The following is an excerpt from

Big Picture Retirement Planning

Les Goldstein, M.B.A.

Personal Financial Strategies, Inc. PARK RIDGE, ILLINOIS

Copyright © 2018 by Les Goldstein.

The following content is for non-commercial educational use only. All rights reserved. No part of this publication may be reproduced, distributed or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other non-commercial uses permitted by copyright law. For permission requests, write to the publisher at the address below.
Les Goldstein/Personal Financial Strategies, Inc.
626 Busse Highway
Park Ridge, IL 60068
Book layout ©2013
Big Picture Retirement Planning/ Les Goldstein. —1st ed.
ISBN 978-0-0000000-0-0


The Powerful Roth IRA


The Roth IRA was established by the Taxpayer Relief Act way back in 1997, and many of our clients have been contributing to Roth IRAs ever since. Roth 401(k)s became available on January 1, 2006, although many companies still do not offer this option to their employees.

At PFS, we love Roth accounts. Of course, everything in my industry comes with “qualifiers,” not absolutes. But, as a general rule, any time we can fire Uncle Sam as our non-working business partner, it’s a good thing. I love the USA. I love our freedom. I still feel that I would never want to have been born anywhere else. But, personally, I want to control my financial picture as much as possible. I believe that you probably feel the same way! So, let’s talk about taxes a little bit more, right now.
Early in my career, I bought into the idea that our clients would be in a lower tax bracket during retirement. Do you believe this will be true for you? Do you think that tax brackets are going down or going up? If you combine “tax bracket creep” with the fact that everyone wants to live at the same (or higher) lifestyle during retirement, it is safe to assume that your desired income level will not decrease during retirement. Neither will your in-come taxes.

Here are some important points to consider:

  1. Contributing to traditional IRAs and 401(k)s builds a future income tax liability. If income tax rates continue to increase, your future income tax liability will also continue to increase.
  2. With Roth accounts for you and your spouse, the 70½ rules do not apply. Once you have reached age 59½ and have satisfied the initial five-year wait rule, you can take money out of your Roth accounts whenever you want. On a tax-free basis. If you do not want to take money out of your Roth accounts, you don’t have to during your lifetime or the lifetime of your spouse. Different rules do apply to Roth accounts, and to regular IRAs and 401(k)s, that are inherited by your children and grandchildren.
  3. Consider annual conversions of 401(k)s and IRAs to Roth accounts. The younger you are, the better the potential outcome. You will have to take income tax on all money you convert from a 401(k) or IRA to Roth, but you’ll never pay income tax on this money ever again. As always, there are rules to follow, such as a 5-year wait rule. But these rules are easy to follow if you or your advisor knows them. Proceed carefully, as we are talking about your money and your future, hopefully successful, retirement plan of action.

It can be a wonderful idea to leave a Roth IRA to your youngest beneficiaries. If you do it right, your beneficiary will be able to create life-long income for himself or herself, income-tax-free for-ever. In our opinion, a Roth IRA is the second-best asset to leave to a beneficiary. The first-best? Life insurance. More on life insurance as a legacy asset later in this book.

Roth IRAs and 401(k)s can be wonderful accounts for yourself and your beneficiaries. You or your financial advisor needs to completely understand the tax rules associated with Roth accounts. Here are some quiz questions for you to test your Roth IRA knowledge:

You have been making Roth IRA contributions for many years. At what age can you begin taking out your Roth balances without any kind of penalty, assuming you have followed the other Roth rules properly?

a. 50
b. 55
c. 59½
d. 70½

Answer is “c.” You can also take out your original contributions at any time, without taxes or penalty.


Let’s assume that your grandchild inherits a Roth IRA from you when he or she is 23 years old. When does that 23-year-old beneficiary have to take money out of this inherited Roth IRA?

a. At his or her age 59½
b. At his or her age 70½
c. Never
d. Beginning in the year of inheritance, and for every single year for the rest of his or her life

Believe it or not, the answer is “d.” With inherited Roths and inherited IRAs, required minimum distributions must begin right away. But the amount your beneficiary has to take out every year is based upon his or her life expectancy, not yours. This allows your beneficiary to stretch distributions over his or her lifetime, potentially creating a pool of dollars much larger than he or she inherited from you. This is known as a Stretch IRA, and it can be a wonderful legacy to leave to children and grandchildren. A Stretch IRA can be created using a traditional IRA or a Roth IRA. The tax benefits of the Roth IRA can be significant, and the Roth IRA is our preferred IRA inheritance asset.


