The Rich Person Roth IRA
If you live in a high tax state (like CA, NY, or NJ) and are a high-earner (over $120,000 for singles and $199,00 for a couple)[i] there is a good chance you will see your taxes going up. Due to earnings caps on certain investment strategies, you may not have thought too much about a Roth IRA. This article will go over what is called “The Rich Person’s Roth” which is a gauche name for cash value life insurance, or Life Insurance Retirement Plans (LIRP) which could be a useful investment option for those who make too much to use a traditional Roth and want the tax saving and retirement benefits.
What is It?
Roth IRAs are not tax deductible, which can be a drawback for some. The benefit of the Roth is that, since the money invested has already been taxed, it is now allowed to grow tax-free and you will not be taxed when you retire. You are also able to pull out money without tax fees. Unfortunately, those making over a certain amount cannot participate, and the max contributions in 2019 were $6,000, or $7,000 for those over 50.[ii] The Rich Person's Roth is a strategy to minimize taxes for those whose income makes them ineligible for Roth IRAs. For those in this income bracket, maxing out a Roth IRA’s contributions would also not necessarily provide them with the monthly income in retirement that they would need, hence the name: Rich Person’s Roth. This savings option is also good for those high-earners who need to make up lost time in their retirement savings or for those who have maxed out all their contributions and looking for tax-savvy places to stash some cash. A Rich Person’s Roth is also a good option for those who worry about their financial risks into retirement: mainly tax rates, market health, and their own health/longevity. Living longer will inevitably cost more.
The first, and main advantage, for the Rich Person's Roth, is that there are no contribution limits. By using LIRPs properly, you will be able to put as much money into your account and it will be treated as a Roth so it will be taxed and then grow tax-free when you need it down the line, it will also come out tax-free. This tax-free income means that, as a retired person, you are able to draw on your LIRP without tax penalties like raising your tax bracket and tax rate once you are retired. It will also not affect your Medicare premiums.
The goal of utilizing a LIRP is that you will save for retirement in a life insurance policy. This is sort of like borrowing against your death benefits. This system will not work for someone in poor health or who may have some costly expenses coming up. This savings method works best when you have the time to leave the money to grow tax-free. So, if you are considering this type of investment, your health must be factored into the decision. To make tax-free withdrawals the insurance company may charge you interest. You may want to do research into the various types of LIRPs and look for one that is a Zero Net Loan. Another caution would be that life-insurance salespeople, unlike a licensed financial advisor, is not security-licensed which can mean that the safety and security of your investment may not be a priority. Anyone interested in a LIRP should do their research and seek out a certified financial planner who is also a Fiduciary.
How Does It Compare to The Back-Door Roth?
A Back-Door Roth is an investment strategy that allows you to get around income limits by converting a traditional IRA into a Roth IRA. Back-Door Roths are legal but can get complicated. The benefits are that anyone can put as much as they want into a traditional IRA, there are also currently no caps for converting that money into a Roth IRA. The drawbacks to this system happen when the transfer happens, as the conversion may count as income and move you to a higher tax bracket, therefore owing more taxes. This will also reclassify the money to “converted funds” and for those under 59 ½, you will need to wait five years to avoid penalty-fees for withdrawing.[iii] For high earner though, who are unable to take advantage of Roth IRAs, this is the only way to do it. Which is why savvy investors should take a look at their Rich Person’s Roth options as another alternative for tax-free retirement funds.
About the Author
Carroll W. “Bill” Hayes, MBA, CFP® Mr. Hayes started his financial career at Merrill Lynch in 1989. In 1992, Bill left Merrill Lynch for Fidelity Investments. During his career at Fidelity Investments he held roles in various divisions of Fidelity. Those roles included positions in the Trust, 401(k), Brokerage, and Money Management divisions. Bill held management positions at Fidelity and in 2001 led a Private Access team based in Boston. In the Private Access role his responsibilities included managing a book of business in excess of $3 Billion and a client base that was international in scope.
In 2008 Bill established Charles Carroll Financial Partners. The firm is an Independent FeeOnly Financial Planning and Investment Management firm. Charles Carroll Financial Partners embraces its fiduciary responsibility to its clients.
Bill is a graduate of Marquette University, and holds an MBA from the Sawyer School of Management. Bill holds the designation, CERTIFIED FINANCIAL PLANNER, and currently presides as a Commissioner on the Disciplinary and Ethics Commission of the Certified Financial Planner Board of Standards. Bill resides in Massachusetts with his wife Christine and travels up and down the East Coast meeting with clients of the firm.