Bridgeriver LLC August 2019

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Create Your Own Tax-Free Retirement

Is it possible to create a tax-free retirement? I recently did this for a client who was amazed that it worked. It all came down to establishing (or converting to) a Roth IRA. This works because you put in after-tax money and avoid additional taxes on any gains made. For example, if your initial $5,000 grows to $10,000 — or $50,000 or $80,000 — you won’t owe any taxes on your gains. That money is yours. Roth IRAs were developed in 1997 and are a powerful tool. A lot of people at that time were already deeply invested in whatever plan their company offered and didn’t immediately jump to the Roth IRA. Fast forward to today, and those people who didn’t contribute or perform any conversions will be paying taxes on all those gains. And to make matters worse, they may be in higher tax brackets and owe far more than they expected when they were working in the ‘90s. One of the biggest misconceptions about Roth IRAs is about how much you can contribute every year — $7,000 max for anyone over 50 for 2019. While contributing is technically limited, you can get around this by converting a traditional IRA into a Roth IRA. There are no limits on converting a traditional IRA to a Roth IRA. Why convert? Under the new Trump tax law, you may be able to convert and avoid jumping tax brackets, even if you convert $200,000 or more. Once the money is in a Roth IRA, you can create tax-free income for the rest of your life. If you’re invested in stocks through a Roth IRA, you can create a situation in which you live off the dividends without touching the principal. The account will never go away and all dividends are tax-free. Alternatively, if you put money into an annuity, you can create a pension for yourself, with all of your payments being tax-free. If you can effectively create a pension plan within your Roth IRA, that gives you even less to worry about. Since the 1970s and ‘80s, more and more companies and municipalities have been phasing out pension plans. Instead, they’ve shifted more of the risk to their employees by offering 401(k)s or similar plans. This often leaves people with plans they don’t know how to manage. The great thing about pensions is that they are, usually, managed on behalf of the workers. In terms of setting up an annuity-based

pension through your Roth IRA, the hardest part is just setting it all up, and it’s really not that difficult. After that, there is very little you have to worry about. Now, when you convert one lump sum from a traditional IRA into a Roth IRA, you will have to pay tax on the conversion amount. It’s like ripping off a Band-Aid. But the benefit is that you’re paying the tax on that sum at a known rate. You don’t have to worry about paying an unknown rate in the future when you may be in a different tax bracket or if and when the IRS increases taxes. People often assume that when you make the conversion from a traditional IRA to a Roth IRA, you have to pay tax on the gains at some point down the road, but this is not the case. Once the conversion takes place, gains remain tax-free from then on out. Keep in mind, once you turn 70 1/2 (and soon probably 72), you must take required minimum distributions (RMDs) from your traditional IRA. It doesn’t matter if you have other income sources. The law requires you to take a certain amount out of your IRA every year, and this can complicate your tax situation. If you don’t take your RMDs, you will be hit with a major penalty: 50% of the amount you should have withdrawn but didn’t. Luckily, you do not have to take RMDs from a Roth IRA, giving you less to worry about. These days, it seems that IRAs are constantly under attack by the federal government. It used to be that once you die, your heirs could take small payments from your IRA. If the SECURE Act passes, if your beneficiaries (usually children) want to take payments from your IRA, they have to do it in under 10 years (unless it’s your spouse and a few other exceptions and that stipulation doesn’t apply). The government wants to put more and more limits on your money.

But when you establish a tax-free pension through your Roth IRA, that gives you far more freedom to manage your hard-earned money in retirement and to take the IRS out of the equation.

-Dan Casey

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