Posted by The TaxAdvocate Group, LLC

The Best Tax Tips For High-Income Earners

The Best Tax Tips For High-Income Earners

15% of family income must be invested to build wealth to prepare for a strong financial future. You are the CEO of your retirement, and it's up to you to take control! But if you have a high income, you are in a unique situation. Maximize contributions to tax accounts, like a 401(k) or IRA, before reaching the15% benchmark.

Now what?

Have you just been blocked by contributing to the tax increase accounts? No! There are plenty of options for accumulating more wealth if you earn a big check. Here are some investment options for high-income earners.


Roth IRA backdoor

A Roth IRA back door is a convenient hatch that allows you to take good advantage of the tax benefits offered by a Roth IRA. Typically, high-income earners cannot contribute or open a Roth IRA because there is an income restriction. Here are the 2020 fiscal year numbers: If you earn $139,000 or more as an individual or you make $206,000 or more as a couple, you cannot contribute to a Roth IRA.

But there is a way around the regulations, and it is perfectly legal. The government says you can convert a traditional IRA to a Roth IRA regardless of your income. 

For instance: You can contribute up to $6,000 per year (or $7,000 if you're over 50) to a Traditional IRA, or you can open a new one. Once the funds are in your traditional IRA, you can convert it to a Roth IRA. That way, you will be paying taxes for that money, so make sure you have the money on hand to pay Uncle Sam.

You can also convert existing IRAs, such as the Simplified Employee Pension (SEP) or the Savings Incentive Match Plan for Employees (SIMPLE) IRA. But if you convert an existing IRA account, you'll pay tax on all the money in that account, including any increases since you opened it. This can be quite a bill, depending on the size of your IRA and the tax rate,  

Don't convert to a Roth IRA if you don't have the money to pay taxes. If you are unsure which investment accounts can be transferred to Roth Options, talk to a tax professional.

When you later withdraw money from a Roth IRA, it's tax-free! And you can repeat this process yearly. Invest. Convert. Pay taxes on the money you have invested. Watch it grow without taxes. Repeat every year.

Now, there may be tax implications if you are in a higher tax category in the year you convert from an IRA to a Roth IRA, so talk to a tax professional before making any conversions.


Let's summarize the pros and cons of Roth Funds IRA.

Cons of investing in a Roth IRA:

  • No income limit: All employees are eligible for a traditional IRA, regardless of their income limit.

  • Tax-free income and withdrawals: If you convert your traditional IRA to a Roth, you will pay taxes upfront and enjoy tax-free growth and withdrawals (after 59½ years).

Cons of investing in a Roth IRA fund

  • Income Tax: When converting from a traditional IRA to a Roth, make sure you have the money available to pay income tax.

  • Contribution limits: you can't invest more than $6,000 in an IRA each year ($7,000 if you are over 50)


Savings account for medical expenses.

A Health Savings Account (HSA) is a savings account and investment account that offers not one, not two, but three tax breaks - if you use it right! It's like a hidden investment gem. To be eligible for an HSA, you must have a health plan with a high deductible. In the short term, an HSA serves as a tax-subsidized emergency fund for health care costs. You can use the money saved on the HSA to pay for medical appointments, prescriptions, and a large number of medical bills. Here's the best thing about the HSA:

  • Contribute pre-tax money.

  • Enjoy tax-free growth.

  • Withdraw tax-free money when used for medical purposes.

It's a win-win situation, but if you change your mind from the short term to the long term, you can use your HSA as a "health IRA." In addition to savings, the HSA offers the possibility of investing. Once you have contributed a certain amount (usually between $1,000 and $2,000), you can start investing that money in HSA mutual funds. And if you invest wisely now, that account can turn into a large sum of money to help cover the cost of medical bills for years to come. The average couple retiring today will accumulate $285,000 in health care costs (and that does not include long-term care costs) or Traditional IRA and spend it for what you want.

In short, these are the pros and cons of investing in an HSA.


