Average Person can Save $100,000+ in Taxes with ther Right IRA Investments

Because investments are not all taxed at the same rates, it makes a very significant difference in IRA tax depending on which investments you choose to hold inside and outside your IRA.  I have covered this in some detail at my blog post on income tax rates.

I this post, I show an example of an individual with $200,000 inside an IRA and another $200,000 of investment outside of the IRA. In the first case below, the individual has correctly placed his aggressive trading stocks in his IRA and holds his index mutual funds outside his IRA.  His total tax over 20 years (assuming he withdraws everything from his IRA after 20 years) is $408,744.

But under scenario 2, the individual puts the wrong investment into the IRA (index mutual funds) and trades aggressively with stocks outside of his IRA.  He owns the exact same investments over the 20 year period but in scenario 2, because he holds the investments in the wrong accounts, he pays an additional $117,000 in taxes.

  • index fund has 25% annual turnover
  • average gain
    on positions sold is 20%(equal to 5% annual appreciation)
  • the aggressive trading
    produces all short term gains and losses, resulting in a net gain of
    8% annually
  • tax rate on dividends and long term gains = 15%tax rate on short
    term gains = 32%
IRA Tax Scenario 1 Outside IRA   Inside IRA
$200,000 index mutual funds $200,000 aggressively traded stocks
dividends at 3% annually $6,000
long term capital gains at 5% annually $10,000
Year 1 tax (15% x $16,000) $2,560 all deferred
Total tax paid over 20 years $117,150
Balance in year 20 ($911,232), taxed at 32% $291,594
total  tax $408744
IRA Tax Scenario 2 Inside IRA   Outside IRA
$200,000 aggressively traded stocks $200,000 index mutual funds
Year 1 tax (32% x $16,000) all deferred $5,120
Total Paid after 20 years $234,301
Paid on IRA balance in year 20 ($911,232), taxed at 32% $291,594
total tax $525,895

Unfortunately, few individual taxpayers will realize this error.  More despairingly, the average financial advisor has never given this issue a thought and your CPA has never asked to see what investments you hold in your IRA.  Accountants seem to be much more focused on simply getting the details on what has already happened onto your tax return than on providing strategies to reduce your IRA tax and lower your overall income tax rates.

IRA Tax and the Roth Conversion

By: Clay Wyatt

A tax-deferred account, such as an IRA, can be converted to a Roth IRA. The money will then be taxed at the present time, at the time of conversion, instead of during retirement. Whether or not this is a good option for you depends on your financial situation and how much IRA tax you will pay and when it will be paid.

Is it good to do a Roth IRA conversion? Let’s take a look at some factors to consider before making a decision.

IRA Tax-Bracket

Your current and expected future tax-bracket are critical pieces of information when wondering “Is it good to do a Roth IRA conversion.” If you expect to be in a higher tax-bracket when you retire than you are now, then a Roth conversion is likely to work well for you. You’ll pay taxes now on yur IRA funds and your contributions and earnings will then be tax free during your retirement. Given the current federal budget deficit situaiton, do you believe your tax rates could be higher in the future?

Alright, we’ve seen how things may work if you plan to have a higher tax-bracket down the line than you do now. Is it good to do a Roth IRA conversion if you plan to be in a lower tax-bracket in the future?

If you plan to be in a lower IRA tax-bracket during retirement than you are in now, then a Roth conversion probably will not work for you. You’ll end up paying higher taxes now instead of waiting to pay them when you are in a lower tax-bracket. However, as the earnings on Roth IRA contributions are not taxed, it may be worthwhile to consult a financial advisor to determine the nuts and bolts of your situation.

Will You Use the Money or Pass it On?

The answer to “Is it good to do a Roth conversion” partially depends on your future intentions for your money. If you are swimming in money and don’t anticipate needing much of your retirement savings, then a Roth conversion will work well for you. The reason for this is that there is no age at which minimum withdrawals must begin with a Roth IRA. However, with traditional tax-deferred accounts, minimum withdrawals must begin by age 70 ½, so you won’t be able to pass on the entire amount of your IRA to your heirs if you reach that age.

