Politicians are notorious foot-draggers.
Both House and Senate Republicans are starting to doubt whether they'll get anything done this year regarding tax reform.
Any tax cut that does pass will likely be temporary. A permanent cut can't be made through the "reconciliation" process that Republicans would likely use. It's another reason why we tell you not to trust the government to take care of you.
In the meantime, millions of Baby Boomers (including me) are seeing their IRAs hit with "required minimum distributions" (RMDs)... and with massive penalties if they don't comply.
Essentially, the IRS doesn't want you to shelter your money in your retirement account forever. So when you turn 70-and-a-half, you're required to start taking money out of your IRA or 401(k) – the required minimum distribution.
If you're one of the millions of Americans with a traditional IRA, you probably think you're saving money when you deduct your IRA from your taxes.
But if you're like me and think taxes are just going to keep going up, you need to consider this simple retirement savings loophole… It could save you and your family thousands of dollars in retirement and greatly increase your family's net worth.
Remember, when you put money in a traditional IRA, the government defers taxing it until you start withdrawing the money after age 59-and-a-half. (Withdrawing before you reach this age incurs a 10% penalty.)
Roth IRAs are the opposite. You pay taxes on the money before you put it in. Like a traditional IRA, the money you earn in the account is tax deferred. And the beauty is you don't pay taxes when you take it out, no matter how large the account has grown. (There are a few requirements, but if you're over 59 and a half, you qualify.) Here's the other key to creating a legacy… you don't have to take money out of your Roth IRA. There's no age requirement to take it out. (This is important, as I'll explain.)
The U.S. government will let people with retirement money in traditional IRAs and even 401(k)s "convert" the money to a Roth IRA. You can do this no matter what your income or assets, and it's easy to do.
The big question now is, should you convert your IRA or 401(k) to a Roth?
The further you are from retiring, the more it makes sense to have a Roth IRA, as you'll have more time to compound your tax-free earnings. And again, no taxes are taken on withdrawals no matter how large your account grows.
Trust me, taxes are going higher in the future.
And even if your tax bracket will be lower than today, the Roth conversion can still make sense, especially if you want to compound earnings past the age of 70-and-a-half.
T. Rowe Price data showed a 45-year-old man who puts $25,000 into a Roth ends up with $62,238 more than if he left it in a traditional IRA. And that even factors in a drop in his tax bracket from 28% today to 15%.
That's a lot more, for very little work. And we haven't even gotten to the best part...
Perhaps the most powerful reason for converting to a Roth is the ability to continuously build money over both your lifetime and your beneficiaries'.
We call it the "Legacy Plan" because it allows you to keep the money growing until you die. This is not true for traditional IRAs and 401(k)s. With those, they have the RMD rule... That means when you turn 70-and-a-half, you must stop putting money in and start taking money out.
Roth IRAs have no such rules. Using a Roth allows you to grow the account longer and further take advantage of the power of compound interest under a tax-free umbrella.
Remember, you don't ever have to take money out of your Roth. And if your beneficiary is your spouse, he or she doesn't have to take the RMDs right away, either. (You can see the full rules for distribution delay right here.)
Moreover, you can contribute money into the Roth at any age, as long as you have "earned income" in the year you add money. This means at age 75, 80, or 85, you can fund your account and continue to see it grow.
Here's a neat trick… consider giving your Roth to a grandchild…
Any non-spouse beneficiary must withdraw the money after your death, but gets to spread those payments out over his much longer life expectancy. Say you end up leaving a $232,000 balance to your 25-year-old grandchild at a 7% return… that account would continue to build tax-free for that grandchild's life and distributions would be tax-free.
Your grandchild would need to take minimum required distributions, however. This is based on the fair market value of the account and his or her life expectancy, calculated by the IRS here in Table I. In the $232,000 account, that would mean he'd have to take $3,986.25 in the first year. Since the account would return $16,240 that year, that would leave more than $12,000 to keep growing in the account.
Then, the account continues to grow (with a 7% return) during his lifetime. By 65, the account would stand at $1.16 million. You can see the real results with Charles Schwab's Beneficiary RMD Calculator right here. If you're thinking of a Roth conversion and have a non-spouse beneficiary, make sure to check with your financial planner to see if the numbers make sense.
That's an incredible legacy to leave...
Tomorrow, I'll share two secrets to keep in mind as you do a Roth conversion, plus two dangers to beware of... Watch your inbox.
And if you've converted an IRA or 401(k) in the past to a Roth IRA, write to us here about your experience: [email protected].
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- Something different: This juicer startup's $400 machines are practically useless.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig and the Retirement Millionaire Daily Research Team
April 24, 2017