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Income taxes are a great
inhibitor to building wealth. I’ve talked about the power of
stretching an IRA across multiple generations and how it can
build tremendous wealth. Now, I’ll show you how it can be
done income tax-free.
Last week I shared a little-known secret of how to legally
turn an investment of $3500 per year into MILLIONS AND
MILLIONS OF DOLLARS. No, it wasn’t by winning the lottery!
It was through the power of ‘stretching’ an IRA. If you
missed it you have to read it under the article archive at
www.guardingyourwealth.com.
Most people think that when they inherit an IRA that they
have to take all the money out and pay taxes on it right
away. But the IRS allows someone who has inherited an IRA to
‘stretch’ it over their life expectancy. They are only
required to take out a small portion each year, allowing the
rest to continue growing within the account.
In the last article a greatly oversimplified example was
used because of space constraints. I used the example of Sam
making a $3500 per year contribution to his IRA for 30 years
until he retired. After retirement, he started to withdraw
5% per year until he passed away at age 80. His 50 year-old
daughter inherited it, continued to withdraw 5% per year and
let the rest grow for 30 years. Assuming the account earned
10%, it could have grown to over $9,000,000 by the time she
passed away.
Technically, the IRS would require Sam’s daughter to
withdraw money more quickly from Sam’s IRA. Based on her
life expectancy, it would be designed to take the account
down to $0 over her lifetime. This changes the amounts.
Based on current IRS tables, there would be over $4 million
left at her death instead of the $9 million.
The income generated by stretching the IRA is enormous. In
the example, the IRA would have provided over $1 million in
income to Sam and an additional $11 million in income to his
daughter. In other words, the IRA would have generated over
$12 million in income and still been worth over $4 million!
In this example, we used a Traditional IRA. A Traditional
IRA provides a tax deduction when you put money into it, but
then you have to pay taxes on every dollar when you take it
out. In our example, assuming a 30% income tax rate,
approximately $3,600,000 would have been lost to income
taxes! If the remaining money in the account was withdrawn
it could result in over $1.2 million in additional taxes. So
almost $5 million is lost to income taxes!
If Sam had used a Roth IRA instead he would not have
received a tax write-off each year he invested the $3500. On
the other hand, there would NOT be ANY income tax on the
distributions. In other words, the $12 million in
distributions plus the $4 million left in the account could
have all been used FREE from income tax! That’s the power of
the Roth IRA.
The power to compound your money tax-free is a great way to
accumulate wealth. If your money is in a Traditional IRA you
may still be able to take advantage of this power by
converting it to a Roth IRA. When you do, you’ll have to pay
taxes on the amount taken out of the Traditional IRA. If you
are under 59 ½ years old, the IRS waives the normal 10%
early withdrawal penalty on the amounts converted.
If you are retired and plan on using the money in your
Traditional IRA then it probably doesn’t make sense to
convert it. If you don’t anticipate using it and your
children understand the power of stretching your IRA, then
converting to a Roth IRA might be beneficial.
You have the flexibility to spread the conversion over
several years, allowing you to time the conversion to take
advantage of drops in market value or years in which you are
in a lower income tax bracket.
The rules surrounding IRAs are complex. For instance, you
can’t convert a Traditional IRA to a Roth IRA if your
Adjusted Gross Income is $100,000 or more. So make sure to
talk with a competent advisor before proceeding or give me a
call.
Mr. Voudrie is a Certified Financial Planner, a nationally
syndicated columnist and the President of Legacy Planning
Group, Inc., a Private Wealth Management firm in Johnson
City, TN. He can be reached by calling 1-877-827-1463
toll-free, by email at
jeff@guardingyourwealth.com or by going to
www.guardingyourwealth.com.
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