The last issue on minimizing IRA tax when considering the Roth conversion is whether you can leave the Roth account alone for at least 5 years after conversion (i.e. not take any withdrawals).  If you will need significant portions of the account for expenditures, then the mechanics of IRA taxation probably argue not to convert.


So, is it good to do a Roth conversion to minimize IRA tax? The mentioned factors are just some of those that you should consider. Before making a final decision, contact a financial advisor for advice unless you are absolutely sure of what you are doing. If you are still wondering “Is it good to do a Roth conversion” after reading this and similar articles, then it is probably a good bet to go to a financial advisor or tax specialist. After all, that is a better bet than rolling the dice with the tax man, right?

Using Your IRA to Pay Off Urgent Expenses

By: Clay Wyatt

Maybe you’ve lost your job and are getting behind on your bills. Maybe you had an unexpected medical procedure that your insurance offered little to no coverage for. Whatever the case may be, that wad of cash that you have invested into your IRA may seem like a tempting way to bail yourself out. Are you considering using your IRA to pay off urgent expenses? Let’s examine the pros and cons of doing so and the IRA tax ramifications.


The obvious pro to using your IRA to pay off urgent expenses is that you’ll keep creditors from blowing up your phone. You won’t have to deal with constant calls and letters asking when you’re going to pay up and the rude collectors who initiate them. They could also eventually sue you, so you can prevent the case from going to court if you use your IRA to pay off your expenses. That will help keep your stress level down during this difficult time.

Another major benefit to using your IRA to pay off urgent expenses is that your credit report won’t be sunk if you are able to use your IRA to pay off your urgent expenses. That $15,000 that you owe for your medical procedure will eventually end up on your credit report if you don’t pay it off within a few months. That will lead to difficulty in obtaining future credit and will make borrowing more expensive for you down the line.

The treatment of your withdrawal may also be a pro when using your IRA to pay off urgent expenses in the sense that penalties can be avoided. If you are using it to pay off medical expenses in excess of 7.5 percent of your adjusted gross income, it may be done IRA penalty-free. The same situation applies if you are using it to pay for health insurance premiums after you have been unemployed for 12 weeks or longer. Additionally, if you are disabled and can prove that you are incapable of working, you can use your IRA to pay for expenses during this time.


When using your IRA to pay off urgent expenses, you may end up paying IRA penalties on your withdrawals (if under age 59 1/2). While there are some ways to withdraw funds from your IRA without incurring penalties, such as those listed above, this won’t always be the case and that means IRA tax as well as penalties. For example, paying off a balance on your car loan may be an urgent expense to avoid a repossession, but the IRS will still levy a penalty on you if you tap into your IRA to do so.

Another downside to using your IRA to pay off urgent expenses is that you won’t accumulate interest on the money that you withdraw. Let’s say that you take $10,000 out to pay for medical expenses that are in excess of 7.5 percent of your adjusted gross income. You won’t be hit with penalties on that amount, but you’ll forfeit any interest that would have been earned on that money. This could end up being a good situation if the stock market plummets during that time, but you’ll still have $10,000 less in your account when it comes time to retire. If the stock market surges during that time, then you’ll lose out on those gains, as well.

And of course, there is the IRA tax on the withdrawals.  So it is quite possible that the federal and state tax could exceed 30%, add another 10% for penalties and you only have 60% left for urgent expenses.  Maybe it's better to consider an IRA loan.


Explore alternate resources before you use IRA to pay bills. A bank loan or money that you may have sitting in non-retirement accounts may work out much better for you. Using your IRA to pay off urgent expenses should be a last resort.

IRA Tax Ramifications--Should You Use Your IRA for Trading?

By: Clay Wyatt

An IRA can be a great tool for building retirement savings. It’s tax-deferred status allows for money to be added to the account that would have otherwise gone to Uncle Sam. However, with a plethora of IRA tax rules, you may be wondering if you should use your IRA for short-term trading. Let’s take a look at the nuts and bolts of what will happen if you use your IRA for trading.