When your grandchild does take money out of this beneficiary Roth IRA, what are the income tax consequences?

a. 15 percent long-term capital gains tax
b. Taxable as ordinary income at beneficiary’s federal income tax bracket
c. Not taxable

The answer is “c,” not taxable.


When can you take out gains from your own Roth IRA with-out any tax cost?

a. 59½
b. 59½ and 5 years from the date of your first Roth contribution
c. 8 years
d. 5 years

The answer is “b.” A very interesting loophole is that the 5-year wait rule is measured from the date of your very first Roth contribution. Future contributions look back to the date of the first contribution.
Here are some more differences between Roth accounts and traditional IRAs and 401(k)s. With regular retirement accounts, often referred to as traditional IRAs and 401(k)s:

  1. You get an immediate income tax deduction, which is nice. The higher your tax bracket, the more beneficial the income tax deduction. Let’s say that you are married and your adjusted gross income is $182,000 in 2016. You are in a 28 percent marginal federal income tax bracket. Every dollar you contribute to your IRA or 401(k) saves you 28 cents in tax. If your adjusted gross income is $466,950 or above in 2016, you are in the top federal income tax bracket, and every dollar you con-tribute saves you 39.6 cents in tax.
  2. Your traditional 401(k) or IRA will grow (you hope) on a tax-deferred basis until you take the money out.
  3. When you take money out of your traditional 401(k) or IRA, you will pay tax at your then-current ordinary in-come tax bracket. Every dollar you take out will be tax-able.
  4. You can begin taking money out of traditional retirement accounts as early as 59½ without penalties. It is possible to take out the money sooner, but you will be forced to follow very specific guidelines in order to avoid 10 percent pre-59½ penalties. Proper pre-59½ distribution planning requires you to adhere to a specific withdrawal schedule for a minimum of five years, or until you reach 59½, whichever event occurs later. If you do not hold to the required 72(t) schedule, all amounts withdrawn may become subject to the penalty tax. In our practice, we try to avoid pre-59½ distributions as much as possible. Why? Because there is always the risk that the principal balance of your retirement investment accounts could be exhausted prematurely in the event that the distributions exceed the net earnings and growth of the investments.
  5. You must begin taking IRA or 401(k) distributions no later than the April 1 following your 70½ birthday. Please, don’t ask me why. This is just another Uncle Sam rule we must follow. So even if you do not need or want the money, you still must take money out. And there is a specific formula you must follow regarding these distributions. The percentage you are required to take out increases every year, and the percent times the value of all traditional retirement accounts on the previous December 31 determines the minimum dollar amount you must take out each year. Now, there’s a ripple effect. Your current taxable income is now in-creased and, combined with your Social Security in-come and/or pension income, you may be in a higher tax bracket than you were earlier in life. Over certain income levels, your Social Security benefits now be-come up to 85 percent taxable.

With Roth IRAs and Roth 401(k)s:

  1. No income tax deduction for putting money in.
  2. All money grows tax-free, not tax deferred.
  3. A non-working spouse can open a Roth IRA based on the working spouse’s earnings and the couple’s tax filing status.
  4. You can contribute to a Roth IRA even if you participate in a traditional retirement plan through your employer.
  5. Your contributions can be taken out at any time without tax or penalty, regardless of your age.
  6. You must wait five years from the date of your first contribution before you can take gains out and avoid taxes. You must be 59½ as well to avoid early withdrawal penalties. The 5-year-wait rule for your Roth IRA earnings starts on January 1 of the year you make your first contribution.
  7. There are no mandatory withdrawals at any age. The 70½ rule does not apply.
  8. These are excellent legacy accounts, because distributions to your beneficiaries will not be taxed.

Our position on regular/traditional IRAs and 401(k)s versus Roth IRAs and 401(k)s:

  1. The younger you are when you begin to contribute to your Roth accounts, the better. You need to make up for the tax savings you did not get by electing to participate in the Roth instead of the traditional IRA or 401(k).
  2. The Roth becomes more beneficial as income tax brackets rise. Think about how good it will feel to not pay income taxes on your retirement income cash flow!
  3. Having control over if and when you take money out of retirement accounts is an excellent position to be in. Roth accounts can help to lessen Uncle Sam’s impact on your comprehensive retirement income planning.
  4. Qualifying distributions from Roth IRAs and 401(k)s are not included in your income for the purpose of determining whether you owe income taxes on any portion of your Social Security benefits.

PFS Pearl of Wisdom: Paying taxes on the seed, not the harvest, can be a significant benefit: forgoing the income tax deduction of your traditional IRA or your traditional 401(k) and going with the Roth versions. When we are discussing Roth planning with clients, we bring in our CPA and also use financial planning software to analyze the costs and benefits. You will want to do the same and discuss your particular situation with a tax professional to see what strategy is most beneficial to your situation.

