The Bogleheads' Guide to Retirement Planning by Taylor Larimore, Richard A. Ferri, Mel Lindauer, Laura F. Dogu, John C. Bogle Page B
Tags: nonfiction, Non-Fiction, Business & Economics, Business, Business & Money, Investing, Personal Finance, Financial, Retirement, Retirement Planning
Ads: Link
original IRA and reinvest the distributions at 8 percent, he could leave behind more than $9 billion. Now that’s an estate tax problem.
When you combine the magic of compounding with tax-free growth and a healthy disinclination to spend, truly amazing things are possible, all for a mere $2,000. Of course, this assumes our country and its current tax laws are still around in 200 years, but even if the benefits are only a fraction of what I’ve illustrated here, it is still the investing deal of the century.
A traditional IRA can also be stretched, but it is much more difficult to leave a large sum of money behind because of the relatively large RMDs in the last few years of the original owner’s lifetime. The pesky issue of your heir having to pay a large amount of taxes with each distribution also rears its ugly head. But you still get some tax-free growth for a large number of years. You should also note that you cannot convert an inherited traditional IRA to a Roth IRA, unless you inherited it from your spouse.
Health Savings Accounts (the Stealth IRA)
A health savings account (HSA) was originally designed to help people pay for medical care, but savvy investors use it as an extra IRA. You are eligible only if your health insurance is a high-deductible health plan that meets IRS rules. Contributions are deductible, just like a traditional IRA, and withdrawals are tax-free, just like a Roth IRA, if you use them for health care. Unlike a flexible spending account, the money does not have to be used up in that particular year. So if you don’t spend it, it just keeps growing for decades. In retirement, you can use this money for health care, tax-free, or, after age 65, you can use it for anything, but you’ll have to pay tax on it at your marginal tax rate, just like a traditional IRA.
Most HSA plans offer either mutual funds or a brokerage account. The 2009 contributions limits are $3,000 for an individual, $5,950 for a family, and an extra $1,000 if you are over 55. If eventually used to pay for health care, an HSA is better than a traditional or Roth IRA, because it eliminates not just three of the four taxable events discussed earlier, but all four of them! The benefit of tax-free growth is so great that you should preferentially pay for health care with current income or taxable savings to keep this money growing until retirement. Remember that if you itemize your taxes, any amount above 7.5 percent of your adjusted gross income (AGI) that you spend on health care qualifies for an additional tax deduction!
Nondeductible IRAs
If you make too much money to deduct a traditional IRA contribution, you should contribute the money to a Roth IRA. But if you make too much to contribute to either, you can still contribute to a nondeductible IRA. This is simply a traditional IRA without the initial tax break. Your money grows tax-free, and when you eventually withdraw the money, the earnings are taxed at your marginal tax rate. Your original contribution is not taxed again.
The paperwork to keep track of the tax basis (what you originally contributed) through the years can be a pain, and if tax-efficient investments such as stock index funds are held in the account, you may be paying your marginal tax rate on income that would have been taxed at the lower capital gains rate if you had used a taxable investment account instead.
It takes many years of tax-free growth to make up for that higher tax rate at withdrawal. Use a nondeductible IRA under only two circumstances: first, if you need more tax-protected space to hold tax-inefficient investments such as REITs or TIPS (see Chapter 10 for more on this subject) and second, if you plan to convert the nondeductible IRA to a Roth IRA in the near future.
ROTH IRA VERSUS TRADITIONAL IRA
Many investors, even knowledgeable and sophisticated ones, struggle with deciding whether to use a traditional or Roth IRA (or a traditional or Roth 401(k)). Although there are times when the
When you combine the magic of compounding with tax-free growth and a healthy disinclination to spend, truly amazing things are possible, all for a mere $2,000. Of course, this assumes our country and its current tax laws are still around in 200 years, but even if the benefits are only a fraction of what I’ve illustrated here, it is still the investing deal of the century.
A traditional IRA can also be stretched, but it is much more difficult to leave a large sum of money behind because of the relatively large RMDs in the last few years of the original owner’s lifetime. The pesky issue of your heir having to pay a large amount of taxes with each distribution also rears its ugly head. But you still get some tax-free growth for a large number of years. You should also note that you cannot convert an inherited traditional IRA to a Roth IRA, unless you inherited it from your spouse.
Health Savings Accounts (the Stealth IRA)
A health savings account (HSA) was originally designed to help people pay for medical care, but savvy investors use it as an extra IRA. You are eligible only if your health insurance is a high-deductible health plan that meets IRS rules. Contributions are deductible, just like a traditional IRA, and withdrawals are tax-free, just like a Roth IRA, if you use them for health care. Unlike a flexible spending account, the money does not have to be used up in that particular year. So if you don’t spend it, it just keeps growing for decades. In retirement, you can use this money for health care, tax-free, or, after age 65, you can use it for anything, but you’ll have to pay tax on it at your marginal tax rate, just like a traditional IRA.
Most HSA plans offer either mutual funds or a brokerage account. The 2009 contributions limits are $3,000 for an individual, $5,950 for a family, and an extra $1,000 if you are over 55. If eventually used to pay for health care, an HSA is better than a traditional or Roth IRA, because it eliminates not just three of the four taxable events discussed earlier, but all four of them! The benefit of tax-free growth is so great that you should preferentially pay for health care with current income or taxable savings to keep this money growing until retirement. Remember that if you itemize your taxes, any amount above 7.5 percent of your adjusted gross income (AGI) that you spend on health care qualifies for an additional tax deduction!
Nondeductible IRAs
If you make too much money to deduct a traditional IRA contribution, you should contribute the money to a Roth IRA. But if you make too much to contribute to either, you can still contribute to a nondeductible IRA. This is simply a traditional IRA without the initial tax break. Your money grows tax-free, and when you eventually withdraw the money, the earnings are taxed at your marginal tax rate. Your original contribution is not taxed again.
The paperwork to keep track of the tax basis (what you originally contributed) through the years can be a pain, and if tax-efficient investments such as stock index funds are held in the account, you may be paying your marginal tax rate on income that would have been taxed at the lower capital gains rate if you had used a taxable investment account instead.
It takes many years of tax-free growth to make up for that higher tax rate at withdrawal. Use a nondeductible IRA under only two circumstances: first, if you need more tax-protected space to hold tax-inefficient investments such as REITs or TIPS (see Chapter 10 for more on this subject) and second, if you plan to convert the nondeductible IRA to a Roth IRA in the near future.
ROTH IRA VERSUS TRADITIONAL IRA
Many investors, even knowledgeable and sophisticated ones, struggle with deciding whether to use a traditional or Roth IRA (or a traditional or Roth 401(k)). Although there are times when the
Similar Books
