Are you planning to retire in the next few years? It’s still not too late to make a difference in how much you’ll have available for retirement. And because you’re likely at a high point in your earnings, you’re well-positioned to help yourself. Consider putting these six strategies to work:
In addition to possibly having higher earnings, you may have another advantage in regard to retirement savings – you can make “catch-up” contributions to your tax-deferred retirement accounts, thereby allowing you to exceed the limits. If you’re 50 or older, you can put in an extra $1,000 a year to your Individual Retirement Account (IRA) above the $6,000 limit; for a 401(k), you can surpass the $20,500 limit by $6,500, for a maximum contribution of $27,000 in 2022.
What if you’re already “maxing out” on your 401(k), even with your catch-up contribution, and you can still afford to put more into your plan? Are you out of luck? Not necessarily – your employer might allow you to make “after-tax” contributions. In 2022, the IRS allows you to put in $61,000 (or $67,500 if you’re 50 or older) to your 401(k), an amount that includes your pretax contributions, your after-tax contributions and any contributions from your employer. Your after-tax contributions, like the rest of your 401(k), can grow on a tax-deferred basis, and you’ll pay taxes on the earnings when you start taking withdrawals. (If you’re younger than 59½, you may also have to pay a 10% penalty.)
If your plan allows it, you may be able to convert your after-tax 401(k) dollars to Roth dollars through an in-plan conversion or a rollover to a Roth IRA. You won't owe taxes on the after-tax contributions because you already paid taxes when you contributed the money, but any earnings on the after-tax contributions will be subject to taxes. The benefit, though, is that future earnings will grow tax free.
And, speaking of a Roth IRA, if you want to contribute the full amount allowed in 2022, your modified adjusted gross income (MAGI) must be less than $129,000 if you’re single or $204,000 if you’re married and filing jointly. Allowable contributions begin to be reduced above those amounts, phasing out entirely when your MAGI reaches $144,000 (single) or $214,000 (married, filing jointly).
Backdoor Roth IRA
If your earnings exceed the Roth IRA limits, you can create what’s known as a “backdoor Roth IRA.” This isn’t actually an official type of IRA, but rather a strategy for taking advantage of the benefits offered by a Roth IRA, such as the potential for tax-free earnings, no mandatory withdrawals (technically called required minimum distributions, or RMDs), and greater flexibility in managing your taxes in retirement.
To create this backdoor arrangement, you make nondeductible (after-tax) contributions to a traditional IRA and then convert your contributions to a Roth IRA. Since the contribution is after-tax, you won't pay additional taxes on the conversion of the contribution; however, any earnings on the contribution will be subject to taxes. Additionally, if you have pretax dollars (deductible contributions and earnings) in any IRA, these dollars, when converted to a Roth IRA, will be fully taxable in the year of the conversion. This strategy tends to work best for individuals who don't already have pretax assets in an IRA because your conversion will include a proportionate share of pretax and after-tax dollars. You may want to consult with your tax advisor to determine when, or if, such a move makes sense for you.
In any case, if you earn too much to contribute to a Roth IRA, but you choose not to use the backdoor strategy, you may still benefit from making non-deductible contributions to a traditional IRA. Like after-tax contributions to your 401(k) plan, the earnings on non-deductible IRA contributions can grow tax-deferred.
Health Savings Account (HSA)
Once you retire, health care will likely be one of your largest expenses – so, if you have a health savings account (HSA) available through a high-deductible health plan, you may want to take advantage of it. In 2022, you can put up to $3,650 in an HSA, if you’re single, or $7,300 for family coverage. You contribute pretax dollars to your HSA, your earnings grow tax free, and your withdrawals are tax free, provided they’re used for qualified medical expenses, creating the potential for triple tax savings. HSAs can also provide greater flexibility in managing your taxes in retirement since withdrawals used for qualified medical expenses don't increase your taxable income. If you don't need your HSA assets for medical expenses, withdrawals for non-medical expenses are taxed just like a traditional IRA, starting at age 65. (Withdrawals used for non-medical purposes prior to age 65 are subject to an additional 20% penalty.)
Many people, though, aren’t getting the most out of their HSA accounts: Only 9% of HSA accountholders invested part of their HSA balance, according to a recent Employee Benefit Research Institute study. The remaining 91% kept their full balance in cash, ignoring the mutual-fund type vehicles available to them in their plan – and thus depriving themselves of the growth potential offered by these investments. As discussed above, it can benefit you to save your HSA assets for retirement, but if you need these assets to pay for current medical expenses, one possible move is to keep enough cash in your HSA to cover your annual health insurance deductibles and invest the rest.
Even if you've contributed the maximum amounts to your IRA and 401(k), including after-tax contributions, you may still have income you’d like to invest for retirement. Consider purchasing a nonqualified annuity, which can be structured to provide you with a lifetime income stream. You can choose either a fixed annuity, which provides a guaranteed interest rate, or a variable annuity, which gives you the chance to invest in mutual-fund type investments. Annuities offer tax-deferred growth potential – you won’t pay taxes until you start taking withdrawals.
To boost your retirement accounts, you may want to consult with both your financial advisor and your tax professional. If you’ve been contributing to your plans for years, you may already be in good shape as you approach retirement – and now, with your higher earnings, you can make an even greater impact.