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Make too Much to Use a Roth?  

Savings Options for High Income Earners

All too often, I find that high-income earners are paralyzed when they are fully funding their retirement plan at work and still make too much to qualify to make a deductible IRA contribution or Roth contribution. The result is that they end up with a big pile of cash at the bank, likely earning next-to-nothing annual interest. Sometimes the cash is sitting in a personal bank account and sometimes it’s sitting in a business account for a company they own.


Fear not! You have several options that may be more suitable for your situation.


After-Tax or Trust Account

You can move money from your personal bank account into an investment account in your name or in the name of a living trust that you control. The investments will be taxed differently than the investments in your retirement accounts. You may be taxed on interest and dividends generated from this account each year and may also owe capital gains taxes on investments.


If you own a business that has a lot of cash on hand that you don’t intend on reinvesting into the business, you may consider investing at least a portion of it into a portfolio for retirement. After-all, the goal should be to find the most profitable way to use your existing assets - cash is usually not the most profitable type of investment. You should speak with your CPA about the best way to do this. Sometimes it makes sense to invest using an account in the name of the business and sometimes it makes more sense to simply invest it in your own name.


Back-Door Roth IRA

If you do not have any existing IRA’s, you may be able to make a non-deductible contribution into a newly opened IRA, then convert it into a Roth IRA. In a Roth IRA, the money can grow and be taken out tax free as long as it’s done with a qualified distribution. There should be no taxes owed converting the IRA to a Roth since you already paid taxes on the cash and couldn’t take a deduction on the IRA contribution. Again, this only works cleanly if you do NOT currently have any existing IRA’s. You can have 401(k)’s, you just cannot have any IRA’s. Otherwise, if there are any contributions that were made into an existing IRA that resulted in a tax deduction, you will owe taxes on the conversion.


Emergency Savings Considerations

You must remember to keep enough cash at the bank for emergencies. As a rule of thumb, I suggest you keep at least 3-6 months worth of living expenses plus any potential expenses that you have coming up such as a car purchase or new roof. For those that are older and have large potential health bills, you may need a larger cash cushion.


If you run a business, it is critical that you keep enough on hand at the bank to reinvest into the business or in case you have a bad season or year. If your business income stream is less than consistent, you may consider leaving a larger amount at the bank.


Everybody’s situation is different and how much should be kept on hand for emergencies should be looked at on a case by case basis. You should always speak with a CPA and financial advisor about your specific situation to develop a strategy based on your financial goals, risk tolerance and timeframe for investment.

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