Where High Income Earners Can Invest Money

10 Min Read | Sep 27, 2021

In order to ready for a solid financial future, you lot should invest 15% of your household income to build wealth. You're the CEO of your retirement—it's upwardly to you to take charge! But if you're a high-income earner, you find yourself in a unique situation. You max out your contributions to tax-favored accounts—like a 401(k) or an IRA—before you reach the xv% mark.

Now what?

Are you stuck with but contributing to tax-favored accounts? Nope! There are enough of options for yous to keep building wealth if you bring home a large cheque. Here are 5 investment options for high-income earners.

1. Backdoor Roth IRA

A backdoor Roth IRA is a convenient loophole that allows you to enjoy the revenue enhancement advantages that a Roth IRA has to offer. Typically, high-income earners cannot open or contribute to a Roth IRA because there's an income restriction. Here are the numbers for 2020: If yous earn $139,000 or more as an individual or $206,000 or more than as a couple, you cannot contribute to a Roth IRA.ⁱ

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But at that place's a way around the rulebook—and it's perfectly legal. The federal government says you lot can convert a traditional IRA into a Roth IRA regardless of your income. Here's how it works: You can contribute up to $six,000 a year (or $seven,000 if you're fifty or older) to a traditional IRA or open a new IRA. As soon as that money posts to your traditional IRA account, yous tin catechumen that IRA into a Roth IRA. When y'all practise that, you'll pay the taxes on that money, so make sure you have the cash on hand to pay Uncle Sam.

Y'all can also convert already-existing IRAs, like Simplified Employee Pension (SEP) IRAs or Savings Incentive Friction match Plan for Employees (Elementary) IRAs. But if you're converting an existing IRA, you'll pay taxes on all the money in that account, including any growth that has occurred since you opened it. Depending on the size of your IRA and your tax rate, that could exist a pretty hefty bill. Know that upwardly front. Don't make the conversion to a Roth IRA if yous don't have the cash to pay the tax neb. If y'all're non sure which investment accounts can be rolled over into Roth options, the IRS has a department on its website dedicated to this topic.

Here's the part that should make you excited: When yous take money from a Roth IRA later, information technology comes out tax-gratuitous! Nosotros like the sound of that! And yous can repeat this process year later on year. Invest. Convert. Pay the taxes on the money yous invested. Then watch information technology grow taxation-free. Echo every yr.

Now, in that location may be some income tax implications if you're in a college taxation bracket during the twelvemonth you convert an IRA to a Roth IRA, and then brand certain you talk to a tax professional before y'all do any conversions.

Allow's summarize the pros and cons of the backstairs Roth IRA.

Advantages of Investing in a Backdoor Roth IRA:

No income limit: Anybody earning an income is eligible for a traditional IRA—no matter your income limit.
Tax-free gains and withdrawals: If y'all convert your traditional IRA to a Roth, you lot pay the taxes upward front and get to enjoy taxation-gratuitous growth and withdrawals (one time you reach age 59 ane/2).

Disadvantages of Investing in a Backdoor Roth IRA:

Income taxes: When you catechumen from traditional to Roth IRA, brand sure yous have the greenbacks on paw to pay income taxes.
Contribution limits: Yous cannot invest more than $6,000 in an IRA each year ($vii,000 if you're 50 or older)

2. Health Savings Account

A wellness savings account (HSA) is both a savings and investment account that gives you lot not one, not two, just 3 tax breaks—if you employ information technology right! It's like a subconscious gem of investing. To qualify for an HSA, yous must take a high deductible wellness plan. In the short term, an HSA acts as a tax-advantaged emergency fund for healthcare expenses. Y'all tin can use the money you save in your HSA to pay for dr.'due south visits, prescriptions and a whole bunch of medical expenses. Here'south what'due south and so great near the HSA: You contribute pretax money, enjoy tax-costless growth, and withdraw from information technology taxation-gratuitous when used for medical purposes. It'south a win-win-win!

But if you shift your thinking from the short term to the long term, you tin can use your HSA as a "Health IRA." In improver to saving, the HSA offers you an opportunity to invest. One time you've contributed a certain amount (normally betwixt $1,000–2,000), you can start investing that money into mutual funds inside the HSA. And if you lot invest wisely now, this account can grow to be a large ol' pot of coin that will help you encompass the cost of medical expenses in your later years. The average couple retiring today volition rack up $285,000 in healthcare expenses (and that doesn't include long-term care costs).^two Once you plough 65, you tin can take coin out of your HSA and pay income taxes—just like you would with a 401(one thousand) or traditional IRA—and spend it on whatever y'all'd like.

