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Use Roths For Wealth Creation And Transfer

Joe Lyons | Thursday, June 25th, 2009

Roth retirement plans are one of the best wealth creation tools available. They are also one of the most underutilized. Simply stated, Roth’s are accounts that are funded with after-tax money, which can grow tax-free as long as the account exists. The contribution limits are the same as for pre-tax accounts. They can take the form of IRA’s, 401K’s, or 403B’s.  There are AGI limits imposed at $116,000 for individuals and $169,000 for joint filers to contribute the full amount to a Roth IRA.  Roth 401K’s or 403B’s have no AGI limit, but must be offered through your employer.

Roth’s have many advantages:

  • Because the contribution limits are the same as pre-tax accounts, you can effectively save more in a Roth because the taxes have already been paid.
  • Earnings in a Roth are never taxed.  Think about making it your trading account if you make short-term equity trades.  It is a great place for income investments that are taxed at your full marginal tax rate.
  • There are no required minimum distributions at age 70.5, allowing many more years of tax-free growth.
  • You are protected from future tax increases.  Considering the current federal deficit, does anyone expect tax rates to decrease in their lifetime?
  • Contributions can be withdrawn at any time without penalty.  This is not true of earnings.

If you have sufficient resources for your own retirement, you should consider gifting Roth’s to family members each year.  This will help to reduce your estate and will be a powerful savings tool for your heirs, who may have many more years than you to accumulate the tax-free growth.  Each of the recipients will need earned income at least equal to the Roth gift in order to do this.  This is not as big a hurdle as you might think.  Even small children can be paid for chores or helping out in the office.  Imagine if someone had funded a single $5000 Roth for you at age 15.  At age 65 it could be worth $234,508 tax-free if it earned 8% per year!

Consider a Roth conversion if you have a traditional pre-tax IRA, or an after-tax traditional IRA.  If your modified adjusted gross income is $100,000 or less, you qualify.  If you make more than that, wait until 2010 when the limit is eliminated.  You will pay income tax when you convert, but never again.  Pay the tax with other after-tax money so that you do not reduce the principal of the IRA.  The decision to convert and how much to convert can be complex.  You should work with your tax advisor to optimize your situation.

About the author:  Joseph Lyons is a principal of Hargrave & Associates LLC, a registered investment advisor, in Riverside CA.  Please visit to learn more.

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