars, but the earnings grow tax-deferred. Upon withdrawal, the earnings get taxed at ordinary income. In some cases, it may just be better to contribute to a taxable brokerage account, since the capital gains rate is in many cases lower than the ordinary income rate for high income earners. You should consult a tax professional for advice on what works for your situation. But also keep in mind that for those looking to eventually convert these after-tax contributions to either a Roth 401(k) or a Roth IRA, making extra contributions to a 401(k) may be a smart move.
Explore More Retirement Savings Options
The tips laid out above are not exhaustive for high income earners, and they leave out those who are self-employed or own a business. In those cases, there are retirement plans like SEP IRAs and self-directed 401(k)s that have much higher contribution limits than traditional retirement plans. In any case, it is important for high income earners not to feel limited by the retirement plan options that are right in front of you. There are plenty of options to explore to save and grow your retirement assets in a tax efficient way. To learn more about what you can do to save more and invest your assets in a tax efficient manner, call one of our Wealth Managers today at 1-800-541-7774. You can also email us at wealth@wrapmanager.com.
------
Source:
1. Fidelity
2. IRS
3. Forbes
