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Retirement

Investment Options for High-Income Earners

You’re the CEO of your retirement—it’s up to you to take charge! And if you practice what we preach, taking charge means you’re investing 15% of your income in tax-favored retirement accounts—like 401(k)s and IRAs.

But if you’re an actual CEO—or someone else who earns a high income—you’ve got a problem (a really good problem): You make so much money that those tax-favored accounts won’t eat up your whole 15%.

Now what?

Are you stuck with only contributing to tax-favored accounts? Nope! There are plenty of options for you to keep building wealth if you bring home a big paycheck.

But before we move on, remember that saving for retirement is Baby Step 4 of the 7 Baby Steps. You should be debt-free (except for your house) and have a fully funded emergency fund before you start saving 15% for retirement.

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Following the Baby Steps is the proven way to build wealth and leave a legacy for generations to come. In fact, there’s a special group of people who have followed our plan and reached a million-dollar net worth in about 20 years. We like to call them Baby Steps Millionaires. The great thing about the Baby Steps is that they work no matter how small—or in this case, large—your income is. Let’s take a look at five investment options for high-income earners, so you can put that income to work!

1. Backdoor Roth IRA

A backdoor Roth IRA is a convenient loophole that allows you to enjoy the tax advantages of a Roth IRA. Typically, high-income earners cannot open or contribute to a Roth IRA because there’s an income restriction. For 2022, if you earn $144,000 or more as an individual or $214,000 or more as a couple, you cannot contribute to a Roth IRA.1

But there’s a way around the rule book—and it’s perfectly legal. The federal government says you can convert a traditional IRA into a Roth IRA regardless of your income. Here’s how it works: You can contribute up to $6,000 a year (or $7,000 if you’re 50 or older) to a traditional IRA.2 As soon as that money posts to your traditional IRA account, you can convert it into a Roth IRA. When you do that, you’ll pay the taxes on that money, so make sure you have the cash on hand to pay Uncle Sam.

You can also convert already-existing IRAs, like Simplified Employee Pension (SEP) IRAs or Savings Incentive Match Plan for Employees (SIMPLE) IRAs. But if you’re converting an existing IRA to a Roth IRA, you’ll pay taxes on all the money in that account, including any growth.

Depending on the size of your IRA and your tax rate, that could be a pretty hefty bill. Know that up front. Don’t make the conversion to a Roth IRA if you don’t have the cash to pay the tax bill.

Here’s the part that should make you excited: When you take money from a Roth IRA in retirement, it comes out tax-free! We like the sound of that. And you can repeat this process year after year: Invest. Convert. Pay the taxes on the money you invested. Then watch it grow tax-free.

Now, there may be some income tax implications if you’re in a higher tax bracket during the year you convert an IRA to a Roth IRA, so make sure you talk to a tax professional before you do any conversions.

Let’s summarize the pros and cons of the backdoor Roth IRA.

Pros of Investing in a Backdoor Roth IRA:

  • No income limit: Everyone earning an income is eligible to open and convert a traditional IRA—no matter how much you earn!
  • Tax-free gains and withdrawals: When you convert your traditional IRA to a Roth IRA, you pay the taxes up front and get to enjoy tax-free growth and withdrawals (once you reach age 59 1/2). 

Cons of Investing in a Backdoor Roth IRA:

  • Income taxes: It only makes sense to convert a traditional IRA to a Roth IRA when you have the cash on hand to pay income taxes.
  • Contribution limits: You cannot invest more than $6,000 in an IRA each year ($7,000 if you’re 50 or older). 

2. Health Savings Account

A Health Savings Account (HSA) is both a savings and investment account that gives you not one, not two, but three tax breaks—if you use it right! It’s like a hidden gem of investing.

To qualify for an HSA, you must have a high-deductible health plan. In the short term, an HSA acts as a tax-advantaged emergency fund for health care expenses. You can use the money you save in your HSA to pay for doctor visits, prescriptions and a whole bunch of other medical bills.

Here’s what's so great about the HSA: You contribute pretax money, enjoy tax-free growth, and withdraw from it tax-free when you use the money for medical purposes. It’s a win-win-win!

But if you shift your thinking from the short term to the long term, you can use your HSA as a “health IRA.” Because not only can you save money in your HSA, you can also invest the money in your HSA. Once you’ve contributed a certain amount (usually between $1,000–2,000), you can start investing that money into mutual funds inside the HSA.

And if you invest wisely now, this account can grow to be a big ol’ pot of money that will help you cover the cost of medical expenses in your later years. The average couple retiring today will rack up $315,000 in health care expenses (and that doesn’t include long-term care costs).3 And again, as long as you’re using the money to pay for medical expenses, you get to use it (including the growth of your investments) tax-free!

Once you turn 65, you can take money out of your HSA and spend it on whatever you’d like—just like you would with a 401(k) or traditional IRA. But you’ll have to pay taxes on those withdrawals.

Here are the pros and cons of investing in an HSA.

Pros of Investing in an HSA:

  • The “health IRA”: Save money for what could be your biggest expense in retirement—health care. 
  • Triple tax break: You can invest in an HSA with pretax money, enjoy tax-free growth, and avoid taxes if you use the money for qualified medical expenses. If you use the money on other expenses, you’ll pay regular income taxes, just like you would with a traditional IRA or 401(k). 
  • No required minimum distributions (RMDs): Traditional 401(k)s and IRAs require you to take a certain amount of money from your retirement accounts every month (Uncle Sam wants his share of that tax money!). But there are no RMDs for an HSA. You can withdraw money on your own schedule.

