Taking Control of Your Future IRA Tax Liability


Are you familiar with Roth conversions? Could a Roth conversion be a powerful planning tool, if properly used, in your overall financial or retirement plan? If you could choose, would you rather pay taxes on a $300,000 or $500,000 account?

The Roth IRA conversion and IRA arbitrage are two tax-saving strategies that could transform taxable IRAs into tax-free income or a tax-free inheritance. Today’s topic is the Roth IRA conversion that could offer an efficacious method to control your retirement accounts. This process allows you the option of paying tax on the seed now and saving the tax on the crop when it is time to harvest your retirement savings. This may be the lowest tax environment we see for a while.

The traditional IRA was first introduced in 1974 as a reaction to the public concern of abuse and mismanagement of private pension funds.1 The whole premise was that individuals would contribute to the IRA on a pre-tax basis. (“Never pay income tax before you have to,” we were told.) The account would grow tax-deferred (no taxes paid while it is growing). These were the years of working for higher income and paying plenty in taxes. The theory was that, in retirement, you would be making less money and be taxed on the portion withdrawn each year.

If less than 10% of the population is saving 25% of their income, this means that that 90% needs more than 75% of their income to live on while working. HOW will they be able to live on less of their current income in retirement? Then, you must factor in inflation. Even if inflation was 2% per year over 20 years, that is a 40% loss of purchasing power. Therefore, retirees need at least the same amount of income, if not more, in retirement.

Second question: If the amount needed is still the same, will taxes be lower or higher in the future? A few items to ponder while answering this question:

· An aging population.

· A declining workforce.

· Government deficit spending.

· A younger generation’s inability to save.

Reasons to consider converting a traditional IRA to a Roth IRA:

· All future growth is tax-free.

· All future withdrawals are tax-free.

· No RMDs to Roth IRA owner or spouse.

· Beneficiaries receive tax-free growth.

You have two numbers that you need to remember: 59 ½ and 70 ½. If you take money out of an IRA before age 59 ½, you get hit with a 10% penalty from the IRS. If you’re over 70 ½ and you don’t take money out to meet your required minimum distributions (RMDs), you get hit with a penalty. Does anyone know how large that penalty is? Here’s a hint: It’s steep. 50% excise tax penalty! So, if your RMD was $5,000 and you failed to take it, that’s a $2,500 penalty, and you still have to take the RMD.2

Uncle Sam does not care whether you pay taxes upfront or throughout your lifetime. However, think of it this way: If money was not an issue, would you rather pay $300,000 for the home you are purchasing or take out a $300,000 mortgage over 30 years? Most often, the answer I hear is to pay for the home outright. The reasoning is that the $300,000 mortgage ends up costing almost $1,000,000 in interest over the 30 years. Well, RMDs end up working the same way. More and more is being paid out in taxes over the years and reducing the principal, instead of compounding tax-free. The Roth conversion would likely be most effective for IRA owners who won’t need income from their IRAs and who desire to pass more on to their heirs and eliminate the income tax.

Before you convert your traditional IRA to a Roth IRA, you should be aware of some important considerations. The Roth IRA conversion can be very attractive to some IRA owners and a big mistake for others. It might be worth running the numbers to find out, as this may be the lowest tax-rate environment we will see in the years to come.

Complimentary financial workshops offered monthly at St. Augustine Main Library and Anastasia Library. Check www.ShalaFinancial.com for details.

1 http://www.traditionalira.com/ira-stand-brief-history 2 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds

Investment advisory services offered through Sound Income Strategies, LLC, an SEC-Registered Investment Advisor. Shala Financial and Sound Income Strategies, LLC are not associated entities. Insurance and annuities offered through Rosa Shala, FL Insurance License #D040183.

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