Roth IRAs Part 3: Planning for Each Stage of Life

At Unified Trust we believe the Roth IRA is an ideal tool to build and transfer tax-free wealth.  In this third blog post we explore some ways the Roth IRA can be of benefit regardless of your stage of life.

Young workers – Even teens with earned income should try to fund a Roth IRA annually with direct contributions.  There are few things so powerful as compounded growth, and with time on their side, younger savers can amass substantial tax-free savings by starting early.  True, Roth IRA contributions will not provide an immediate tax break like contributions to a Traditional IRA or a 401(k) plan, but for those who are in a low marginal tax bracket the trade-off is not extreme.  Indeed, younger workers may enjoy the best of both worlds, contributing pre-tax dollars to an employer’s 401(k) plan AND after-tax dollars to a Roth IRA.  Since Roth IRA contributions can always be withdrawn free of tax or penalty, they can be a source for emergency funds if times get tough.

Accumulation Years – For the Gen X’ers and all those toiling away in their accumulation years, your youth may be fading but don’t lose hope.  If you have had other financial priorities and haven’t opened a Roth IRA, then we suggest you do so to at least get the 5-year clock started.  Even a small dollar contribution or the conversion of a stray, low balance IRA is enough to get started.  If your household has a non-working spouse (and your income isn’t too high) you may be able to contribute for that spouse.  And watch your tax rates too, to see if you can do modest annual Roth IRA conversions without creeping into a higher bracket.

RMD Phase – If you’ve reached the point where you no longer have earned income but aren’t taking Required Minimum Distributions (RMDs), you may find yourself in prime position to do regular Roth IRA conversions.  Conversions get the 5-year clock started, can be used to “top off” your marginal tax bracket, and will lead to lower RMDs and lower taxes later.  But take caution:  IRA and retirement plan withdrawals impact Medicare premium calculations, so it may be best to consult with your advisor or CPA before you go wild with Roth conversions.  On the plus side, if by this age you’ve built up a nice nest egg of Roth IRA funds then you may shift your focus to withdrawals.  Funds taken from your Roth IRA do not affect Medicare premium calculations and can be done strategically to keep your taxable income within a desired bracket.

Retirees – Especially those taking RMDs, these people typically no longer do conversions and often view their Roth IRAs as funds for their heirs.  The original owner need not take RMDs from a Roth IRA, but the beneficiaries must take all funds out within 10 years of the owner’s death.  There are no income tax consequences when a beneficiary finally closes out an inherited Roth IRA, but it does bring the tax-deferred party to an end.  Retirees who are well-funded to meet their spending may wish to help other family members open and fund Roth IRAs so they, too, can enjoy tax-free growth over time.  An annual exclusion gifting program for children or grandchildren, for example, could incorporate Roth IRA funding.  Let’s look at an example of how to get creative with Roth funding with a strategy we call “Re-Rothing.”

Assume there’s a 75-year old retiree with $65,000 in a Roth IRA that is unlikely to be needed for spending.  The retiree takes a bit more risk in the Roth IRA than in the rest of his portfolio since he probably won’t use the funds for himself.  He invests to earn a 6% rate of return.  He wishes to help his granddaughter, who is 25, fund a Roth IRA as part of an annual gifting program.  The granddaughter has earned income greater than $6,000 annually and isn’t otherwise prohibited from contributing to a Roth IRA.  The retiree withdraws $6,000 at the start of each year from his Roth IRA, for 15 years, and funds the granddaughter’s Roth IRA in each of those years.  The granddaughter invests her Roth IRA in such a way to earn a 6% rate of return.  In effect, the retiree is “Re-Rothing” his own Roth IRA so that the granddaughter can extend the period of tax-free growth on the underlying funds.

The retiree starts with a $65,000 Roth IRA and at age 90, when he finishes the gifting program, his Roth IRA is valued at $7,741.  He withdrew $90,000 from his Roth IRA income tax-free.  He gifted that same $90,000 over 15 years to his granddaughter tax-free through annual exclusion gifts.  She invested the gifted funds to earn 6% annually and at her age 40 has $148,035 in her Roth IRA.  Even if she makes no further contributions (or withdrawals), at age 75 she will have over $1.1 million in her Roth IRA.  The retiree sacrificed some continued tax-free growth on “surplus” wealth but was able to extend the tax-free life of $90,000 for about two additional generations.  We believe that is a bargain well worth pursuing.  And imagine the downstream impact if the granddaughter, when she is retired and well-funded for the rest of her life, is inspired to repeat this program!  Re-Rothing:  it’s the gift that keeps on giving.

We hope these three related blogs have you motivated to open, fund, and properly allocate the investments in your Roth IRA.  Contact your Fiduciary Investment Advisor with questions or to illustrate ways a Roth IRA can help you build and transfer tax-free wealth.

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