It is easy to be dubious about the value of Roth IRAs. The money is taxed before it goes in, so you don’t get the immediate bang of a tax deduction that takes away some of the pain of the initial contribution.
Then the money comes out of the Roth IRA tax free at a time in many people’s lives when their income is too low to result in many taxes under any circumstances.
That’s a short-sighted view of it, according to Leon LaBrecque, CPA, CFP, CFA and managing partner of LJPR Financial Advisors. LaBrecque just published a useful booklet, “50 Good Ideas to Make the Best Use of IRAs, Roth IRAs, 403(b) and Qualified Plans.”
Here are 3 ideas from that booklet that might convince you to embrace the Roth.
Bracket topping. A married couple filing jointly can earn taxable income up to $75,300 and stay in the 15% tax bracket. “If you have money in a regular IRA, convert whatever you can into a Roth and fill out your bracket,” says LaBrecque. That means convert as much as you can without moving into the next bracket up.
He offers this example: Crassius and Evita are both 62. They sold a business and are living on $90,000 in income — $40,000 in qualified dividends and $50,000 in municipal bond interest. LaBrecque calculates that they can convert about $55,500 a year from their traditional IRA into a Roth without pushing themselves into a higher tax bracket. That amount takes into consideration the standard deduction amount of $12,600 for the couple and personal exemptions of $4,050 each. If they do that every year for 8 years, by the time they start to receive Social Security at age 70, they’ll have a Roth IRA worth $580,00, assuming 7.5% earnings. And they’ll have paid a federal tax rate of less than 6%.
How to turn Mom’s IRA into My IRA. Let’s say your mother is older than 70 1/2. She lives on a pension and Social Security. She also has a modest IRA — $20,000 or $30,000 — that she hopes to leave to you. While that is a generous thought, you would owe taxes on the inherited IRA that make the gift smaller, especially if you are are in a higher tax bracket. Here’s a better way. “Mom can convert her conventional IRA into a Roth IRA. If there are any taxes, you pay them,” LaBrecque says. “For as long as Mom lives, the Roth continues to grow tax free. After Mom dies, you can inherit her Roth tax free.” In the meantime, Mom will stop owing required minimum distributions from her savings because Roths are exempt from RMDs. Win. Win.
Keep working and open a Roth. Not only is a Roth IRA not subject to RMDs, you also can open and contribute to a Roth when you are 70 1/2 or older as long as you have earned income. Keep in mind that this won’t work for a self-employed contractor or consultant because you can’t be a 5% or greater owner of the business. But if you or your spouse are still on someone’s payroll, contributing to a Roth IRA can save you taxes while shoring up your nest egg for your later years. “Load it up,” LaBrecque says.
Download LaBrecque’s booklet for free.
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