What If Your Income Is Too High for an IRA?

by Emily Guy Birken · 9 comments

High-earners are in something of a Catch-22 when it comes to saving for retirement. On one hand, they have the extra income available to fully fund tax-deferred retirement vehicles — but that extra income often disqualifies them from the accompanying tax breaks.

The IRS limits tax-deductible contributions to Traditional IRAs to those individuals who earn $69,000 or less, and married couples who earn $115,000 or less. Roth IRA contributions are limited to individuals who are making less than $127,000, and married couples who are making less than $188,000.

So, what are the best investment options for these high-earners? Here are three ways high-income individuals and couples can still put away money for retirement — without feeling overwhelmed by the taxman.

1. Roth IRAs

If your income is above the Traditional IRA limit, but below the Roth IRA limit, this is an excellent option. The Roth version of this investment vehicle front-loads your tax burden. So, instead of funding the IRA with pre-tax dollars (as you do with a Traditional IRA) and then owing taxes when you withdraw the money, you put money you’ve already paid taxes on into the IRA, and owe nothing when you withdraw.

2. Non-Deductible Traditional IRAs

If you can’t contribute to a Roth IRA because your income is above that limit, you still have the option of contributing to a non-deductible Traditional IRA. Basically, you’ll be putting taxable income into the IRA; you can’t deduct your contribution, and will have paid taxes on the amount you contribute.

You’ll also owe taxes on the money you withdraw from your non-deductible IRA — but only on your gains. The original amount you contributed has already been taxed, so it’s safe from Uncle Sam’s tax bite.

This is better than a fully taxable brokerage account because your money does grow tax-deferred. So even though you’ll owe money on the gains you receive from your investments, you won’t be taxed until after your money has compounded over the years, thereby reducing your overall burden. Taxable brokerage accounts owe money to the IRS on interest and dividends each year, meaning there’s less money available in the accounts to benefit from compound interest.

3. Backdoor Roth IRA Contributions

The best option for many high earners will be using the backdoor provision for opening a Roth IRA. As of 2010, the government eliminated income limits for converting a Traditional IRA to a Roth IRA. This means that any high-income earner who’s priced out of opening a Roth account still has the opportunity to take advantage of one.

What you’ll have to do is open a non-deductible Traditional IRA account, and then immediately roll it over into a Roth IRA. Since you’ve already funded the non-deductible Traditional IRA with post-tax dollars, you’ll only owe money on any gains your investment has made — and if you do an immediate conversion, there should be no gains and therefore no tax bill.

Your money in the Roth account will then grow completely tax-free, and you’ll owe nothing when you withdraw it during retirement.

David’s Note: Be careful when you attempt a backdoor Roth conversion. It’s true that this maneuver can turn a non-deductible Traditional IRA contribution into money inside a forever tax free Roth IRA, but taxes on the conversion will be calculated based on all assets in your pre-tax IRAs (like a Traditional or a Rollover IRA). Before you consider such a move, make sure you don’t own any pre-tax IRAs first. Otherwise, you might get an unexpectedly large tax bill.

The Bottom Line

Having a high income is certainly a good problem to have, but that doesn’t change the fact that figuring out a tax-efficient way to save for retirement can be a headache. Any of these three options can help high-earners save for retirement and minimize their overall tax burden.

Have you tried any of these methods of saving for retirement?

Editor's Note: I've begun tracking my assets through Personal Capital. I'm only using the free service so far and I no longer have to log into all the different accounts just to pull the numbers. And with a single screen showing all my assets, it's much easier to figure out when I need to rebalance or where I stand on the path to financial independence.

They developed this pretty nifty 401K Fee Analyzer that will show you whether you are paying too much in fees, as well as an Investment Checkup tool to help determine whether your asset allocation fits your risk profile. The platform literally takes a few minutes to sign up and it's free to use by following this link here. For those trying to build wealth, Personal Capital is worth a look.

Money Saving Tip: An incredibly effective way to save more is to reduce your monthly Internet and TV costs. Click here for the current Verizon FiOS promotion codes and promos to see if you can save more money every month from now on.

