It’s Not Too Good to Be True!

by Daryl Dagit, Savant Capital Management

What if I told you that you could save money in an account that would grow tax-free, and when you die, you can pass the account to your children or grandchildren, who would not pay income taxes on it? What if you could put money into an account and potentially take out the principal any time you want—with no penalty or tax? Would this interest you, or does it sound too good to be true?

It turns out this is exactly what you can do with a Roth IRA. There are a few simple rules to follow, and if you think you make too much to contribute to a Roth IRA, keep reading for an easy, effective way to help you achieve this goal. Let’s explore this great estate and tax planning tool.

If you are married with an adjusted gross income of no more than $194,000—or $132,000 if filing single—you can contribute directly to a Roth IRA in 2016. You can also contribute to a Roth IRA even if you have a 401(k) at work! It is that simple.

For those with salaries exceeding these thresholds, there is still hope. Here are the steps to follow:

  • Contribute up to $5,500 to a non-deductible IRA. If you are over age 50, you can contribute an additional catch-up contribution of $1,000 for a total of $6,500 (which applies for non-working spouses as well).
  • Complete the conversion to a Roth IRA.
  • Consider Roth 401(k) contributions, if available through your employer.

This would result in a fully funded Roth account with little or no tax consequences. If you currently have an IRA, you should check with a tax advisor, as there may be tax consequences to this strategy. Some of the other rules surrounding the Roth IRA include:

  • Tax-free distributions can be taken from a Roth IRA if the account has been open for at least five calendar years and the distribution is a qualified distribution. Keep in mind: you can open a Roth IRA on December 31st of the current year and the entire year would count towards the five-year qualifying period.
  • Contributions can be made even if you participate in your employer’s retirement plan.
  • Contributions can be made at any age up to your earned income or $5,500—whichever is less.
  • The principal can be withdrawn at any time with no penalty or tax. The interest and earnings must follow the rules for a qualified distribution. This applies to Roth contributions only, not conversions (a 10-percent penalty applies to conversions paid out within five years if under age 59½… unless an exception applies).
  • The deadline for contributing to a Roth IRA is the tax-filing deadline for that year, normally April 15th of the following year.
  • The maximum contribution is phased out starting at $184,000 for married filers and $117,000 for single filers.

Sometimes, the government does give us options that seem too good to be true. Take advantage of this great tool to help grow wealth and pass assets to your next generation. iBi

Daryl Dagit is the market manager and financial advisor in the Peoria office of Savant Capital Management. He can be reached at (309) 693-0300.