Common sense about Roth and multi-generational IRAs
February 25, 2016
By Dr. Harold Wong
Warren Buffett says that few people exhibit common sense in their investments and financial strategies. Lets focus on comparing how most view the Traditional IRA versus using two advanced strategies: the Roth IRA and the Multi-Generational IRA.
You should definitely contribute the maximum to your IRA, which is $5,500 (or $6,500 if you are age 50 or older).
Example: If you are 25 now, and contribute $5,500 annually for the next 25 years, and can earn a 5 percent rate of return, you will have $275,624 at age 50. If you contribute $6,500 annually for the next 15 years until age 65, you will have an additional $147,273, or a total of $422,897. If it’s a Traditional IRA, you get to deduct what you contribute each year, and earnings are tax-deferred. Once you start to pull money out of your Traditional IRA to spend, it’s 100 percent taxed as ordinary income. Also, when one becomes age 70.5, one is forced to distribute a Required Minimum Distribution that is based on your remaining life expectancy.
Many who have attended my seminars, have said that they don’t need the RMD and wish it could accumulate instead of becoming taxable income.
In contrast, the Roth IRA contributions are not tax-deductible. However, there is no tax on the earnings, no matter how much you earn, as long as you are at least age 59.5 when you distribute money and it has been at least five years since you opened your first Roth IRA.
There are no RMDs with a Roth IRA. Here’s the common-sense question: “Would you rather have tax-free income when you are retired and on a relatively fixed income or not?” The answer is obvious, and not taking the $5,500-$6,500 maximum annual deduction to a Traditional IRA is relatively painless. Suppose your annual contribution over your lifetime was $6,000 and you are in a 15 percent federal tax bracket. Your increased tax from contributing to a Roth IRA instead of a Traditional IRA is only $900, less than the $75 a month many spend at Starbucks.
Should I do a Roth IRA Conversion of my 401k funds? Suppose you have $400,000 in your 401k, based on what was contributed by you, your employer, and any earnings during the last 30 years. You are now age 58 and plan on working for the next 8 years. You could convert $50,000 each year into a Roth IRA so that all of your $400,000 will become a Roth IRA by age 66. You are not paying an extra tax, as money distributed from any tax-deferred retirement account, such as a Traditional IRA or 401k, is fully taxable as ordinary income. Most married couples are only in a 15 percent ($18,551-$75,300 taxable income) or 25 percent ($75,301-$151,900 taxable income) federal tax bracket. If your average federal tax rate is 20 percent, then converting $50,000 each year results in $10,000 more federal tax.
Question: Is the best time to pay tax when one is working, or when one is retired on a fixed income?
Should I consider a MGIRA? Upon death of both spouses, the Traditional IRA funds gush out to the heirs and are fully taxable. If you use the MGIRA strategy, only a little is distributed (and therefore taxable) each year, based on IRS tables that project the life expectancy of the heirs. Would you like $500,000 to gush out to your only kid, with 40 percent or more lost in tax that year, and can you trust your kid not to blow it? With the MGIRA strategy, your child might receive two to four times as much and have an income each year for the rest of his life.
Warren Buffett and I believe that few people use common sense strategies to multiply IRA income and eliminate taxes. © Harold Wong 2016