Trading time frame

Federal Reserve Regulation T requires payment for trades in an IRA within 3 days. Existing cash within the account must be used to pay for the trade, not stocks. Basically, money that is sitting in a money market or other cash account or cash that you deposit into the account must be used to pay for each trade if you use your IRA for trading. With this in mind, you’ll have to be sure that you have enough cash in the account, not just enough value to cover the fees. Otherwise, your account will be restricted for 90 days.

Deposit Limitations

If you decide to use your IRA for day trading and intend to cover some or all of your fees with deposits, you must make sure that the deposits do not go over the contribution limit for that year. For those who will be under age 50 at the end of 2011, the limit is $5,000. If you own other IRA accounts, such as a Roth IRA, this is a combined maximum, so you’ll have to make sure that your total contributions do not go over $5,000.

The limit for those who are 50 or older before the end of 2011 is $6,000. The same rules will apply in 2012. Make sure that you have not reached your maximum contribution amount for the current year before you decide to use your IRA for day trading - especially if you plan to pay for the trades with deposits.

If you want to get more money into your IRA for trading and the favorable IRA tax benefit described below, roll over money from a 401k or other tax sheltered plans into the IRA.
IRA Tax Implications

If you use your IRA for trading, you won’t pay taxes on any gains or losses. This is great if you have gains. However, if you suffer losses because you use your IRA for trading, you will rarely be able to claim them as such. So, you probably won’t benefit from reporting a loss on your taxes, even though you actually suffered them.

However, since you trade short term to make profit, the IRA is a great place to do it.  You pay no taxes on profits today and will pay ordinary income taxes later.  Rather than using your on-IRA funds for short term trading, use them for buy-and-hold stocks on which you pay a maximum 15% tax (same low rate applies to qualified dividends on common stocks).  By restricting short term trading to your IRA and using non-IRA funds for those securities and holding periods taxed at favorable rates, you reduce your lifetime total tax.


If you wish to trade, an IRA or tax sheltered account is a great place it do it as it allows more favorable use of your non-IRA funds for securities taxed at lower rates.

IRA vs. Roth IRA Taxes

By: Clay Wyatt

The winner in the battle of IRA vs. Roth IRA taxes depends on your financial situation. Those who wish to save on taxes now will be better off with an IRA. A Roth IRA may be better for those who wish to save on taxes during retirement. Let’s take a look at IRA vs. Roth IRA taxes.

IRA Taxes

IRA accounts are taxed during retirement. So, you can deduct your contributions from your current taxes and the money will grow tax-free in your account. Of course, it’s never that easy, as you’re maximum contribution amount can be $5,000 if you are under the age of 50 at the end of 2011 and $6,000 if you are 50 or older before the end of 2011, according to the IRS. The same applies for 2012.

So, when comparing IRA vs. Roth IRA taxes, this may seem great. You’re money will not be taxed when you put it in and it will grow free. However, there is always a catch when dealing with IRS regulations.

The money will be taxed at your ordinary income tax-rate when you retire, provided that you wait until at least age 59 ½ to take withdrawals. Before this age, you’ll have to pay taxes and a 10 percent penalty to take withdrawals unless you meet 1 of the IRS waiver provisions. The taxes will be on the amount that you deposited and your earnings, so you’ll eventually pay the piper on everything in your IRA account.

Roth IRA Taxes

When comparing IRA vs. Roth IRA taxes, a key difference is that a Roth IRA’s contributions are taxed. So, if you decide to invest $5,000 in a Roth IRA, you’ll pay taxes on that contribution in the current year.

Why would anyone want to do that when they are tax-free with an IRA? The answer is that IRA contributions are not really tax-free - just tax-deferred. This means that you’ll pay taxes on them during retirement instead of at the present time. However, with a Roth IRA, you’ll pay taxes at the present time and that is it. There are no taxes on Roth IRAs during retirement - including on earnings. So, only the contribution is taxed, not the earnings, giving it a major advantage over an IRA.

