The High-Income Earners Guide to Saving for Retirement
If you are lucky enough to have a high income, you may face some unexpected roadblocks to saving for retirement. There are upper limits on some retirement-savings accounts. But there are also a number of strategies for working around these limits. Two of them are:
Saving in a taxable brokerage account, which does not have limits. The short-term capital gains tax rate is a tax on the profits from the sale of an asset held less one year or less. It is taxed at your ordinary income tax rate. Long-term capital tax is a tax on assets held longer than one year and the the rates range from 0% to as high as 20% depending upon your tax bracket, but with either, until you sell, you only pay taxes on dividends. There are no penalties for taking money out, and no upper limits.
Putting money in a vehicle similar to a 401(k) designed for business owners. A financial planner can help you find such funds, and guide you regarding your estate plan, strategic giving, and more.
Why Are High-Income Earners at a Disadvantage?
The IRS offers several tax-advantaged retirement savings options. Most of these options, however, offer some sort of income cap - making it harder for earners of six figures to take advantage of them. But high earners face the same challenge as moderate- to low-income earning employees: sustaining a similar lifestyle in retirement similar to what they had when working and maintaining financial independence.
Once you identify the barriers you may be facing, focus your attention on the retirement saving strategies that can work best for you and your family:
401(k)s
If you aren’t doing so already, contributing to an employer-sponsored 401(k) plan is an effective place to start saving for retirement. You may defer up to $19,500 (or $26,000 if you’re 50 or older) of your pre-tax earnings toward your employer-sponsored 401(k) plan.1 Many employers will offer matching contributions as well, up to a certain percentage of your contributions. The total contribution limit for a 401(k) plan in 2021 is $58,000 (plus an additional $6,500 for those 50 and older) or 100 percent of an employee’s compensation, whichever is lower.1
The salary limit for deferring compensation is $280,000 for 2021. If you make more than this amount, this doesn’t mean you can’t contribute to your 401(k) plan. Employees can defer compensation to their 401(k) plan throughout the year, until their year-to-date earnings reach $280,000. Once that maximum is reached, employees can no longer defer earnings toward their 401(k) plan.1
As a high earner, your 401(k) will likely offer the highest contribution cap for tax-deferred retirement savings - making it an important cornerstone of your retirement saving strategy.
Traditional IRA
Roth IRAs allow retirees to make tax-free withdrawals in retirement, meaning they can be appealing for those saving for retirement. Unfortunately, it may not be an option for some high-earners. If your modified adjusted gross income is more than $140,000 as a single filer or $208,000 as a joint filer, you are not eligible to contribute after-tax dollars to a Roth IRA account. If you make between $125,000 and $140,000 as a single filer or $198,000 and $208,000 as a joint filer, you may be eligible to contribute a reduced amount.2
A traditional IRA, however, does not have an income limit, which makes it an available option for high earners. The only prerequisite is that you earn any income at all. It’s important to note, however, that you may be limited to how much of your IRA contribution you can deduct on your tax return.
How much you are able to deduct from your taxes will depend primarily on two things:3
- Your modified adjusted gross income
- Whether or not you actively contribute to your employer-sponsored retirement plan (such as a 401(k))
Backdoor Roth IRAs
Building on the strategy above, those interested in tax-free withdrawals in retirement - but aren't eligible to utilize a Roth IRA - may benefit from a backdoor Roth IRA. As the name suggests, this strategy offers high-income earners a roundabout entrance into placing their after-tax dollars into a Roth IRA account.
To do this, you'll have to:
- Open and contribute to a traditional IRA account.
- Have an account administrator provide the paperwork and instructions for converting your traditional account into a Roth IRA.
- Prepare to pay taxes on the money in the account and any gains it may have incurred.
If this is an option you may be interested in pursuing, your financial advisor or CPA will be able to offer more guidance.
If you’re earning six figures or more, it may be helpful to work with a financial advisor or retirement specialist who can help you understand your savings options. Depending on your age, goals for retirement and current financial standings, together you may determine a more aggressive strategy. Whatever strategy you choose, be sure to stay up to date on contribution limits and eligibility requirements. This can help you and your retirement savings avoid any surprise tax bills now or as you move toward retirement.
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- https://www.irs.gov/retirement-plans/401k-plans-deferrals-and-matching-when-compensation-exceeds-the-annual-limit#:~:text=The%20annual%20limits%20are%3A,401(a)(17))
- https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2021
- https://www.irs.gov/publications/p590a
This content is developed from sources believed to be providing accurate information and provided by Kelly Financial Planning. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.