For most high-income professionals, the first step in a long-term savings strategy is to fund an employer-sponsored retirement account (such as a 401K or SIMPLE IRA).
There are several ways that you can position the income you have earmarked for retirement savings, often in accounts that have tax advantages, such as Traditional and Roth IRAs, but there are other options as well.
Each of these options offers unique benefits and considerations that make them better suited for different circumstances and goals.
So, once your retirement accounts are being max funded on a recurring basis, where should additional cash allotted for long-term savings goals be positioned, and what risks and benefits do each offer?
That is the question we will discuss in today’s blog, so let’s dive in!
Maxed Out Retirement Accounts
High-income professionals tend to find themselves in higher tax brackets and more complex tax situations. As a result, it is often advisable to invest additional money intended for long-term savings goals into accounts that have tax benefits associated with them.
Some popular examples of accounts that fit these criteria are Traditional IRAs and Roth IRAs.
However, the IRS imposes income limits on who can contribute to these types of accounts and still enjoy the tax benefits. Let’s discuss some details for IRAs, deferred compensation agreements, and brokerage investment accounts:
Traditional IRAs
For most high-income households that have access to an employer-sponsored retirement plan (such as a 401K), contributions to a Traditional IRA are often not able to be deducted from taxable income.
However, non-deductible contributions can still be made to this type of account regardless of taxable income. These non-deductible contributions can continue to grow in the account, with tax being deferred on the gains until the funds are withdrawn later in life (when one’s tax situation might possibly be less complex).
Roth IRAs
Roth IRA contributions are not deductible for tax purposes. However, the funds grow tax-deferred and can be withdrawn tax free later in life. As a result, these types of accounts are very beneficial!
The IRS imposes income limits on who can contribute to a Roth IRA. However, these income limits are much higher than the limits on deductible Traditional IRAs noted above. As a result, some high-income households can still contribute to these accounts.
For those with incomes high enough to exclude them from eligibility to contribute directly, a strategy that is often considered is called a Roth conversion.
A Roth conversion strategy is very complex and there are nuances to consider, so careful coordination between your tax professional and financial advisor is important.
Deferred Compensation Agreements
A third, less popular alternative for long-term savings for some high-income professionals is to work with their employer to enter into a deferred compensation agreement.
This involves voluntarily deferring income from the current year to a future year when taxable income is projected to be lower. These types of arrangements are complex, and it is important to fully understand all the ramifications.
As a result, working with a tax advisor, a financial advisor, and an attorney is advisable.
Brokerage Investment Accounts
Lastly, a very common place for additional cash savings is for that cash to be contributed to a brokerage investment account and positioned in a diversified mixture of stocks and bonds.
This is a very common strategy for additional savings for intermediate- and long-term goals for the following reasons:
- There are no maximum contribution amounts, the sky is the limit!
- There are no account-related or tax-related restrictions on withdrawing the funds from the account (unlike the other accounts noted previously).
There are a few things to consider with this type of account, however:
- It is important to understand how the funds are being invested, as some investments have withdrawal restrictions of their own.
- Interest, dividends, and capital gains realized in these types of accounts will affect taxable income. As a result, careful investment selection and ongoing management is vital.
Coordinated, Comprehensive Financial Planning Is the Key
As you can see by now, there are numerous rules and restrictions on the strategies outlined above and many factors to consider on which strategies are best to employ. As a result, consultation and coordination with your entire planning team (your income tax professional, attorney, and financial advisor) is very important!
If we can help you, or someone you know, please feel free to contact us!