When comparing IRA vs. Roth IRA taxes, a Roth IRA also has the advantage of you knowing your tax rate. Taxes may be lower or higher in the future, but who really knows what they’ll be? With the enormous national debt and a plethora of unfunded liabilities, Uncle Sam is probably going to have both hands out for tax revenue in the future, meaning that rates may be higher. Think of a Roth IRA as a less risky way to pay taxes on your retirement investments, although that is not a guarantee that you’ll end up paying less in the long run.


Be sure to speak with a financial advisor or tax professional before making any tax-related decisions on your IRA or Roth IRA accounts. Determining the winner of IRA vs. Roth IRA taxes is too big of a gamble to take without knowing the ins and outs of your financial outlook. Have a financial advisor assist you with figuring out the specifics if you are unsure of what to do.

Unintentional IRA Taxes to Avoid

By: Clay Wyatt

If you invest in an IRA, you probably do so because your money will not be taxed until you retire. Paying IRA taxes on it now would defeat the purpose of having an IRA. However, the IRS just loves to make life complicated, so there are some taxes that they can hit you with if you are not careful. The following are some unintentional IRA taxes to avoid.

Taxes on a 60 Day Rollover

If you intend to rollover a pension plan, 401(k) plan or another IRA to your current IRA plan, you can do so on an IRA tax free basis. You’ll still have to pay taxes on it once you withdraw the fund eventually, but that won’t happen until retirement (hopefully).

Of course, there are rules for doing such a rollover. Among other unintentional IRA taxes to avoid, there is a tax for those who do not complete the rollover within 60 days. Failure to complete a rollover within 60 days will result in the money being taxed and may also incur a 10 percent penalty if under age 59 1/2.

As this is one of the unintentional IRA taxes to avoid, you may wonder how to properly go about completing a rollover into your IRA. The best way is to do a trustee-to-trustee transfer in which your previous custodian transfers the money directly to your current custodian. You’ll never touch the money and won’t have to worry about getting it to your current account on time. Contact your current custodian to initiate this process if you’d like to go this route.

If you end up getting a check for whatever reason, do not cash it. Instead, speak with your financial advisor and/or current custodian and make sure that it gets deposited into your rollover IRA within 60 days of the date on the check. Otherwise, the tax man will have his hand out and you’ll probably have to pay up. There are waivers to such taxes and penalties, but do you really want to count on the IRS to sympathize with you?

IRA Tax on Inherited IRAs

If you plan to pass on your IRA to someone else after you pass away - a good idea if you don’t want Uncle Sam to get his hands all over it - there are a few unintentional IRA taxes to avoid. A key member of such unintentional taxes to avoid is the estate tax. This won’t cost you any money, but could cost your beneficiaries a substantial amount of money.

Make sure that  you have a named beneficiary on your IRA and never leave it to your estate.  Let's assume your beneficiary is age 40.  He will be able to inherit your IRA and will be allowed to have it continue to grow.  He will be forced to take IRA minimum distributions but very small amounts over 42 years.  This allows the tax deferral of your IRA to work powerfully for your beneficiary over a long period.  If you name your estate as IRA beneficiary, the IRA must be withdrawn and taxed all within 5 years.


There are plenty of unintentional IRA taxes to avoid out there. As with any matter involving retirement planning, it is best to consult a financial advisor before hammering out any plans. There are simply too many taxes, loopholes and traps out there for those who are not absolutely sure of what they are doing.

Roth IRA Contributions and the IRA Tax

By: Clay Wyatt

The rich get richer and the poor get poorer, right?

That is not always the case with Roth IRAs. Counter-intuitively, the amount that can be contributed to a Roth IRA diminishes once certain income thresholds are met. Eventually, if you make enough money, you won’t be able to contribute at all. So in the case of IRA tax benefits, the rich don't get the benefits.

