By Dennis Kagel
Fidelity Investments has estimated that a couple retiring today at age 65 can expect to pay $240,000 in Medicare premiums and uncovered expenses over the course of their golden years. The fact that rising health care costs also is among the biggest concerns among many retirees means employing financial strategies for both accumulating money and withdrawing money to prepare for the possible burden of future medical expenses. The fact that withdrawals from Roth IRA accounts are tax-free means that it’s possible that the strategies that we’re going to discuss in this month’s article could result in more net dollars for retirees that could be used for health care costs.
Every person who owns a traditional IRA can convert it to a Roth IRA. Many people are not even aware of this simple fact. The conversion right also applies to other qualified plans such as 401(k)s, etc.
When we discuss the conversion option with our clients, in most cases they seem to be hesitant initially when we bring up the fact that the amount they convert is subject to ordinary income tax. The thing to keep in mind is this is not a new tax or an additional tax, it’s simply the tax that’s due on a withdrawal from an IRA. Someone is going to pay the tax someday, regardless. Whenever one withdraws money from an IRA it is going to be taxed as income whether that’s this year or next year or many years into the future. The key thing to keep in mind is that you do have a choice as to when you pay the tax. This control along with proper planning can make a huge difference in total taxes paid on these funds.
One of the biggest challenges we have in our daily work is to get our clients to think in terms of, and to look at, “the big picture.” This means that we shouldn’t limit our thinking when making an important financial decision to only the present (today or this year). We need to take into account the present as well as many years into the future. How this applies to this article about converting IRAs is the fact that many people are clearly better off paying the tax today at the time of the conversion and know that everything in the Roth (principal and all the future interest growth) will be tax-free when withdrawn in the future.
The importance of a “big picture” perspective is also demonstrated by taking into account not only the tax impact on the account owner, but on his/her spouse and children and grandchildren, etc. You see, taxes are due at the time anyone (account owner and/or beneficiary) receives money from a traditional IRA. As we mentioned previously, there are never any taxes due on money withdrawn from a Roth IRA. This is true whether it is the account owner or a beneficiary.
During every speaking engagement that I have, I ask the audience this question, “Do you think income taxes in the future will go up or down or stay about the same?” Without exception, everyone responds (after chuckling) that they think taxes will definitely go up in the future. I have to say that I agree just based on the financial condition of Social Security, Medicare, and our national debt. If, in fact, the odds are that taxes will go up, wouldn’t it be better to pay the taxes on your retirement funds today at a lower rate rather than wait to withdraw and pay taxes in the future when tax rates are higher?
If you’d like a no-cost and no-obligation analysis of your IRA situation and ways you might convert taxable dollars now into tax-free* dollars down the road give us a call at 309-454-9171 to schedule a visit. Dennis Kagel is insurance-licensed in the state of Illinois.
By contacting us, you may be offered information regarding the purchase of insurance products, including annuities.
* According to current tax law. Not intended to give tax or legal advice. See experienced professionals in these areas for the applicability to your situation.