High Earners: Maximize Your Retirement Savings

Saving for retirement is a top financial goal for everyone, but for high-income earners, traditional methods may not be enough to secure a comfortable future. Here are a few advanced strategies to help bolster your retirement savings.

What about a Roth IRA?

In some cases, it makes sense to forgo the immediate tax deduction of a traditional IRA in favor of the tax-free growth and tax-free distributions of a Roth IRA. Unfortunately, there are IRS limitations on how much you can contribute to a Roth IRA if you’re a high-income earner. In 2024, these income threshold levels start at $146,000 for single filers and $230,000 for married people filing jointly. So, what can you do if you participate in your employer-sponsored retirement plan and are hindered by IRS income limitations? Consider two less common alternatives to saving that can offer tax-free growth and tax-free distributions.

A backdoor Roth allows high earners to qualify for a Roth IRA

If your income level exceeds the allowable amount to qualify for a Roth IRA, you can use the backdoor Roth strategy. The backdoor Roth strategy involves making nondeductible contributions to a Traditional IRA and subsequently converting it into a Roth IRA. Although this incurs ordinary income tax on the conversion amount, the earnings and growth in the Roth IRA become tax-free after five years. This strategy is particularly beneficial for individuals in their early retirement accumulation phase with discretionary income unable to make direct Roth IRA contributions.

Ideally, this strategy works best for those with discretionary income who are in their early retirement accumulation phase, and who can’t make direct Roth IRA contributions. As with any IRA contribution, deductible or non-deductible, an individual must have earned income from wages, tips, and other taxable employee pay. Optimally, it helps if you don’t have other traditional or rollover IRAs lingering from previous years that are eligible for deductions (IRS aggregation rules apply when you own multiple IRAs). To ensure that you have a clean transaction with minimal tax implications, be mindful to convert non-deductible contributions in your IRA to a Roth IRA.

Some caveats about Roth conversions

If you have other open IRAs from previous jobs or rollovers, it may still be possible to take advantage of a Roth conversion. Complexities and potential tax implications exist; we recommend consulting with your financial advisor.

In addition, you can no longer change your mind once you’ve processed a Roth conversion (previously called a “recharacterization”). With the passage of tax laws in early 2018, the IRS removed this option – but Roth conversions may still make sense.

Determining if you are a good candidate for these Roth conversion strategies involves several factors:

• You may be eligible for a Roth conversion if at some point in the past you made after-tax contributions to your401(k), but never converted those dollars to Roth dollars or an IRA.
• If you have tax-deferred growth on your after-tax dollars in an IRA, it can be moved to one of your other tax-deferred retirement accounts, such as a 401(k), allowing it to continue to grow tax-deferred, and helping you avoid an immediate taxable event.
• If you have excess discretionary income saved in a checking, savings, or brokerage account.

Maximize your 401(k): Unlock after-tax plan contributions

High-income earners can optimize their retirement savings through after-tax contributions within their employer’s defined contribution plans, such as the 401(k). These plans, including 401(k), 403(b), and most 457 plans, offer tax-deferred benefits and have annual employer-plus-employee funding limits. In 2024, the limit stands at $69,000, rising from $66,000 in 2023, and $76,500 for individuals aged 50 and older. While the salary deferral limit is commonly known, it’s crucial to recognize the potential for additional contributions beyond this limit.

If the combination of employee and employer contributions doesn’t reach the annual funding limit, after-tax contributions present an opportunity. This commonly overlooked strategy will depend on whether your 401(k) plan provides this option. Typically, larger company plans offer this feature.

If your 401(k) plan does permit after-tax contributions, you may be able to make additional non-deductible contributions to reach the maximum funding limit. But the optimization doesn’t end there. To fully capitalize on the strategy for tax-free growth and distributions, converting these after-tax dollars into Roth dollars is recommended.

Conversion methods include utilizing a Roth IRA to receive the conversion from the 401(k) or exploring “In Plan” conversions offered by some plan administrators. Your company’s retirement plan rules dictate whether you can leverage these options effectively. Hence, consulting your plan administrator is imperative to understand available strategies and maximize your retirement savings potential.

Talk with your advisor

Generally, the faster you can turn after-tax dollars into Roth dollars, the quicker you can start compounding tax-free growth, instead of just deferring eventual taxes on the growth. If you are an existing client, contact your advisor and your plan administrator to see if you can implement these strategies for your retirement planning. If you’re not a client and would like more information, contact us.