I'm always surprised that many well-off individuals don't make better use of their tax shelters.
The only real excuses, besides ignorance, for not taking advantage of Uncle Sam's tax-advantaged saving strategies are that they are not available to you or you simply don't have enough money to invest in them.
My first priority is that tax-free savings are superior to tax-deferred savings unless you are sure you will be in a much lower tax bracket when you retire.
Getting as much money as possible into tax-free-forever Roth 401(k), 403(b), and IRA plans before you quit working is ideal.
Unfortunately, it is estimated that fewer than one out of five of those eligible to invest in a Roth IRA and/or a Roth pension plan at work do so. Last year, the average amount invested in all 401(k) plans was 10.9 percent of total income, virtually unchanged from the 10.4 percent 15 years ago.
Roth 401(k) and 403(b) plans at work allow up to $19,000 this year for workers younger than 50 and $25,000 for those 50 or older.
There are no income limitations for employer Roth plans - unlike the Roth IRA where younger workers may contribute $6,000 per year and older workers 50 and over may put in $7,000 annually.
Adjusted gross income limits to max out Roth IRA contributions this year are $122,000 for singles and $193,000 for couples.
An awesome tax shelter for high-income workers at companies that have a Roth 401(k) plan and allow after-tax contributions into their pension plans gives their employees the opportunity to tax shelter as much as $56,000 (under 50) or $62,000 (50 and over) yearly.
Let's use a 55-year-old making $230,000 a year as an example. (His income is too high to qualify for a Roth IRA.)
He contributes the maximum $25,000 to his Roth 401(k) or traditional 401(k) and his employer match into his tax-deferred 401(k) is $5,000. He has therefore used $30,000 of the $62,000 max so he can contribute $32,000 into an after-tax 401(k).
on that money are tax-deferred but he can roll over, without paying any taxes, that $32,000 into his Roth 401(k), or even into a Roth IRA if his employer permits out-of-plan rollovers.
Unfortunately, many employers don't offer after-tax 401(k) contributions either because they are unaware of them or because employees haven't requested that option.
Typically, the cost to employers to add an after-tax 401(k) choice is quite reasonable.
Another so-called "back door" method for getting money into a Roth IRA for high-income investors is to purchase an after-tax IRA and then immediately roll it over tax free into a Roth IRA.
However, this only works if the individual doesn't own any traditional IRAs; otherwise proportional calculations are required that create a tax nightmare when money is withdrawn.
Finally, the last way to secure the benefits of tax-free Roth-IRA increases is to convert traditional IRA positions into a Roth IRA.
Two problems with this approach are that conversion money is fully taxable and it must occur before year-end rather than waiting until the traditional April 15 due date for filing taxes.
Also, once a conversion is made, there is no cancellation allowed as was possible previously up until last year.
If you can afford the additional taxes, I argue that anyone in the 12 percent tax bracket or below should seriously consider a conversion for an amount that would not push them into the higher 22 percent bracket.
Singles with taxable income (after all deductions) are in the 12 percent tax bracket with income less than $39,475 and for marrieds it is under $78,950.
Adding in the 5.5 percent N.C. tax makes the total tax cost 17.5 percent, about one dollar for every six converted.
For seniors age 70½ or older, there are two ways to avoid paying taxes on required minimum distributions (RMDs) from traditional IRAs. (There are never any RMD requirements from Roth IRA plans unless they are inherited from a non-spouse.)
One method is to donate qualified charitable deductions (QCDs) up to $100,000 yearly directly to charities - discount brokerages will provide an IRA checking account that is much more convenient than filling out several pages of forms.
I'm glad I did that last year because I did not have enough write-offs to exceed the standard deduction.
This year, it is $24,400 for couples with an additional $2,600 for a spouse age 65 or older for a total of $29,600 for seniors.
Given the limit of only $10,000 that is allowed to be deducted for state income and property taxes, it is estimated that only about one in nine taxpayers (11 percent) will be able to itemize this year compared to about 3 in 10 (30 percent) before the 2018 tax-law changes.
If you can't itemize, you lose your charitable deduction!
One way to delay RMDs from your traditional IRA and receive income that you can never outlive is to purchase a Qualified Longevity Annuity Contract (QLAC) from an insurance company as my wife Sue did 3½ years ago. The most you can invest is $130,000 or 25 percent of your IRA - whichever is less.
No RMDs are required until you annuitize the contract that then pays you a lifetime income that you can't outlive beginning at an age you choose, but no later than 85.
We chose age 85 for Sue because her dad lived until 95 and her mother until 99.
I argue that a lifetime income annuity is an excellent substitute for bonds.
It provides a safe investment that helps offset the higher risk from your stock holdings.
Future prospects for bonds providing appreciation above inflation seem unlikely given their recent rally as interest rates have plunged.
The 10-year U.S. treasury bond now yields only about 2 percent.
One other advantage to seniors required to take RMDs is they can have extra money withheld for taxes.
Therefore, they can avoid the cumbersome filing of quarterly estimated taxes.