Saving for retirement…when you make a lot of money

Derek Bostian, CFP Derek Bostian, CFP

Save for retirement….invest more….save more…..

We hear this constantly as young professionals…Almost anything we read on Facebook, CNBC, or any other source of news is yelling the same message at us.

But, once you actually start making money it seems like it gets harder to save for retirement.  Let’s face it, what happens when you start making more money?

  1. You spend more
  2. Your tastes change
  3. The IRS changes the rules and limits of what you can do with your money

When my family started making more money (and ultimately paying more in taxes) I started trying to find strategies that would help.

First thing was to invest in rental real estate.  Then we found out that with only one property, it didn’t really make sense to form a corporation or anything and the IRS has their own rules about losses and how you can use them.

Then we had a kid.  But, the IRS takes the child tax credit away to above certain income levels.

But you still have to find ways to save for retirement.  So you max out your 401(k) and get your company match.  Then you probably put some money in savings, or buy a larger home, or invest in stocks.  And all of those things are great but you still don’t have much long-term tax advantage.   You’re still buying stocks that you’ll pay tax on, have taxes on your home that you’ll owe (in addition to maintenance), and you’ll pay taxes on  withdrawals you make from your 401(k) or other qualified retirement accounts.

Enter the IRA contribution.  One of the most common things you likely hear is to contribute to an IRA.  Once you start making more money (typically six-figures or higher) you’re “phased out” of contributing.  So then you go back to the conventional advice you hear about saving and investing.

From a tax perspective and a long-term viewpoint, you’re still going to owe the IRS money  at whatever rates they feel like charging you in the future.

So what do the wealthy do to invest for their retirement?

Enter the back-door Roth IRA!  I’ve rarely heard CPA’s or other financial advisors talk about these but it’s a way to fund a Roth IRA as long as you follow the rules and report it correctly.

The IRS dictates whether or not an IRA contribution is deductible based on your employment status and income level.  But, the IRS DOES allow you to contribute to an IRA no matter what – you just don’t get a tax benefit.

Each year, you fund a non-deductible IRA at $5,500 ($6,000 is the limit in 2019).  Then, when the time is right you convert the IRA that you’ve funded to a Roth IRA.  There’s currently not a limit on Roth IRA conversions.

You may be thinking, so what?  Now I have $5,500 in a Roth IRA for retirement – why does that matter?

Follow the rulebook that the IRS gives you and you could have a $500,000+ TAX-FREE bucket to enjoy.  Put away $5,500 using this strategy for 30 years, and follow the rules in the IRS playbook, earn a 7% rate of return, and you have $561,000+ in that account.

If we assume a 25% tax rate, your taxable account is worth $384,000.  $180,000 is a lot of money to pay the government.

How much worse is a 50% tax rate?  $288,836 is left.  If you have all of your retirement funds in 401(k) or IRA accounts that’s what you could be looking at.

What’s your plan if tax rates to go higher in your working years or retirement?  The highest bracket in history was 94% for certain incomes.  Imagine for every $100 you get, you actually keep $6.

Maybe the IRS will change the rules in the future.  Maybe they won’t.  For now there’s strategies the wealthy are using to build wealth and dis-inherit the IRS.  If you have questions about these or other things you can do to build wealth our doors are always open.

You can learn more about Roth IRA strategies here.

Derek Bostian, CFP