Our November 18, 2014 blog discussed why living a long life creates retirement problems. Thus, it is important to plan for your retirement as early in life as possible (and there is no better time than today!).
The Public Broadcasting Station (PBS) recently broadcasted a session hosted by a very prominent Individual Retirement Account (IRA) consultant whom I respect very much for his IRA tax law knowledge. His message during this PBS broadcast was that the American public needs to realize that their traditional IRAs do not belong solely to them, but also belong to the IRS. This statement is true since the distributions from a traditional IRA are subject to income tax when withdrawn. He also stressed that Americans need to realize that they have tax deferred accounts (such as the traditional IRA), but can also own tax-free accounts. The tax-free accounts included Roth IRAs and permanent life insurance. This too is sound advice. Where we parted ways with the host was his message that taxpayers should be converting their traditional IRAs to Roth IRAs and investing in permanent life insurance. And if your tax professional is not recommending this strategy, then you need a new tax advisor. Why? . . . Because one is better off having their money in tax-free accounts rather than tax deferred accounts.
While the premise is correct that tax-free accounts are preferred over tax deferred accounts, we believe the host failed to pay enough attention to the factors that must be considered when analyzing Roth conversions and investing in permanent life insurance. This may not be the best strategy for everyone. Perhaps the host discusses these factors when you listen to the CDs he was selling, but in our opinion he did not adequately discuss those factors during his presentation which prompted this post.
What are some factors that one needs to consider?
First and foremost, we have yet to see a single analysis of a Roth conversion making economic sense if the income taxes that are due when the conversion is made are paid from the IRA account. In other words, one needs to have sufficient funds outside of the IRA to pay the income taxes due on the conversion.
Another factor to consider is the tax rate you pay when the conversion is made compared to your future tax rate when you would be taking your required minimum distributions (RMDs) from your traditional IRA starting at age 70 ½. The host of the show implied that the retiree is likely to be in a higher tax bracket when the RMDs are taken. While nobody can predict what future income tax rates and brackets will be, it is a very important consideration when computing whether the conversion makes economic sense. Thus, different scenarios need to be done to analyze the results if tax rates decrease, remain the same, or increase. The person making the conversion needs to be fully aware as to how the economics of the conversion are affected by tax rates.
While one can argue that Americans are living longer and thus the increased timeline makes the conversion economically more feasible, living longer is only one consideration. Another factor is when will the retiree need to begin taking distributions? Regardless of life expectancy, the IRS rules are that RMDs must begin at age 70 ½. Another consideration is the amount of the distribution. While the IRS says that you must take a RMD, perhaps that minimum amount is not sufficient to meet your financial needs. Perhaps the retiree cannot financially wait until age 70 ½ to begin taking distributions, and must begin taking distributions in his sixties to pay the bills.
We believe that permanent life insurance has many strategic advantages over term life insurance and should be a topic of discussion when considering life insurance needs and retirement planning. Where we differ from the host, is that when persons consider permanent insurance as part of their retirement plan, we believe they must have a need for life insurance outside of retirement planning because there is a cost to purchase life insurance that other investments do not have. This premium cost will likely result in a less monies being available for retirement when compared to more traditional investments. There is also a long-term commitment by the policy holder to pay those insurance premiums one needs to consider when purchasing life insurance. The age when one purchases term insurance is also a very important factor. The annual premium for someone in their 30’s may be affordable, but someone purchasing permanent insurance in their 60’s may be cost prohibitive.
Rather than depending upon your tax professional solely for tax preparation services or tax planning strategies, you should also include that person when planning your retirement. And it is important to begin planning for retirement early in life and not wait until the year of retirement. We invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
