Most people think of tax shelters as being available only to massive corporations and the ultra-rich. But if you have a job, you have access to a tool that can help you and your family avoid having to pay any taxes on your investment income not just throughout the rest of your life but for your heirs' lifetimes as well. Best of all, it's never been easier to take advantage of these benefits. All it takes is opening a Roth IRA.
How you can become like a big corporation
Back in 2011, the Institute on Taxation & Economic Policy collaborated with the Citizens for Tax Justice to create a list of what it called "Corporate Taxpayers & Corporate Tax Dodgers" covering the preceding three years. Noting factors like accelerated depreciation, deductions for stock options, offshore tax shelters, and industry-specific tax breaks, the report identified many companies that not only avoided paying income tax over that three-year period but also got net refunds back from the U.S. Treasury. Corning (NYSE:GLW) and Honeywell (NYSE:HON) were among the 30 companies that had negative tax liability from 2008 to 2010, according to the report, while Wells Fargo (NYSE:WFC) and AT&T (NYSE:T) received the largest amounts in what the report called "tax subsidies" -- representing the difference between what those companies paid in tax versus what they would have paid under the 35% corporate tax rate. Through perfectly legal means, these companies all managed to hold the IRS at bay.
Roth IRAs don't involve any of the strategies that corporations use to their advantage, but they're equally effective. When you open a Roth IRA, you don't get any upfront tax deduction, which is why so many taxpayers never even think to go beyond the traditional IRAs that they're more familiar with. When you're focused on saving taxes now, the traditional IRA delivers a valuable tax deduction you can use on this year's tax return, while the Roth doesn't give you any current benefits at all.
But what you get in return for giving up those upfront benefits is so much more valuable. Throughout your lifetime, the income and gains that your Roth IRA investments generate are tax-free. Once you retire, you can take money out of your Roth IRA without paying any tax as well.
But how can you protect your heirs?
Those benefits are great for retirees, but the even more valuable aspect of Roth IRAs is that you can hold onto them forever. Unlike traditional IRAs, which force you to start taking distributions from your retirement account when you reach age 70 1/2, Roth IRAs have no minimum required distributions at any age. If you don't need the money in your Roth, you can leave it untouched and let those tax-free earnings continue to build.
Even better, you can pass on your Roth IRA to future generations. They will be required to start taking minimum distributions from their inherited accounts. But under the current rules, most heirs can stretch out their withdrawals from inherited Roth IRAs over the course of their expected lifespan, using life expectancy tables to pull out an appropriate percentage of the account balance every year. And best of all, those distributions are free of income tax for your heirs as well, giving you and your family generations of avoiding tax entirely -- all for the cost of forgoing a small upfront tax deduction.
What about income limits?
Some workers aren't allowed to contribute directly to an IRA because their income is above the appropriate Roth IRA income limits. For single filers earning more than $127,000 and joint filers above $188,000, Roth IRA contributions are completely disallowed.
But there's a back-door way into a Roth IRA. If you have a traditional IRA, you can convert all or part of that account to a Roth IRA without worrying about any income limits at all. The catch is that you have to include the amount you convert as taxable income on your current-year tax return, but again, that tax bill is the last one you'll ever have to pay on that money and the income and capital gains it generates over the rest of your life and beyond.
A truly long-term investment
If you've ever thought about leaving a legacy for your children or grandchildren, think carefully about opening a Roth IRA. With decades of potential tax savings ahead, your loved ones will thank you.