Our guest, the Mad Fientist delves deep into advanced IRA strategies. Find out why you should have one and which one will best fit your needs.
Brandon shares the same goal as many of us, to retire at a young age and avoid paying as much tax as is legal! How you handle your IRA’s can be a big part of achieving both goals.
Traditional IRA
A Traditional IRA is not taxed upfront but at the point of withdrawal. The money grows tax-deferred. Upon withdrawal after age 59 1/2, the money is taxed as income. For 2016, you can contribute up to $5,500, $6,500 if you are aged 50 or older.
Roth IRA
A Roth IRA is taxed upfront and not upon withdrawal after age 59 1/2. For 2016, the contribution limits are the same as for a Traditional IRA.
401k
Many people have a 401k through their employer. A 401k is similar to a Traditional IRA. The money goes in tax-free. When you leave your job, whether it’s to take a new one or to retire, roll that account into a Traditional IRA. This simplifies things so you aren’t trying to keep track of several accounts, and it gives you more control over fees.
You may not even know how much you’re paying in fees for your 401k, and if you take the time to find out by reading the prospectus, there isn’t much you can do about it anyway because your options are selected by your employer. And investment account fees can cost you a lot of money. Americans pay over $6 billion dollars in investment fees per year.
Vanguard makes rolling over your 401k easy, and they have very low fees.
Why Traditional Over Roth?
When you’re in the prime of your career, you’re being taxed at a higher than you are likely to be in the future. You want the tax advantage of the Traditional IRA during your highest earning years because once you give up those tax advantages, they’re gone forever.
Will tax rates be raised in the coming years? Yes, probably. But new loopholes will be added too and as long as there are people like Brandon around, we will know ways to take advantage of them. Is it a risk? It is, but it’s a calculated one.
Roth IRA Conversion Ladder
Both types of IRA’s are used at different stages of life to reap the most tax benefits possible. Brandon has a method for this, the Roth IRA Conversion Ladder. You contribute to a Traditional IRA during your working life because it’s likely that your tax rate is higher now than it will be after retirement.
After you leave your job, you will have less taxable income. During this time, you slowly roll the Traditional IRA to a Roth. This rollover counts as ordinary income so to do this tax-free, convert a dollar amount equal to your tax deductions and exemptions.
During this time, you live off your capital gains and dividends because they are taxed at 0% so long as you’re in the 10 or 15% tax bracket. For 2016, anyone making less than $9,225 is in the 10% bracket, and anyone making between $9,226-$37,450 is in the 15% bracket.
LLC
As we learned in our Natali Morris episode, it’s the people who earn salaries from an employer who take the hardest tax hit. The reason a bunch of LMM listeners are rushing out to start LLC’s! Unsurprisingly, Brandon has a way to super hack your LLC to mine even more tax benefits.
We did a little calculating during the episode, and if you paid yourself $80,000 a year via dividends from your LLC, you would only be liable for $5,000 in taxes! If you were making $80,000 from a salaried job, you would pay over $19,000 in taxes!
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