Retirement Investors Take Advantage of the Greatest Government Tax Loophole Ever
Personal_Finance / Pensions & Retirement Sep 30, 2010 - 02:08 PM GMTBy: DailyWealth
On December 31, 2010, the government will close an amazing loophole... one that affects 60% of the U.S. population.
In an attempt to collect taxes today to pay for its excesses, the government is promising to never tax our retirement money in the future. Let me explain...
It turns out, close to 90 million people are holding $7 trillion in either IRAs or 401(k) plans. Some of you are holding it in the wrong accounts.
When you put money in a traditional IRA or 401(k), the government defers taxing it until you start withdrawing the money after age 59 and a half. Roth IRAs are the opposite. You pay taxes on the money before you put it in. The money you earn in the account is tax-free – you don't pay taxes when you take out your savings.
This year only, the U.S. government is letting everyone – no matter their income or assets – "convert" retirement money in traditional IRAs and 401(k)s into a Roth IRA. To encourage you to do so, the government has sweetened the deal...
Usually, when you do a conversion, you pay the taxes in full at the time of the conversion. But right now, if you agree to convert to a Roth by the end of the year, you can delay paying the taxes until next year. You can even split the bill 50-50 between 2011 and 2012.
If you're one of the millions with a traditional IRA or 401(k), taking advantage of this loophole could save you thousands of dollars in retirement.
If you defer your tax bill and split it, you'll essentially get a tax-free loan for eight to 20 months. And T. Rowe Price data showed a 45-year-old man who puts $25,000 into a Roth ends up with $53,300 more by the time he is 85 than if he left it in a traditional IRA. And that even factors in a drop in his tax bracket from 28% today to 15%.
If your income tax rate will be the same as today or higher in your retirement, converting is even more attractive. And trust me, taxes are going higher in the future.
Next year alone, tax rates are scheduled to rise. The two top marginal rates are rising to 39.6% and 36% from 35% and 33%, respectively. It's only a matter of time before they rise again.
But perhaps the most powerful reason for converting to a Roth is the ability to continuously build money over both your lifetime and your beneficiaries'. I call it the "Legacy Plan" because it allows you to keep the money growing until you die. This is not true for traditional IRAs and 401(k)s.
When you turn 70 and a half years old, traditional IRAs require you to stop putting money in and start taking money out. It's known as the Required Minimum Distribution, or RMD.
Roth IRAs have no such rules. So using a Roth allows you to grow the account longer and take advantage of the power of compound interest under a tax-free umbrella.
Even better, you don't ever have to take money out of your Roth. The money goes tax-free to your spouse and your beneficiary.
Moreover, you can contribute money into the Roth at any age, as long as you have "earned income." This means at 75, 80, or 85, you can fund your account and continue to see it grow.
Converting to a Roth protects your retirement savings and allows it to grow in several ways. And now (with the 2011-2012 split available) is an ideal time to do it.
It's not often the U.S. government gives us a loophole this important to our retirements. But the feds are cash-starved and desperate to take in as much tax money as possible. The time to take advantage is now.
Here's to our health, wealth, and a great retirement.
Doc Eifrig
P.S. There are lots of things to consider before you make the conversion, and I didn't have room to go into all of them here. But in the latest issue of my Retirement Millionaire advisory, I showed readers two secrets that will maximize your retirement savings while limiting what the IRS can claim.
This one issue of Retirement Millionaire could easily save you tens of thousands of dollars in taxes. To learn more about Retirement Millionaire, click here.
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