Increasing your wealth over time takes patience. But there are a few lesser-known strategies and ways of thinking that can help along the way.
1. Non-Deductible IRA vs. Roth IRA
Given the choice, contributing to a Roth IRA is always a much better choice than a non-deductible IRA - Roth eligibility for 2016: $194,000 joint or $132,000 single. While you do not get a tax deduction for either, the money in the Roth IRA will be tax-free when withdrawn, while the non-deductible IRA will be taxable to the extent of growth in the account. See my “IRA Cascade” below. (For more, see: 3 Simple Steps to Building Wealth.)
2. Which Assets to Spend First in Retirement?
The spending order of your assets in retirement matters. In general, it is preferable to spend principal from your non-IRA investments rather than taking a taxable distribution from your IRA and/or retirement plan. This is based upon paying lower capital gains tax rates (now) in the non-IRA account versus ordinary income tax rates (later) in the IRA and or retirement account. Generally, the spending order should be:
- Income Sources: Pensions, dividends, interest and capital gains, Social Security.
- Non-IRA Assets: Investments that will sell at a loss or break even, than more highly appreciated assets.
- IRA and Retirement Plan Assets: IRA, 403(b), 401(k) and so forth, dollars over and above required minimum distributions.
- Roth IRA: Roth IRA dollars.
3. Roth Conversion
Converting IRA assets to a Roth IRA will preserve tax-free distributions for generations. Under current law, the Roth IRA will grow income-tax free for the rest of your life, the rest of your spouse’s life and lives of your children, your grandchildren and potentially even your great grandchildren.
4. Purchasing Power Not Total Dollars Is Best Measure of Wealth
It’s what you get to spend after-tax that matters. If you have $1 million in a traditional IRA, you do not have $1 million in purchasing power. This is because the money in the traditional IRA is tax deferred, not tax free and you will have to pay income tax when you cash in that IRA. (For more, see How Much to Save to Become a Millionaire.)
If you agree that the correct measuring tool for wealth is purchasing power rather than total dollars than making a Roth IRA conversion will not diminish your purchasing power as of day one when you have to pay taxes on the conversion. Going forward, your purchasing power will be greater with the Roth IRA than with a traditional IRA.
5. Give Away More Than Annual Gift Tax Exclusion and Not Pay Taxes
Because of the generous lifetime gifting/estate tax exemption under current tax law the annual gift tax exemption (limit) is not meaningful. Many are under the assumption that making a gift greater than the current $14,000 exclusion per donee will result in tax. This is not true. No tax will be owed because any amount over the $14,000 will simply reduce your estate or lifetime gift tax exclusion of $5.45 million by the amount of the gift value over $14,000. The only thing you would need to do is file Form 709 informing the IRS that the current year gift consumed part of your estate exemption.
6. Your Will Or Living Trust Does Not Control the Distribution of an IRA
A will or trust cannot change to whom your IRA money goes to. Any account that has a specific beneficiary designation will be distributed to the individuals listed on the beneficiary form, regardless of what your will or trust says. (For more, see: Getting Rich: What Are Your Odds?)