Keep Your Nest Egg Safe From Uncle Sam

Mark Vilrokx, 37, and Carine Beysen, 35, ought to ace retirement. The San Mateo, Calif. couple have great jobs - he's a manager at Oracle, she's a research director for a biotech company - and they earn a combined $210,000 a year. They have no mortgage, no student loans, no car loans, no credit-card debt. They're also diligent savers who put away a hefty chunk of their income every year for retirement.

Trouble is, they're rapidly running out of places to shelter those retirement dollars. While he's maxing out his 401(k), she's shunning hers because of poor investment choices. Even if they fully funded both qualified plans, they could still have savings left over.

But they are well past eligibility for a tax-deductible IRA (top modified gross income for a partial contribution is $109,000 for couples with other retirement plans). And last year they earned too much to contribute to a Roth IRA. (In 2009, couples earning less than $166,000 can put in a full $5,000 each, and only those making up to $176,000 can make a partial contribution.) "I had put money in one but later had to pull it back out," says Vilrokx.

Thus, Vilrokx and Beysen have been putting some of their long-term savings in taxable investments - much to their dismay. Saving outside tax-deferred plans, as you know, means paying taxes every year on any fund distributions, plus dividends, as well as on gains when investments are sold, including when you rebalance. So much for efficient compounding.

Still, if you're a high earner who saves more for retirement than you can stash in traditional tax-deferred plans, you're not completely at the mercy of the IRS. You can minimize the bite. Just follow these tax-efficient savings strategies.

Use Unusual Shelters

First off, make sure you're truly saving the max in your 401(k) - that is to say, the full $16,500 allowed, $22,000 if you're 50 - not just up to the company match. Also, if like Beysen you don't like the investment options, hold your nose and contribute anyway, says Cincinnati financial planner John Evans. You can't beat the automatic 33% or so savings, depending on your tax bracket. Fund a Roth IRA if you can, then consider these lesser-known tax-deferred accounts.

Retirement plans for the self-employed. Do any moonlighting? A Simple IRA lets you save 100% of what you make, up to $11,500 this year ($14,000 if you're 50 or older). If you make more than $60,000 in self-employment income, consider a solo 401(k), which lets you save $16,500 plus catch-up contributions; or a SEP (simplified employee pension), which lets you shelter up to $49,000.

Nondeductible IRA. There's no income cap on these, and you can put away up to $5,000 in one, $6,000 if you're over 50. You don't get an up-front tax break as with a deductible IRA. But if you have a long time horizon, you'll benefit from years of tax-free compounding, says Evans. Plus, in 2010, regardless of income, you can convert a nondeductible IRA to a Roth. You'll pay taxes on gains, but you can spread this bill over two years.

Health savings account. If you're healthy and have low annual medical costs, consider a high-deductible health insurance plan, which your employer may offer. With such a policy, you can open a health savings account to cover medical expenses; this doubles as a retirement account. In 2009, individuals in high-deductible plans can stash up to $3,000 pretax (families $5,950) in an HSA. Money you don't use remains in the account indefinitely. You're not taxed on withdrawals for medical purposes. And after 65, there's no penalty on nonmedical withdrawals; you pay only ordinary income tax as you would with a traditional IRA.

Open a Taxable Account

Investing outside a tax-deferred plan doesn't have to cost you a lot in taxes. In fact, taxable accounts have some surprising tax advantages, says New York City financial planner Madeline Noveck. Consider that money you withdraw from an IRA is taxed as ordinary income, at a current top rate of 35% (due to increase to 39.6% at the end of 2010). But long-term capital gains in taxable accounts are taxed at a max of 15% (20% at the end of 2010). Plus, you can harvest capital losses to off-set gains, particularly useful in today's market. To avail yourself of these benefits, however, you must be strategic about how you invest.

Know What to Put Where

Being conscious about what investments you put in taxable vs. tax-deferred accounts can help you keep tax costs down. Put taxable bonds and REITs in a 401(k) or IRA, as you'll otherwise pay ordinary income tax on their gains. Actively traded stock funds throw off a lot of short-term gains, so they're best in tax-deferred accounts. Put growth stocks and growth funds in a Roth IRA, since you'll pay no taxes on the gains now or later, says Evans. Don't qualify for a Roth? Invest in these via a nondeductible IRA or 401(k). Finally, stash individual stocks and tax-efficient funds as well as exchange-traded funds - which don't throw off much taxable income - in taxable accounts. (Vanguard Total Stock Market Index Fund and iShares S&P 500 Index ETF are two options from our Money 70.)

Say No to Insurance

A broker or financial planner may try to sell you a cash-value policy or variable annuity as a way to save for retirement. The pitch is that money grows tax deferred. But these policies carry hefty fees. In an IRA or a 401(k), you can invest in a low-cost mutual fund with expenses of less than 1% a year. The annuity, on the other hand, generally charges 2% or more annually. And there may be a "surrender charge" as high as 15% if you drop the policy. Cash-value life insurance - which combines a savings or investment account with a death benefit - also has big fees and doesn't offer the potential gains most people need for retirement. Use insurance for estate planning or income replacement, not saving.

For Vilrokx and Beysen, fully funding her 401(k), opening nondeductible IRAs and smartly allocating investments should help them meet their goal to quit work when Mark is 55. "We're interested in retiring in Spain or Southern France," says Mark. "One reason I save like crazy is that it gives me more choice." And the less he gives the IRS, the more choice he will have.