Cons of Investing in an HSA:

  • Conflict with Medicare: Once you enroll in Medicare, you can’t contribute to an HSA since it’s only for high-deductible health plans. But you can still use the money you’ve saved! 
  • Contribution limits: For 2022, the IRS has set the individual contribution limit to $3,650 and the family contribution limit to $7,300.4

3. After-Tax 401(k) Contributions

The maximum amount you can contribute to a traditional 401(k) with pretax dollars is $20,500 ($27,000 for those age 50 and older).5 But some employers also allow you to make after-tax contributions once you’ve reached the pretax limit.

If you decide to go this route, in 2022, you can contribute a maximum of $58,000 of both pretax and after-tax dollars (or $64,500 if you’re 50 or older).6

Now, that limit includes the pretax $20,500 you put in, plus any money your employer put in and any after-tax contributions you make. For example, if you contributed your maximum of $20,500, and your employer matched $5,000 (for a total of $25,500), then you could contribute an additional $32,500, for a total pretax and after-tax contribution limit of $58,000.

When you retire or when you leave a company, you can take that after-tax 401(k) money and put it in a Roth IRA where you can continue to grow wealth.

Before you go with the taxable 401(k) contributions, make sure you max out your other tax-favored accounts, like your IRA or Roth IRA. Here’s a quick recap of the pros and cons of after-tax 401(k) contributions.

Pros of After-Tax 401(k) Contributions:

  • Automated contributions: Every time you get paid, you can sweep some of that money into your 401(k). Putting your savings on autopilot is a great way to consistently build wealth. 
  • Access to mutual funds: Invest in the same mutual funds where you invested your pretax dollars. 
  • Simplify your life: Keep all (or most of) your investment dollars in one convenient location—your 401(k).

Cons of After-Tax 401(k) Contributions:

  • No tax break: Any of your contributions above $20,500 are not tax-deductible.

4. Brokerage Accounts

Brokerage accounts—also called taxable investment accounts—allow you to purchase basically any type of investment: stocks, bonds, mutual funds and exchange-traded funds (ETFs). 

Once you’ve maxed out your tax-favored plans, like your 401(k), 403(b) or IRA, you can still save your money wisely by investing it in a brokerage account. Sure, you won’t get a tax advantage. But you’re still getting more for your money by growing it instead of letting it gather dust in a checking or savings account!

You can open a taxable investment account with a bank or brokerage firm directly. And you can even set up automatic withdrawals from your bank into that investment account each month.

There are some pros and cons to taxable investment accounts. Here are a few to think about.

Pros of Investing in a Brokerage Account:

  • No contribution limit: With a taxable investment account, you can invest as much as you want each year. 
  • Flexibility: You can take money out at any time for any purpose without having to pay penalties. This flexibility is important if you want to retire early and need an income stream. 
  • No required minimum distributions: You get to decide when and how much you want to withdraw.

Cons of Investing in a Brokerage Account:

  • No tax breaks: You invest with after-tax money, and you pay capital gains taxes when you withdraw money. You also pay taxes on dividends that you keep instead of reinvesting. 
  • Liability: Investments made in a 401(k) (and other similar retirement accounts) are protected from a lawsuit. That’s not the case with a taxable account. That’s why you need umbrella insurance.

5. Real Estate

Investing in real estate is super popular, and if you do it right, you can get a good return on your money. Homeownership is the first step in real estate investing—so pay off your house before investing in any other real estate.

Real estate is the most hands-on and time-consuming of your investing options. So don’t dive headfirst into real estate unless you have a real passion for it. Before you buy, do your homework. Talk to people who’ve done it. They’ll tell you what it’s really like.

Also, talk to an insurance agent about what kind of coverage you’ll need, especially if you invest in rental property. Do the math to see how much money you’d actually make after expenses, including taxes, utilities and other costs. And never, ever borrow money to buy real estate. Only buy investment properties when you can pay cash for them.

Purchasing land is a less hands-on approach to investing in real estate. If you’re in an area where the housing industry is booming, purchasing land on the outskirts of town might be a good option. The outskirts may become a new subdivision before you know it! As with other investments, do your homework before you buy land. And be sure you’re working with a top-notch real estate agent when you’re ready to buy.

Pros of Investing in Real Estate:  

  • Tried-and-true investment: If you play it right, real estate can be a great source of income. Real estate almost always goes up in value, and you can make good passive income from rental properties. 
  • Diversify your portfolio: Diversification (spreading out your money over different types of investments) is one of the most important ways to build wealth while minimizing risk. 

Cons of Investing in Real Estate:

  • Time consuming: Real estate is a hands-on, all-consuming investment. Being a landlord has challenges.
  • Risk: A rental property could sit vacant for months, which means you’re not collecting rent. You also have to pay for repairs and other expenses.
  • Property values fluctuate: Just like the stock market rises and falls, the value of your property can change depending on what happens in the area surrounding it.

Work With an Investment Professional

Whether you're a high-income earner or just getting started in your career, always talk with an investment professional before you choose any of these investing options. If you don’t have a financial advisor, check out a SmartVestor Pro. These men and women will help you make sure you know all your options based on your income and investing goals. They know the IRS rules for income restrictions, contribution limits and catch-up options for investing. These decisions are too important to go it alone.

Get a pro on your team!

These are general guidelines. Your situation may be unique. If you have questions, connect with a SmartVestor Pro.

Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners. Learn More.

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