Want to know how income affects Roth IRA contributions in more detail. Let’s take a closer look at how income affects Roth IRA contributions.

Married Couples Who File Jointly

If you are married and file jointly, you can contribute up to the maximum amount to your Roth IRA each year if you and your spouse make a combined income that is less than $169,000. The maximum annual contribution amount is currently at $5,000 for those who will be under age 50 at the end of the year and $6,000 for those who will be age 50 or older by the end of the year.

You may wonder how income affects Roth IRA contributions for couples who make $169,000 or more. For couples who make $169,000 to $179,000, the amount gradually decreases. For couples who make over $179,000, no contributions are allowed at all.

Keep in mind that the contributions go into the Roth IRA without any tax benefit but the distributions come out IRA tax free.  And because of the Roth IRA contribution limits, only those of middle and lower income benefit.

Single Filers

Alright, we’ve seen how married couples who file jointly are affected by their own income. Singles may wonder how income affects Roth IRA contributions for them.

If you are single, you can contribute the maximum amount (same as for married people) as long as you make under $107,000. If you make more than this amount, it may not be the best idea in the world to ask for a pay cut so that you can contribute more to your Roth IRA. However, you will have to deal with lower contribution limits from this point on.

The contribution limit is gradually reduced for singles who have an income of $107,000 to $122,000. After the $122,000 mark, you won’t be able to contribute to a Roth IRA at all.

Conclusions on IRA Tax benefits

Now you know how income affects Roth IRA contributions and how the rich don't get the benefits that others can. However, it still is not bad to have a high income and there are plenty of other ways to invest for retirement, so check with a retirement advisor if you’d like to find a retirement tax shelter that works for you.

How to Pay Less IRA Tax?

You hold two containers full of money: The amount that has been taxed already, let's name the taxed cash as "ordinary cash," and the non-taxed cash, i.e. IRA, 401k, 403b, as "retirement cash." It will cost you $1 at the time you expend $1 from the ordinary cash. But, when you spend the retirement cash, the real cost of $1 is effectively $1.51, due to the fact that you must pay the federal IRA tax ( and possibly state tax) on withdrawals. Therefore, if you want to reduce your IRA tax and your overall income tax bill, consider taking ONLY the required minimum IRA distribution from your retirement money.

Some people consider not spending their principal and are hesitant to do so. This can however be an error if you are interested in reducing the IRA tax. To benefit from the tax-deferral that comes with IRAs and retirement plans, spending of your ordinary cash first, even the principal, is more effective. While you spend the ordinary cash including the principal, remember that the retirement cash continues to grow, tax deferred.  You make the IRS wait. Spending your funds in this order (non-IRA funds first)  delays tax reporting on your income tax returns and reduces your IRA tax and your lifetime tax bill.

Consider the following hypothetical example that assumes you have a taxable regular money account and a tax-deferred retirement account with a $100,000 balance each (the table below illustrates). Say, the amount in the account gets a return of 6% per annum. Let's further assume that annual distributions of $6,000 per year are being taken for a 20-year period.

Under one scenario, the $6,000 will be taken first from the taxable money and the other scenario considers what would happen if the money was taken first from the qualified or IRA money. Considering this illustration, you should be able to have 140,000 dollars extra by the 20th year if you expend your ordinary funds at first. As IRA taxes are lower over one's lifetime (because the withdrawals are held to zero in our hypothetical illustration) the opportunity to accumulate more wealth is a big plus.  Would an extra $140,000 help your retirement plan?

Surely, the disadvantage is that your benefactors will ultimately have to pay IRA  tax on the IRA balance they inherit after your death. Since the data provided by this illustration is theoretical, real results will differ according to the performance of your funds.

Spend Regular Money First

Today In 20 Years
Spend Regular Money First
Regular Money $100,000 $40,916
IRA Money $100,000 $320,713
TOTAL $200,000 $361,629
Spend IRA Money First
IRA Money $100,000 $0
Regular Money