Written By : Scott Inman
It’s hard to admit now that I’m an adult, but when I was a kid, I used to watch professional wrestling. I didn’t know it was as much of a scripted drama as “The Love Boat” was. I would be on the edge of my seat, cheering for the “good guys” like Junk Yard Dog, and “Hacksaw” Jim Dugan. But, I hated the “bad guys,” and there was no one I enjoyed hating more than “Nature Boy” Ric Flair. Man, he was arrogant, always bloviating about how great he was. One of the things I always remember him saying over and over again was, “If you want to BE the man, you gotta BEAT the man.” How conceded was this guy? I mean, did he really think he was on the mountain top alone and no one could knock him off? But, it turns out, there’s a lot of truth in that statement, even when it comes to planning for retirement.
In the financial world, the “Man” is the system. It’s the rules that govern when, where, and how much we can save for our retirement, and we all have to play under those rules. I am, by no means, suggesting that we should break those rules. But, I am suggesting that there are advantages we can gain by digging a little deeper into the flexibility we may have while operating under them. Here are 3 examples:
RETIREMENT SECRET #1 : “Back-door” Roth IRA
The Roth IRA is one of the most under-utilized accounts out there. It differs from a traditional IRA, in that it is funded with after-tax dollars, allowed to grow tax-free, and, provided that certain requirements are met, supply the owner with tax-free withdrawals. But, most people have the bulk of their retirement savings in other accounts. I’ve rarely seen a Roth IRA with a six-figure balance.
One reason may be that Roth IRA’s do have income restrictions that limit contributions. In 2018, if you earn more than $199,000 as a married couple filing jointly, or $135,000 as single filer, you cannot contribute to a Roth IRA. At least, not directly. You can, however, contribute to a traditional IRA during the year, up to $5,500 if you’re under 50, and $6,500 if you’re over 50, then, convert those contributions to a Roth IRA. This is known as “back dooring” into a Roth IRA. Any gains on those contributions would be taxable as ordinary income for the year in which the conversion was made. But, if you make the conversion immediately after the contribution, there may be no gains.
There are complex formulas that may apply if you have other traditional IRA money, and you should consult a financial advisor to determine if it’s right for you. But, in its simplest sense, if you make too much to contribute directly to a Roth IRA, this is a possible way to get funds into a Roth IRA that will provide you tax-free withdrawals in retirement.
RETIREMENT SECRET #2 : Tax Diversifying Your Retirement Income
I routinely meet with people for the first time who do not realize that most, if not all, of their sources of income in retirement will be taxed. If you have a pension, it will likely be taxed as ordinary income. If you make withdrawals from a 401k, traditional IRA, or other qualified retirement account, it will be taxed as ordinary income, if the funds were contributed before taxes were withheld. Even Social Security benefits will be partially taxed, if your annual adjusted gross income exceeds $25,000 as an individual filer, or $32,000 for married couples filing jointly.
Retirement is essentially an income problem. Having a source of income that is tax-free can make a huge difference in your retirement income plan, and in how long your assets could last. For example, if you need $5,000 a month in net income in retirement, you would need around $6,300 per month, if all of the income sources were taxed, based on an effective tax rate of 20%. Depending on when you retire, tax rates could go up, meaning the money you’ve yet to pay taxes on could be taxed at a higher rate.
Having tax-free income can also provide flexibility. Let’s say your income plan keeps you under a certain tax bracket, but you need to make a major purchase during the year and need to withdraw from your retirement accounts to pay for it. If those withdrawals are taxable, you might jump into a higher tax bracket. But, if you have a tax-free income source, that money can be withdrawn with no effect on your tax rate.
RETIREMENT SECRET #3 : Invest Your Health Savings Account
Health Savings Accounts, created in 2003, allow workers to make pre-tax contributions and withdraw the money tax-free if the funds are used to pay for qualifying health care expenses. They are often used to satisfy big health insurance deductibles, while someone is still employed. This is evident in the results of a recent survey from the Employee Benefits Research Institute that discovered 55% of account holders said they typically spent the full balance of their account every year. In addition, 96% of these accounts were sitting in cash. Changing your time horizon and treating your HSA as a retirement account can provide value to your overall retirement income plan.
According to some estimates, healthcare costs are rising 6% annually, and the average 65-year-old couple could need close to $300,000 to pay for things that Medicare does not. If you use an HSA as a long-term investment vehicle, allowing it to grow tax-free during your working years, you have a better shot at paying for these costs without tapping other taxable retirement accounts.
If you still need to use the HSA to pay your deductibles now, think about contributing more if you can, or take a look at the balance at the end of the year, and use that money to invest. If you don’t need it to pay for health care costs in retirement, you can still access it. Once you reach age 65, HSA funds can be used for any reason, but, if the money is not used to pay healthcare expenses, the withdrawal will be taxable.
If these three examples were actually “retirement secrets” to you, they shouldn’t be. Working with a financial advisor can be great way to uncover tools and strategies that will help you be better prepared for retirement. A GenWealth advisor is waiting to talk to you. And, none of us remotely resembles “Nature Boy” Ric Flair. Give us a call at 501-653-7355 today!