Don’t Let Income Limits Limit You: Retirement Savings Strategies for High-Income Earners

While workers have a variety of ways to save for retirement in tax-advantaged accounts such as individual retirement accounts (IRAs) and 401(k)s, high-income professionals face restrictions that can curb their ability to fully utilize these plans’ tax benefits. Retirement plans have income limits that can cap the amount they and their employers can contribute. If you earn a good salary, your expenses such as housing and education costs for your children may understandably be higher. Yet if you save only to the annual limit in your 401(k), you may not be saving the recommended 15% or more of your salary needed to maintain your lifestyle in retirement.

For example, on top of 401(k) plans capping the amount that any worker can defer from their salary at $19,000 as of 2019 (plus $6,000 in catch-up contributions for those 50 and older), an annual compensation limit of $280,000 affects employer contributions. With this limit, employers can match contributions only until the employee reaches that income level year-to-date.

So, if someone makes $560,000 a year, the employer can match contributions for the first six months of the year, until the employee has earned $280,000. But after that, the employer wouldn’t be able to make contributions. Most importantly, saving $19,000 a year (or $25,000 a year including catch-up contributions for those 50 and older) is not likely to be enough if your lifestyle is supported by a high income. The IRS officially considers “Highly Compensated Employees” to be those who earn more than $120,000 in 2019. 

Although these restrictions have the good intention of making saving for retirement more equitable among workers of all income levels, high-income professionals can miss out on saving enough for retirement if they are not careful.

Thus, you may not have enough to keep up with your expenses in retirement—unless you take other steps to save, such as:

Optimize the Timing of 401(k) Contributions
If your employer offers 401(k) matching, you may maximize the amount they can contribute by saving more in your 401(k) at the beginning of the year, before you reach the annual income limit.

As in the example above, if you’ll hit the income limit in July, try to reach the $19,000 contribution limit in the first half of the year so that your employer doesn’t face restrictions on matching contributions.

Maximize HSA Contributions and Postpone Withdrawals
If you have access to a health savings account (HSA), you can use this as a supplementary savings account in retirement. HSAs are triple tax-free: The contributions you make are tax-deductible, earnings are tax-deferred, and withdrawals are tax-free if used for qualified medical expenses, such as medications, consultations, dental care, and eye care.

To qualify for an HSA, you need to have a high-deductible health insurance plan, with a deductible of at least $1,350 if the plan is just for yourself and $2,700 for a family plan. You can then contribute up to $3,500 if you have a plan for yourself and $7,000 if you have family health coverage.

To optimize this account, try to max out your contributions, but do not withdraw from the HSA until you turn 65. In the meantime, pay for your medical bills with your regular after-tax income, and let the money in the HSA accumulate to be used as a supplemental asset in retirement.

Consider a “Backdoor” Roth IRA
Roth IRAs are a popular way to save for retirement, allowing you to contribute after-tax money that can grow and be withdrawn tax-free. However, you can’t directly contribute to a Roth IRA if your modified adjusted gross income (AGI) is $137,000 or more, or if you’re married filing jointly and have a modified AGI of $203,000 or more.

Still, there’s a fairly simple way to convert a traditional IRA into a Roth IRA by paying income taxes on the traditional IRA and then completing the conversion. (The Roth will be subject to a five-year holding period before you can withdraw that money without a penalty.)

The annual contribution limit for an IRA is $6,000 per person, so both you and your spouse, if applicable, could contribute this amount to your respective IRAs each year and convert these contributions into Roth IRAs—or wait a few years and convert larger amounts.

That said, Roth IRAs are not guaranteed to be a better option than traditional IRAs. Their benefit to you will depend on your tax status and how income taxes might change in the future. Speak with your financial advisor or a tax professional to see what’s best for you.

Invest in a Taxable Brokerage Account
While taxable brokerage accounts don’t come with immediate tax benefits, they have advantages that make them attractive to high-income earners.

Contributions are made with after-tax dollars, but there’s no limit to how much you can save in them. If you hold investments for at least a year, you’ll only pay the long-term capital gains tax rate, which is currently 15%—unless you fall into the top income tax bracket ($425,800 for single filers or $479,000 for married filing jointly), where you would then pay 20% on the gains.

Another positive of these accounts is that they are flexible in terms of when and how you contribute, invest, and withdraw from them. However, this flexibility can make them tempting to use before retirement, so you may want to set up a separate brokerage account for retirement savings, aside from a brokerage account that can be used for expenses during your working years.

Consider Working for Yourself
If self-employment is an option, even if it means transitioning into an independent contractor role with your current employer, you may be able to expand your savings options by setting up your own retirement plans.

Your options may include:

  • Solo 401(k) plan: If you’re self-employed and set up this type of plan, you can contribute up to $19,000 for yourself and make a contribution from your business to your account. That amount can be up to 25% of your compensation as long as the contribution does not exceed $56,000.

  • Simplified Employee Pension IRA (SEP-IRA): SEPs are like solo 401(k)s, where you can make profit-sharing contributions totaling 25% of net earnings, up to $56,000. These plans can potentially be easier to manage administratively than a solo 401(k), but you should compare both with your financial advisor or a tax professional to see what works best for your business and personal situation.

  • Personal defined benefit plan: A more complex but potentially lucrative option is to set up a personal defined benefit plan. Setting one up begins by determining your projected annual benefit once you retire. You then calculate the annual contribution you need to reach the defined benefit, based on your life expectancy, current age, and return assumptions. Some annual contributions can reach more than $100,000, which allows small business owners to save significantly more in this plan compared with others.

    Here’s the caveat: Defined benefit plans have setup and administration fees that you don’t find in other retirement contribution options. And when the plan is in place, you are required to pay the annual contributions for at least five years. This plan is best suited for individuals who can contribute at least $80,000 yearly.

Talk to Your Boss About a Safe Harbor Plan
If your employer’s 401(k) plan does not meet certain thresholds of deferrals and contributions among most employees to the point where primarily just high-income employees benefit from the plan, then contributions from high-income earners may not be tax-deductible.

These IRS rules can be complex, but the bottom line is that if your employer wants to avoid this problem and help ensure that all employees can benefit from 401(k)s, they may want to switch to a safe harbor 401(k). These plans avoid the complex rules testing benefits amongst employees, in exchange for all employer contributions being fully vested for employees right away.

Explore If Your Employer Offers an After-Tax 401(k)
Certain 401(k) plans allow you to contribute after-tax dollars up to $56,000 ($62,000 if eligible for catch-up contributions) or 100% of your compensation. The earnings from after-tax 401(k) contributions grow tax-free until you withdraw them, at which point they will be taxed as ordinary income. Contributions to these plans can also be rolled into a Roth account, thereby providing further tax benefits.

These are just some of the many ways you can increase your retirement savings as a high-income earner so that you have enough to support your lifestyle during your golden years. Your financial advisor can help you navigate the ins and outs of each option and assess which ones will fit your income and financial goals.

The ideas in this article are general in nature and are not meant to be tax advice. You should consult with a qualified tax advisor about your specific situation.

Schedule a complimentary “get acquainted” meeting with a fee-only financial advisor to discuss your situation.