CAN YOU TURN A $14,000 INVESTMENT INTO $73,000 OF TAX SAVINGS? MAYBE, HERE’S HOW:

TO DO’S:

  1. Create a new non-deductible traditional IRA account and in January 2022, contribute $7,000 attributed to the 2021 tax year and $7,000 to 2022.  Leave in cash.
  2. Convert this IRA to a Roth IRA as soon as practical thereafter (likely within a couple of weeks of funding).  Since you just contributed it, there will be no gain and therefore no tax due upon conversion (see requirements below to ensure you qualify). 
  3. Invest these Roth IRA funds into a diversified portfolio of stocks like the S&P 500 ETF (SPY).  Over a 30-year retirement, these stocks should earn the long-term average annual returns of large U.S. stocks (average return is 10.2% since 1926).  If there are no distributions out of the account, after 30 years there will be over $243,000 of investment earnings.  NY state investors with over $500K of annual income pay 30% tax on qualified dividends and LT capital gains.  These taxes are avoided in a Roth, saving over $73,000 in taxes.  
  4. All future distributions from this Roth IRA will be tax free, including those made to heirs after your lifetime. 
  5. Do the same for your spouse and double the tax savings.
  6. In order to get even more tax savings, repeat the above process every other year. 

REQUIREMENTS:

  • You or your spouse must have annual earned income in excess of each year’s IRA contribution and in order to contribute $7,000 per year you must be 50 + years old ($6,000 maximum for 49 and under).
  • This strategy may not work if you already have existing IRAs due to potential taxes due upon conversion.  When converting an IRA to a Roth IRA, one must aggregate all IRA accounts to determine a gain on conversion (401K plans are excluded from this calculation).  Check with your tax advisor as there are specific rules to be followed and potential work arounds for certain issues.

Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. Source for all return data is “2020 Stocks, Bonds, Bills and Inflation Yearbook”, Roger G Ibbotson and Duff & Phelps. For our full disclosures, click here.

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