Pros of investing in an HSA:

  • Health IRA: Save money on what may be the biggest expense in retirement: health care.

  • No Required Minimum Distribution (RMD): Traditional IRAs and 401(k) accounts require you to withdraw a certain amount of money from your retirement accounts each month (Uncle Sam wants his share of that tax money!). But there is no RMD for an HSA. You can withdraw money on your schedule.

  • Triple Tax Cut: You can invest in pre-tax cash HSA, get a tax-free increase, and avoid tax if you use your retirement money for qualifying medical bills. If you use the money for other expenses, you'll pay regular income tax just like you would with a traditional or 401(k) IRA.

Cons of investing in an HSA: 

  • Conflict with Medicare: Once enrolled in Medicare, you cannot contribute to an HSA because it is a high deductible plan. But you can still use the money you saved!

  • Contribution limits: For the 2020 fiscal year, the IRS has set the individual contribution limit at $3,550 and the family contribution limit at $7,100.


401(K) after-tax contributions

Some employers allow after-tax contributions to their 401(k) plans, in addition to the maximum pre-tax amount you can contribute ($19,500 plus $6,000 for those over 50). If you decide to go this route, you can contribute up to $57,000 in pre-and after-tax dollars (or $63,500 if you're 50 or older) for the 2020 fiscal year.

This limit now includes the pre-tax contribution of $19,500 you made, plus any money your employer contributed and any after-tax contributions you make. For example, suppose you contributed a maximum of $19,500 and your employer contributed $5,000 (for a total of $24,500). In that case, you could contribute an additional $32,500 for a total before and after the contribution limit of $57,000.

When you retire or leave a business, you can take that money after 401(k) taxes and put it in a Roth IRA.

Before making your taxable 401(k) contributions, be sure to maximize other accounts with tax incentives, such as the IRA or Roth IRA. Here are some pros and cons of 401(k) after-tax contributions.


Pros of 401(k) after-tax contributions:

  • Access to mutual funds: invest in the same mutual funds in which you invested pre-tax dollars.

  • Automatic contributions: You can transfer part of this money to your investment account with each payment. Setting savings on autopilot is a great way to consistently build wealth.

  • Make your life easier: Keep all (or most) of your investments in one convenient place: 401(k).

Cons of 401(k) after-tax contributions:

  • No Tax Break: All your contributions over $19,500 are tax-deductible.


Brokerage Accounts

Brokerage accounts, also known as taxable investment accounts, allow you to buy virtually any type of investment: bonds, stocks, mutual funds, and exchange-traded funds (ETFs).

Once you've exhausted your plans with tax incentives like a 401(k), 403(b), or IRA, you can spend your money wisely by investing it in a brokerage account. Obviously, you will not have tax benefits. But you always get more for your money by raising them instead of letting them collect dust in a checking or savings account!

You can open a taxable investment account directly with a bank or broker. And you can set up automatic withdrawals from your bank to this investment account every month.

Taxable investment accounts have certain advantages and disadvantages. Here are a few to think about.


Pros of investing in a brokerage account:

  • Flexibility: you can withdraw money at any time and for any purpose without having to pay taxes or fines. This flexibility is essential if you want to retire early and need an income stream.

  • No contribution limit: You can invest as much as you want each year with a taxable investment account.

  • No minimum distribution is required: you decide when and how much you want to withdraw.


Cons of investing in a brokerage account:

  • Debts: Investments made in a 401(k) account (and other similar accounts) are protected by legal action. This is not the case for a taxable account. This is why you need non-life insurance.

  • No tax exemption: invest in after-tax cash and pay capital gains tax when you withdraw money.


Bottom Line

Whether you have a high income or are just starting your career, always talk to your investment professional and a tax expert before choosing any of these investment options. They will help you figure out the best options based on your income and investment goals. They know the IRS rules on income restrictions, contribution limits, and investment rebate options. These decisions are very important to be made on your own.


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