The Simplest Move To Reduce Your Tax Bill
If April 15th is a dreaded day for workers. Of course, it’s been a little different this year (and last), thanks to extensions from good old Uncle Sam. This year, taxpayers have until May 17th.
Still, it’s no easier for retirees living on a fixed income. Uncle Sam can (and does) take a big bite out of millions of nest eggs each year. Those lost savings could mean fewer luxuries, such as winter cruises or trips to visit the grandkids.
After seeing how fast taxes eroded their savings, some people have even been forced to rejoin the labor force.
Wouldn’t it be great if the taxman retired the same day you did? Imagine how much better retirement would be without sending Washington a check every time you withdrew money from your accounts. Well, thanks to the Taxpayer Relief Act of 1997, this dream is now a reality.
Specifically, I’m talking about the provision in this law that allows for a new type of retirement account: the Roth IRA. If you haven’t used this special tax-advantaged account before, now may be the time to consider it.
Roth IRAs: The Basics
A Roth IRA is similar to a traditional IRA or 401(K) in that it offers special tax perks. But while those plans allow for tax deductible contributions upfront, this new account gives you a tax break when you may need it the most… when you actually decide to spend your money.
That’s right. Any dividends, interest, and capital gains earned in this account are allowed to compound, grow, and eventually be withdrawn and used entirely tax free.
You don’t get to deduct contributions as they are made. But you get something much better in return… the freedom to pull out this money tax-free on the back end. That’s an incredible upgrade. Because every $1 you invest now could easily grow to $3 or more by the time you retire — quite possibly more for younger workers.
So instead of getting the tax break on the $1 now, you get it on the $3 later.
That’s a radical change from every other type of retirement account. But that’s not the only major difference. This unique plan is also more flexible with regard to investment choices. Sure, you can invest in stocks, bonds, and funds. But there are numerous other options.
Through this account, you can invest in real estate, race horses, private jets… even in bulls for cattle breeding. But you don’t have to make such exotic bets to take full advantage of this incredible loophole.
But Wait! There’s More…
But the benefits don’t stop there.
— By putting your savings in this retirement account, you also rid yourself of the mandatory (and taxable) withdrawals from IRAs and 401(K)s that begin at age 70-and-a-half.
— With no forced withdrawals, your entire balance can grow without taxes for the rest of your life if you wish and pass on to your heirs. Since there is no income tax due, you can provide a child or grandchild with a lifetime stream of tax-free income.
— Since the income from this account isn’t taxable, it doesn’t count as income in figuring the tax on your social security payments. So if your only other source of income is Social Security, then you have a fully tax-free retirement.
— You can withdraw original contributions tax-free and penalty-free at any time for any reason, such as a down payment on a new home.
— You can keep putting earned income into this account even after you retire.
It Might Be Time To Open An IRA Right Now…
Establishing a Roth IRA is no harder than opening a checking account. Any broker or financial advisor will ask a few simple questions to make sure this account is right for you. All you have to do from there is sign a couple forms. If you prefer the do-it-yourself route, most any online broker has Roth IRA accounts available.
There are income restrictions to be eligible to contribute to a Roth IRA. This year, the maximum adjusted gross income to qualify is $139,000 for a single filer or $206,000 for joint married filers. But even if you are above that threshold, anyone can transfer traditional IRA assets to a Roth IRA regardless of filing status.
Be careful before making this decision, as it may not be appropriate for everyone. Converting from a traditional IRA to a Roth IRA will trigger a tax bill on the amount of the conversion. For that reason, it can be smart to convert after a big market drop (when your account balance is lower).
Generally speaking, Roth IRA conversions are most advisable for investors who don’t plan to withdraw assets for 10 years or more. They also make sense for investors who anticipate being in a higher tax bracket in the future than they are today.
The Upside, Plus What To Buy In Your IRA
As I mentioned before, once the Roth IRA account is established, any money you contribute will grow tax-free. Assuming an 8% annual return, that $60,000 you deposited will grow to $129,535. That’s $69,000+ in earnings that you can withdraw without owing the government a dime.
And that assumes no additional contributions. But what if you continue depositing $200 from each monthly paycheck into your account? Well, then you would be looking at $165,792 after 10 years.
Again, completely tax free. Now that’s what I call a good tradeoff.
The question, then, is where to invest that money once you’ve opened a Roth IRA. Well, you could always invest in a blue-chip dividend payer like Home Depot (NYSE: HD). With a 3% yield, a $20,000 stake would put $400 in your pocket each year. Plus, you’re likely to enjoy solid appreciation in the stock price over the long run.
But to really take full advantage, you need to elevate your income stream beyond the usual suspects. That’s why I carefully scour the world of high-yielding investments each month to find the absolute best picks for readers of my premium newsletter, High-Yield Investing.
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