High-income households may find retirement savings beyond the 401(k) method daunting. Depending on tax filing status, higher income earners may contribute after-tax amounts to a Roth IRA, thanks to recent Internal Revenue Service changes. Notice 2014-54 outlines how pre- and post-tax amounts may be contributed to 401(k) and Roth 401(k) plans. Investors can check with their plan administrators to see if this is an option.
The Backdoor Roth
Another legal strategy carries the sketchy name “Backdoor Roth IRA.” It works by first funding a traditional IRA account. That account converts to a Roth IRA, the day after the original account sets up. Tax bills probably won’t happen, due to the quick conversion. Taxes would apply only on money earned prior to conversion. The short time between the flip from traditional to Roth IRA keeps this amount small, if there at all.
Avoid Non-Deductible IRAs
While there it’s an option to receive tax-deferred growth this way, there’s no upfront tax savings, with future withdrawals remaining taxable as income. This makes investments that produce capital gains attractive. Even though these are taxable, the rate is almost always lower than income tax rates. Individual stocks and exchange-traded funds, or ETFs, work the same way. When you sell these investments, earnings get taxed as capital gains. While there are minor costs along the way, qualified dividends also tax at the capital gains rate. As well, you can harvest losses from these investments strategically, further reducing long-term tax exposure. Taxable accounts also feature some estate planning benefits. Finally, having a mix of tax-advantaged and taxable accounts gives some flexibility when it comes to tax bracket management when planning post-retirement cash flow.