High Income Earners and ROTH IRA’s

Do you earn too much for a traditional IRA or a ROTH IRA?  If you do there is an option available for high income earners but it is not always the best choice.  For higher income earners the tax deferred advantage may not outweigh the simplistic brokerage account when it comes to taxes.  As April 15th approaches everyone is thinking of making contributions to their IRA’s.

For a ROTH IRA an individual must earn less than $129,000 and a couple $191,000 in order to contribute.  The positive of a ROTH is it grows tax deferred and all proceeds are tax free.  A double win and a powerful ally to compounding interest.  If an individual earns less than $70,000 and a couple less than $116,000 they can contribute to a traditional IRA and get a tax deduction in the year they make the contribution.  But unlike the ROTH, the growth is tax deferred but the gains are taxed as ordinary income when they are withdrawn after age 59 ½.

For high income earners there is an option and that is to contribute to a traditional IRA with no tax advantage and then let the contributions grow tax deferred.  But in theory this is not the best course of business as any proceeds would be taxed as ordinary income and chances are your tax rate will not go down all that much in retirement.  So many investors do invest in these IRA’s and then convert them into a ROTH IRA after the fact.  And if this is done shortly after the IRA is established the taxes will be minimal as it will only be on the appreciation since the IRA was opened.  Then the proceeds will grow tax deferred and the gains will be tax free when withdrawn.

If a high income earner does not wish to open a traditional IRA and convert it to a ROTH there is a reason why it may not even make sense to open the IRA in the first place.  Unless there is a ROTH conversion the gains in a traditional IRA are taxed as ordinary income which will most likely be higher than 15%.  Had you as a high income earner invested in a brokerage account you would be taxed on an annual basis so the growth would not be tax deferred but would get good tax benefits.  If the account is established and the security is held over a year any gains would be long-term and therefor taxed at 15% as would dividends.  Chances are this 15% tax rate could very well be lower than your ordinary income tax rate.

Always save for retirement in some manner.  But save in a manner that is most beneficial to you both tax wise and savings wise.  Sometimes a combination of many different retirement savings plans provides the best return and protection for you as the investor.

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