Here’s an example. Let’s say that you have accumulated $500,000 in traditional retirement assets. You take out 5 percent per year to live on. Let’s also assume for illustration purposes only that your accounts earn 5 percent per year on average. Remember, returns do not occur in a straight line. Some years you might lose money or earn very little. Some years, you may do much better than 5 percent. But in this example, you will pay ordinary income tax on $25,000 every year. Let’s say that this results in $7,500 in federal and state taxes. Over 30 years of distributions, at a 25 percent federal tax bracket, this will result in cumulative total taxes of $225,000. This illustration assumes that taxes remain constant over your lifetime. Do you believe that will happen? Or do you think that taxes will increase over time? The higher your tax bracket, the more taxes you will pay over time.

Now, you (and your spouse, if you are married) pass away. Under this very simplistic illustration, how much will you leave in your retirement accounts? It would be $500,000. This $500,000 legacy is still fully taxable, and it may be taxable right away if you don’t plan properly. More tax. All of this taxable income could have been tax-free if you had either contributed to Roth accounts or converted to Roth accounts.

We believe that an inherited Roth IRA is the second-best asset to leave as a legacy. The first-best is a properly structured life insurance legacy. We analyze each client’s situation on a case-by-case basis to determine if clients should participate in traditional or Roth 401(k)s and IRAs and if they should convert traditional retirement ac-counts to Roth retirement accounts. The correct answer comes down to several factors, including:

  1. Will you be spending this IRA or 401(k) to support your lifestyle during retirement?
  2. How many years do you have before needing income from this particular account to live on?
  3. Do you anticipate being in a higher or a lower income tax bracket during retirement?
  4. Is your IRA or 401(k) intended to be a legacy asset for children and grandchildren? Or, will you be spending this account on yourself and your spouse?

Here’s an interesting idea about Roth IRAs as a legacy. Right now, the maximum any person can contribute to a Roth IRA is $5,500. If you’re over 50, the maximum annual contribution to $6,500. So, it is a little hard to accumulate significant dollars inside a Roth IRA if you’re just starting now. But, let’s look at it a different way. Let’s say you’re 55 years old, and you can afford $6,500 a year to contribute to your Roth IRA for the next 12 years until you retire. Your total contributions are $78,000. Just as an example, let’s say that the $78,000 in total contributions grew to $100,000 by the time you retire at the age of 67.

Now, let’s say that you leave this account alone during retirement and name your grandson, who is currently five years old, as the primary beneficiary. You live to the age of 90 and never take distributions from this account. [Remember, Roth accounts do not have required minimum distributions for the person who established the account or for his or her spousal beneficiary, different than traditional IRAs and traditional 401(k)s.]. At a 5 percent per year rate of return, which is about 60 percent of the historical rate of return of the stock market as measured by the S&P 500 over the last 90 years, this $100,000 at your age 67 will have grown to approximately $300,000 by your age 90. Again, a 5 per-cent per year return, or any rate of return in the stock market, is no guarantee of future results, and your results will vary.

Now that we understand the benefits of owning a Roth IRA or Roth 401(k), the big money is in converting your 401(k) or traditional IRA to a Roth IRA. Prior to 2010, there were income limitations that restricted higher income earners from converting traditional IRAs and traditional 401(k)s to Roth IRAs. Now, those income limitations have been eliminated, and anyone who has a traditional IRA or traditional 401(k) can convert these accounts to a Roth IRA. But, there is a catch. Every dollar you convert from a traditional IRA or traditional 401(k) is taxable to you in the cur-rent year as ordinary income. The more you convert, the more tax you will pay. Again, think about our PFS Pearl of Wisdom on “paying tax on the seed, not the harvest.”

Here are a couple of caveats worth mentioning. First of all, we would never recommend borrowing to pay for the tax costs of doing the conversion. Second, even though it is completely legal and legitimate, we would never recommend paying the tax liability out of the account that you are converting from a traditional IRA or traditional 401(k) to a Roth IRA. To us, shrinking the size of this newly converted Roth IRA to pay the tax cost of conversion most likely will not make sense. The most intelligent way to pay the tax cost of conversion is to use cash on hand.

Important Disclosures for This Chapter

All information presented herein is considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to any error or omission is accepted. This mate-rial should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, the investor should make an independent assessment of the legal, regulatory, tax, credit, and accounting, and determine, together with their own professional advisors, if any of the investments mentioned herein are suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making an investment.