1. Roth Conversion
How Does a Roth Conversion Work?
When you transfer money from a traditional retirement plan to a Roth account, it’s known as a Roth conversion. Roth conversions come in a variety of forms:
- Contribute to a Roth IRA from a regular IRA.
- Make a 401(k) rollover to a Roth IRA.
- Transfer funds from a traditional 401(k) plan to a Roth 401(k) plan.
- Use a Roth IRA backdoor strategy.
Benefits of ROTH Conversion
- Tax-free growth and withdrawals.
After you’ve paid the conversion tax, you won’t have to pay any further taxes on money in a Roth account while it accumulates, and you won’t have to pay any tax on withdrawals (after you’ve met the five-year criteria and are at least 59 1/2 or meet another preapproved exemption).
- Keep your RMDs to a bare minimum.
There are no required minimum distributions in a Roth IRA. Remember that RMDs apply to Roth 401(k)s as well. Even if you simply convert a portion of your traditional account holdings, the lesser balances left in traditional accounts entail fewer yearly RMDs when you reach the age of 72.
- Diversification of taxes.
If you have all of your retirement assets in traditional accounts, moving it to a Roth account might help you pay for big-ticket items without increasing your taxed income. Taking money out of a conventional account in excess of your RMD will raise your taxable income for the year, whether it’s for a new roof or a multi-generational trip to commemorate a significant birthday or anniversary. If you take money out of a Roth IRA, you won’t have to pay taxes on it (just keep an eye on that five-year rule).
- Heirs won’t have to worry about taxes.
If you want to leave an account to someone else, new laws that took effect in 2020 require non-spouse recipients to empty an inherited IRA within 10 years. If a non-spouse recipient inherits a Roth IRA, they must take the whole amount before the end of the 10-year period, but they will not be liable for any taxes.
Is a Roth Conversion Right for You?
If you have a big portion of your funds in traditional retirement accounts, a Roth conversion might be a sensible strategy to control your tax cost in retirement. It can also assist future heirs in managing their inheritance.
However, because the money you convert is recorded as taxable income, you must take care to avoid racking up a large tax bill in a single year. It’s a good idea to speak with a knowledgeable tax professional or financial advisor who can guide you through all the details of a Roth conversion.
2. Life Insurance Retirement Plans (LIRP)
A life insurance retirement plan is a long-term life insurance policy with a cash value component that may be used to assist pay retirement. LIRPs are similar to Roth IRAs in that you don’t pay taxes on withdrawals beyond the age of 59 /12, and capital gains are tax deferred. Any cash-valued permanent life insurance policy, such as whole life insurance, can help you save for retirement. Term life insurance has no cash value and so cannot be used to fund a life insurance retirement plan.
Key Takeaways
- LIRPs are mainly only advantageous to high-net-worth persons due to their high cost.
- A life insurance retirement plan cannot be implemented with term life insurance since it does not include a cash value component.
- For most people, buying a term life insurance policy plus contributing to a 401(k) or Roth IRA is a better option than an LIRP.
How can you use an LIRP to fund retirement?
In the event of a stock market slump, LIRPs can supplement your current retirement savings accounts and fill in the gaps. If you contribute the maximum amount to your traditional investing accounts, you may put any remaining funds into your cash value account, giving you another tax-deferred investment option. In a weak year for the stock market, it may be more advantageous to withdraw from a cash value with a fixed rate of growth than a depreciated retirement account.
Who needs a life insurance retirement plan?
By the time they retire, most individuals will no longer require life insurance. Because your financial commitments, such as paying off a mortgage or supporting dependents, often reduce as you become older, so does your need for life insurance.
- However, for folks with more complex financial demands or who know they’ll need life insurance coverage for the remainder of their lives, buying a cash value policy to supplement retirement income may make sense. These are some of them:
- Individuals with a high net worth who have already maxed out their previous retirement accounts and are looking for another way to save tax-free.
- People who have long-term dependents, such as disabled children, who will require life insurance coverage when they retire.
3. IRA to HSA Rollover
Transferring IRA Funds to a Health Savings Account (HSA)
Did you know you may transfer money from your individual retirement account (IRA) to a health savings account (HSA) once, penalty-free and tax-free? The eligible HSA money distribution method was made possible by the Health Opportunity Patient Empowerment Act of 2006, which made it practicable.
Key Takeaways
- HSAs come with out-of-pocket expenses and annual contribution limits, and you must be enrolled in a high-deductible health plan to be eligible for one.
- You can make a one-time distribution of money from your IRA into a health savings account.
- A testing period requires you to remain eligible for the HSA for at least 12 months after the rollover.
- You must first roll funds into an IRA before moving them from another type of retirement account, such as a 401(k) or a 457 plan, to an HSA.
- Contributing to both an HSA and a traditional IRA will lower your adjusted gross income and reduce your taxes.
What Is a Health Savings Account (HSA)?
An HSA is designed for people with high-deductible health plans (HDHPs). These are health insurance policies with annual deductibles of at least $1,400 for individuals and $2,800 for family coverage for 2021 and 2022.
Here are a few key figures you need to know about the HSA:
The annual maximum out-of-pocket expense must be less than $7,000 for individuals in 2021 and $7,050 in 2022 ($14,000 and $14,100, respectively, for family coverage).