{ read the comments below or add one }

  • Poobah says:

    Looking for advise on weather or not to contribute to a Traditional IRA that is nondeductible. Our household income is too high for Roth, and Tradtional is nondeductible at our level. We both have 401ks. One of our 401ks is an individual, and does not allow us to save much per year, as it is tied to profits of a very, very small business. Look forward to hearing suggestions. Thank you.

  • fredjohnson says:

    My income is too high to qualify for Roth or deductible Traditional IRA. I max out my SIMPLE at work. I can contribute to a Traditional IRA, but choose not to because I’d rather accumulate that money in 3 broadly diversified stock/bond index funds. The advantage to using these funds is that they are ultra low expenses—.06% annual for the cheapest one. Index funds do very little trading so there is never any substantial capital gains until you sell out. There is some dividend income but that is “qualified” so it’s at a lower tax bracket. I use Vanguard Tot Stk Mkt, Vang Intl Stk Mkt and Vang Interm Municipal Bond. I have several million dollars in these three funds/ETF’s. If I put money into and IRA instead, then all the gains are taxed as “ordinary income”, so that means you are taxed at your highest income tax bracket when you take the money out. I don’t like that idea, and not sure why anyone would. Lastly, $5k a year max into an IRA isn’t that much to mess with when I need to find a place to invest closer to $200k per year of new money.

    • CFPKCMO says:

      You clearly don’t know what you’re talking about Fred Johnson and need to hire a Financial Planner. You could hold all 3 of those index funds inside an IRA or other type of qualified account. There are also much better places to park 200K a year with tax advantages than in a standard brokerage account. Lastly, another reason you need a Financial Planner is to help minimize that tax burden when you do withdrawal from the qualified accounts. It is taxed as ordinary income you are correct but there are ways to offset, minimize and control those taxes.

      You sound like an arrogant physician who thinks he knows far more about financial planning industry than he really does.

      • Gabe W says:

        CFPKCMO – at least Fred Johnson gives a thought out response which can be validated. All you do is talk, do not outline a way to offset the enormous amount of taxes that you claim a financial planner can “minimize.” You also put down doctors, for no good reason.
        If you are so knowledgeable, tell us, how can you minimize taking the gains from the IRA?
        Oooh, I think I know the answer, talk to a Financial Planner….

  • Tony O. says:

    One other consideration before you put money into a Roth IRA… for many retirees you may actually end up in a lower tax bracket come retirement… so it might not make sense to pay higher current taxes upfront by participating in a Roth IRA when you could potentially pay lower taxes during retirement when withdrawing from a traditional IRA.

    Of course it might be hard to predict what tax bracket you’ll be in 10-40 years from now, but it’s a calculated projection – when you retire you won’t have a steady salary anymore and will rely instead of your retirement savings, which likely will be be less than what your household earnings were during your peak working years.

  • Emily nice post. However I would view the retirement savings opportunities for high wage earners a bit differently. First if they work for company offering a 401(k) or similar plan they likely can afford to contribute the maximum amount to the plan which in virtually all cases should be done. Additionally if they are at a high enough level some companies offer supplemental retirement plans which offer additional retirement savings and tax-deferral opportunities. A note of caution here is that these are generally non-qualified plans which carry a set of risks that should be understood before investing.

    Self-employed professionals also have a variety of opportunities including a SEP-IRA, Solo 401(k), and even a pension plan. the opportunities for tax-deferred retirement savings are plentiful, but this takes some planning.

    I think that not being able to contribute to an IRA on a tax-deferred or a Roth basis should be a pretty low priority for a high income person.

  • Good advice. I actually did run into this when I was still working. It was a big pain to sort out at the time and is still confusing from a tax standpoint today.

  • You can also try to bring your income below those limits by making pre-tax contributions to your 401(k) plan (if that’s an option, and if you’re close enough to the limit, and if you want to save pre-tax money…).

  • Amber says:

    I was contributing to an IRA and then we started hitting these maximums and the converting thing is such a pain in the butt with liquidation and paperwork and extra tax stuff to report.

    So I decided to just contribute what I would have put in the IRA into my work’s 401k, which they match, and I don’t have to deal with limits and conversions and stuff. Even if my employer didn’t match, these seems like a simpler solution, unless you’re 401k options are crap or you’re already maxing those out.

Leave a Comment