To sum upward, here are the pros and cons of investing in an HSA.

Advantages of Investing in an HSA:

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

Disadvantages of Investing in an HSA:

Conflict with Medicare: Once you enroll in Medicare, yous tin't contribute to an HSA since it's a loftier-deductible plan. But you can even so employ the coin you've saved!
Contribution limits: For 2020, the IRS has set up the individual contribution limit to $3,550 and the family contribution limit to $7,100

3. Afterwards-Tax 401(K) Contributions

Some employers volition allow afterward-taxation contributions to their 401(m) plans in addition to the maximum pretax amount y'all tin can contribute ($19,500 plus $6,000 for those historic period 50 and older). If you decide to become this route, in 2020, you tin can contribute a maximum of $57,000 of both pretax and subsequently-tax dollars (or $63,500 if you're 50 or older).³

At present, that limit includes the pretax $19,500 you put in, plus the money your employer put in and any later on-tax contributions y'all make. For example, if y'all contributed your maximum of $19,500, and your employer matched $5,000 (for a total of $24,500), then you lot could contribute an additional $32,500, for a total pretax and subsequently-tax contribution limit of $57,000.

When yous retire or when you go out a company, you tin take that afterward-revenue enhancement 401(grand) money and put it in a Roth IRA where you tin continue to abound wealth.

Before you go with the taxable 401(k) contributions, make sure you lot max out your other tax-favored accounts, like the IRA or Roth IRA. Hither's a quick recap of the pros and cons of after-taxation 401(1000) contributions.

Advantages of After-Tax 401(grand) Contributions:

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

Disadvantages of After-Tax 401(g) Contributions:

No taxation break: Any of your contributions above $nineteen,500 are non tax-deductible.

4. Brokerage Accounts

Brokerage accounts—also chosen taxable investment accounts—permit you to purchase basically whatsoever type of investment: stocks, bonds, common funds and exchange-traded funds (ETFs).

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

Yous can open a taxable investing account with a depository financial institution or brokerage firm directly. And you tin fifty-fifty gear up automated withdrawals from your banking company into that investment business relationship each calendar month.

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

Advantages of Investing in a Brokerage Business relationship:

No contribution limit: With a taxable investment business relationship, you tin invest as much as you want each year.
Flexibility: You can take money out at any fourth dimension for whatsoever purpose without having to pay income taxes or penalties. This flexibility is important if you desire to retire early on and need an income stream.
No required minimum distributions: You become to determine when and how much you want to withdraw.

Disadvantages of Investing in a Brokerage Account:

No tax breaks: Y'all invest with afterward-tax coin, and you lot pay capital gains taxes when you withdraw money.
Liability: Investments made in a 401(k) (and other similar accounts) are protected from a lawsuit. That's not the case with a taxable account. That's why y'all need umbrella insurance.

5. Real Manor

Another investment option many people cull is real estate. This kind of investment is the well-nigh hands-on and time-consuming of your investing options. We wouldn't recommend real estate unless you lot have a real passion for it. Before you lot buy, exercise your homework. Talk to people who've done it. They'll tell yous what it's really like.

As well, talk to an insurance agent about any liabilities you lot might have, particularly if you invest in rental property. Do the math to see how much money you'd actually brand afterwards expenses, including taxes, utilities and other costs. And never, always borrow money to buy real estate. Merely buy information technology if you have the cash on hand.

A middle-ground option for real estate is purchasing land. If you're in an area where the housing industry is booming, purchasing land on the outskirts of town might exist a good option. The outskirts may get a new subdivision before yous know information technology! As with investments, practice your homework before you buy country. And exist sure yous're working with a top-notch real estate agent when you're ready to buy.

Advantages of Investing in Existent Manor:

Tried-and-true investment: If y'all play it right, existent estate tin can go a wonderful source of income. They're affectionate assets, and you can brand proficient passive income from rental backdrop.
Diversify your portfolio: Diversification (spreading out your money over dissimilar types of investments) is one of the most important means to build wealth while minimizing risk.

Disadvantages of Investing in Existent Estate:

Time consuming: Real estate is a hands-on, all-consuming investment.
Liability: But similar the stock marketplace rises and falls, the value of your property tin modify depending on what happens in the expanse surrounding it.

Piece of work With an Investment Professional

Whether y'all're a loftier-income earner or just getting started in your career, e'er talk with your investment professional earlier you cull whatever of these investing options. They will assist you determine the best options based on your income and investing goals. They know the IRS rules for income restrictions, contribution limits and catch-upwards options for investing. These decisions are as well important to go information technology alone.

Get a pro on your team!

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