“A penny saved is a penny earned.” Many people attribute this quote to Benjamin Franklin. However, I would change this statement – especially for high-income earners – to “A penny saved is more than a penny earned.” Why? Because taxes can impact your earned income so much.
Those in the top income tax bracket pay 39.6% federal tax on earned income. If you live in a state like Indiana, there may also be state and/or county income taxes. FICA (Social Security and/or Medicare) taxes may also be applicable. But wait…there’s more. As your income increases, certain tax deductions may disappear, which is like increasing the tax rate even more.
You can now see how sizeable taxes can be and the benefit of tax-free income for high-income earners.
Some may ask, “How can I create tax-free income?” One example is by funding a Roth IRA- an account with certain tax characteristics. Although contributions to a Roth IRA are not tax deductible, the Roth IRA grows without tax, and qualified withdrawals are completely income tax-free.
You may say, “That’s nice, but my high income makes me ineligible to contribute to a Roth IRA.” There may be other options. Here is one example.
Joe’s high income excludes him from making Roth IRA contributions. However, he does NOT own a Traditional, SEP nor SIMPLE IRA. This is a very important fact as other IRA balances may negatively impact this strategy. Joe may consider asking his tax professional if he can contribute to a Traditional IRA. The contribution may not be tax deductible so his Traditional IRA will then consist solely of “after tax” money. He may then “convert” his Traditional IRA (with little to no tax) to his Roth IRA. This may be a method of indirectly contributing to his Roth IRA. He should discuss this strategy with his tax professional before executing.
Depending on your situation, there may be other options for funding a Roth IRA for high-income earners. These rules are complicated, and stiff penalties can be incurred if you make mistake. Partner with professionals skilled in this area of tax law to avoid such pitfalls.
Every dollar you save on lifetime taxes is another dollar you can use for what’s important to you and your family. Are you receiving proactive planning advice to lead your best life? Let’s start a conversation about what’s important to you.
Published: November 23, 2016
Author: Terry Prather, CFP®, ChFC®, MSFS
Phone: (812) 602-6307
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