The annual contribution limit is $3,600 and $3,650 for individuals for 2021 and 2022, respectively ($7,200 and $7,300 for families)
Keep in mind, though, that your premiums don’t count as out-of-pocket costs, but deductibles, copayments, and coinsurance do.
You contribute to an HSA using pre-tax funds, which reduces your taxable income. You can then withdraw money from your HSA tax-free if you use it for qualified medical expenses. If you’re 64 or younger, you’ll owe taxes and a 20% penalty if you use funds for nonmedical reasons. Withdrawals for nonmedical reasons don’t incur the penalty after you turn 65 or if you have a disability at any age, although they’re still taxed at your current tax rate.
You can keep your HSA funds in the account to use later in life, such as after you retire. The account (and all the money in it) belongs to you, even if you change health insurance plans, switch jobs, or retire.
IRA to HSA Rollover Rules
You can move funds from an IRA to an HSA only if you’re eligible to contribute to your HSA. In other words, you need to do the transfer while you’re covered by an HDHP and are otherwise eligible to have an HSA.
What’s more, the IRA-to-HSA rollover includes a testing period that requires you to remain eligible for your HSA for 12 months following the transfer. This means you must stay in your HDHP at least until the testing period expires. If you don’t remain eligible (for example, you switch to a non-HDHP), you’ll need to include the money you rolled over as income when you file your taxes. In addition, the amount will be subject to a 10% penalty.
You can only roll funds from an IRA to an HSA once during your lifetime. The maximum amount you can rollover is the same as your annual HSA contribution limit for that year.
The limits for 2021 and 2022 (respectively) are as follows:
- $3,600 and $3,650 for individuals, with an additional $1,000 catch-up contribution if you’re age 55 or older.
- $7,200 and $7,300 for family coverage, with the same $1,000 catch-up contribution.
Keep in mind that HSAs and IRAs are individual accounts. There’s no such thing as a joint IRA or a joint HSA. This means that you and your spouse can each roll funds over from your respective IRAs to your own HSAs but not to each other’s HSAs if you’re married. But you can cover health care expenses for each other and other family members out of either account.
4. Net Unrealized Appreciation (NUA)
Employees at certain firms have the option of owning shares in the company they work for. Employees will develop an ownership attitude as a result of this, even if they only hold a tiny fraction of total shares. The difference in value between the average cost basis of employer stock and the current market value of the shares is known as net unrealized appreciation (NUA). If you’re distributing highly valued employer stock from a tax-deferred employer-sponsored retirement plan, such as a 401(k), the NUA is crucial (k)
Key Takeaways
- The gap between the initial cost basis and the current market value of employer stock is known as net unrealized appreciation (NUA).
- After certain qualifying events, the IRS has a provision that allows for a lower capital gains tax rate on the NUA of employer shares upon distribution.
- The disadvantage is that ordinary income tax must be paid on the cost basis of the employer stock immediately.
5. Stretch IRA
A stretch IRA was an estate planning strategy for a non-spouse recipient who received an individual retirement account (IRA). An IRA might be passed down from generation to generation utilizing the stretch technique, allowing the assets within it to grow tax-deferred and/or tax-free.
The SECURE Act, which was enacted by the US Senate on December 19, 2019 and signed into law by President Donald Trump on December 20, effectively abolished the stretch IRA and its strategy of protecting inherited wealth. Non-spouse beneficiaries will be required to remove all monies in an inherited IRA within 10 years after the original account owner’s death under the new rule. It applies to inherited IRAs received after December 31, 2019.
The term “stretch IRA” did not refer to any particular IRA. Rather, it’s a financial technique, mostly utilized with traditional IRAs, that allows users to extend the account’s life—and consequently the tax benefits—for a longer period of time. Stretching out an IRA allows the cash in the account to multiply tax-free for a longer period of time—possibly decades. A recipient who is extremely young might get payments for decades.
Key Takeaways
- Following the SECURE Act, all beneficiaries are no longer eligible to extend an IRA distribution in a tax-advantaged way. There are certain exceptions, therefore familiarity with the new standards is essential.
- Beneficiaries who received an IRA before 2020 are grandfathered, which means they can still “extend” post-death payouts based on their life expectancy. The new 10-year payment rule has little impact on sole-spouse recipients.
- It’s critical to guarantee that the new regulations, which are based on the many sorts of beneficiary categories suggested by the legislation, are followed.
Who’s Using Stretch IRAs?
In general, wealthier retirees who know their spouse will have enough money for retirement would use a stretch IRA to preserve their family’s fortune by choosing their youngest child as a beneficiary. Because of their low RMD taxes, the remainder of their IRA will continue to grow tax deferred.
When combined with Roth IRAs, stretch IRAs were extremely effective. As previously stated, unlike the Roth IRA’s original owner, inherited Roth IRA recipients were obligated to do RMDs. However, unlike regular IRA payouts, which are considered as ordinary income, the distributions were often tax-free.
Find the Right Advisor for You
It doesn’t have to be difficult to find the perfect financial advisor for your requirements. If you’re ready to invest your money. Working with Lion’s Wealth Management, we can assist you in achieving your financial goals.
