Income Too High for a Roth IRA? Try These Alternatives

August 30, 2023
If you're interested in contributing to a Roth IRA but your income exceeds IRS limits, you still have options to save for retirement in a tax-smart way.

High earners may have a variety of choices for saving for retirement—but income limits mean that direct contributions to Roth IRAs may not be among them.1 This is unfortunate because Roth IRAs offer tax-free earnings growth and withdrawals in retirement,2 making them a potentially valuable part of a broader investing and tax-planning strategy. Having both Traditional and Roth accounts can help with tax diversification in retirement.

Here are some strategies to consider.

Are you getting the most from your 401(k)s?

Maxing out contributions to a traditional 401(k) is a good place to start. Such accounts have no income phaseout limits, so you can generally contribute the lesser of your income or $22,500 (plus an additional $7,500 if you are 50 or older). Pre-tax contributions to these accounts reduce your taxable income, and potential earnings will grow on a tax-deferred basis—though distributions in retirement are subject to taxation at ordinary income rates in the future.

If your employer also offers access to a Roth 401(k), then you could consider using one to set aside some post-tax retirement savings. Like their traditional 401(k) counterparts, Roth 401(k)s don't have income phaseouts. So even if you don't qualify for a Roth IRA because your income is above IRS limits, you can make after-tax contributions to a Roth 401(k). Potential earnings will grow tax-free, and you pay no taxes when you take withdrawals after five years and are older than 59½.

If you own both a traditional 401(k) and a Roth 401(k), it's important to note that the annual contribution limit applies across all your 401(k) accounts, not on each account individually.

Consider a Roth conversion

Converting some or all the funds in a traditional IRA into a Roth IRA is another possibility. This entails taking funds from traditional IRAs, paying ordinary income tax on those funds, and rolling them into a Roth IRA. This can make sense particularly if you expect to be in a higher tax bracket in the future and have a long time horizon.

Some advisors also see a so-called backdoor Roth IRA as another way to secure the tax features provided by Roth accounts. It's a unique strategy, but it could work for you. The backdoor Roth involves opening a traditional IRA, making non-deductible contributions to it, and rolling over those funds to a Roth IRA at a later date. When those funds are rolled over, you'll have to pay taxes on any appreciation that occurred prior to the conversion; in addition, the pro-rata rule may also apply. However, once in the Roth IRA, the savings are eligible to grow and be distributed tax-free.

What about non-deductible IRAs?

Does it ever make sense to contribute to a traditional IRA even if you can't deduct the contributions? At the very least, you could still enjoy the potential for tax-deferred growth in the account.

"Think carefully before considering this choice," said Rob Williams, managing director of financial planning at the Schwab Center for Financial Research. "You wouldn't be getting any upfront tax break, and future withdrawals of growth on your original contribution would be taxed at your ordinary income tax rate."

It's possible that the future tax rates you'd pay would be higher than what you'd owe if you'd invested in a tax-efficient way in a regular taxable brokerage account. "With today's low long-term capital gains and qualified dividend rates, non-deductible contributions to a traditional IRA may make less sense," Rob explained.

As of 2023, long-term capital gains are taxed at a federal rate of either:

  • 0% for single filers with taxable income up to $44,625 or joint filers with taxable income up to $89,250.
  • 15% for single filers with taxable income between $44,626 – $492,300 or joint filers with taxable income between $89,251 – $553,850.
  • 20% for single filers with taxable income above $492,300 or joint filers with taxable income above $553,850.

In addition, single filers with an adjusted gross income (AGI) over $200,000 or joint filers with AGI over $250,000 may have to pay the Net Investment Income of 3.8%.

Tax-efficient investing in a taxable account

There are many tax-efficient ways to invest in taxable accounts. If you don't trade often, individual stocks, as well as most exchange-traded funds (ETFs) and index mutual funds, can result in a lower tax bill.

You may owe only the long-term capital gains tax rate on earnings if you sell an investment held longer than a year at a gain, which is generally lower than the tax rates on ordinary income. There may be some distributions along the way, but qualified dividends from stocks are generally taxed at the long-term capital gain tax rate, and ETFs and index funds can be managed tax-efficiently.

Having some money in taxable accounts can provide opportunities to reduce your tax bill by strategically harvesting losses. That's not something you can do in your 401(k) or any IRA. Investing in tax-advantaged municipal bonds or muni bond funds, depending on your tax bracket, can help too.

Saving in a taxable account can also be helpful for estate planning goals. If you hold long-term investments in a traditional brokerage account, you can donate low-cost-basis securities to charity for a full fair market value deduction and no capital gains tax. You can also leave your appreciated shares to heirs who would receive a step-up in cost basis.

Finally, as noted above, having money in taxable accounts as well as tax-advantaged accounts can give you greater flexibility and access to savings for needs prior to age 59 1/2—the minimum age from which you can generally withdraw from traditional IRAs and qualified retirement plans without a 10% early withdrawal penalty.3 It can also provide flexibility in managing your tax bracket as you plan for post-retirement cash flows. "This sort of tax diversification can be helpful, no matter your future tax rate," Rob said.

1For 2023, as a single filer, your modified adjusted gross income (MAGI) must be under $153,000 to contribute to a Roth IRA. As a joint filer, it must be under $228,000. 

2You must be 59 1/2 and have held the Roth IRA for five years before tax-free withdrawals on earnings are permitted.

3Subject to certain exceptions for hardship or other situations specified by the IRS.

Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges, and expenses. Please read it carefully before investing.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk including loss of principal.

This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax free, and subsequent conversions will require their own 5-year holding period. In addition, earnings distributions prior to age 59 1/2 are subject to an early withdrawal penalty.

Tax‐exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax‐exempt status (federal and in‐state) is obtained from third parties, and Schwab does not guarantee its accuracy. Tax‐exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

A rollover of retirement plan assets to an IRA is not your only option. Carefully consider all of your available options which may include but not be limited to keeping your assets in your former employer's plan; rolling over assets to a new employer's plan; or taking a cash distribution (taxes and possible withdrawal penalties may apply). Prior to a decision, be sure to understand the benefits and limitations of your available options and consider factors such as differences in investment related expenses, plan or account fees, available investment options, distribution options, legal and creditor protections, the availability of loan provisions, tax treatment, and other concerns specific to your individual circumstances.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.