Understanding the ‘Rich Person Roth’

Understanding the ‘Rich Person Roth’

A Strategy for High Earners to Create the Most Tax-Free Retirement Income

Understanding the ‘Rich Person Roth’
Wednesday, 05 May 2021

Recent world events have made it clearer than ever that it’s imperative to have a long-term financial strategy that allows you to weather volatile economic times. The Roth IRA is a popular tax-minimizing strategy, as it allows for tax-free growth and withdrawals in retirement, and many people make it part of their long-term financial plan. Unfortunately, high-income earners are either limited or ineligible when it comes to Roth contributions. For 2021, that means single workers with incomes greater than $140,000 and couples with incomes greater than $208,000 can’t take advantage of Roth IRAs the way those under these thresholds can.

Fortunately, there are a few ways around this. A Backdoor Roth lets you convert a traditional IRA to a Roth – even if your income precludes you from contributing directly to a Roth – through what amounts to some intricate paperwork. The option we’ll discuss below, however, is a different type of tax-advantaged investment altogether. It’s called the Rich Person Roth and, though it’s not for everyone, it can be incredibly valuable for some high earners.

Rich Person Roth: The Basics

An ongoing concern for those with high incomes is the amount they’ll lose to federal, state, and local taxes. Naturally, it’s ideal for workers in this scenario to find ways to pay less in taxes and, therefore, have more money available in retirement. The Rich Person Roth does this through a vehicle that is quite dissimilar to a Roth IRA, but that offers comparable benefits during retirement.

What we’re talking about here is actually a type of cash-value life insurance, and it’s a strategy that could help you unlock financial independence. It doesn’t apply to just the super-rich either. If you’re ineligible for a Roth IRA and you’re contributing the maximum to your 401(k) or IRA ($19,500 annually or $25,500 if you’re 50 or older and making catch-up contributions), you may be a great candidate for the Rich Person Roth.


SEE ALSO: 8 Things to Know About an Inherited IRA from a Non-Spouse


Understanding the Details

To be clear, this strategy isn’t about whether or not you need life insurance. Rather, it’s a way to park some of your hard-earned money in an IRS-approved cash value life insurance policy. This allows tax-free growth and tax-free withdrawals. The younger you are when you start the policy, the longer your assets have to compound tax-free, and there are no contribution limits if you set the policy up properly. (Your options will vary by insurance company, so do your research before signing on the dotted line.)

Since this type of life insurance is permanent, rates will be higher than term-life policies. However, the benefits are much greater if you’re looking to minimize your taxes. As the policyholder, you can use the cash value of your life insurance as a source of cash or loans, making it a valuable asset during retirement. It’s also a great way for those playing a serious game of catch-up to hit their retirement savings goals faster if they’re already maxing out catch-up contributions elsewhere.

When you think about some of the main sources of risk to your financial security in retirement, taxation, stock market volatility, and longevity likely come to mind. The Rich Person Roth allows you to mitigate against all three of these by creating an income stream for life that lessens your overall financial risk. Importantly, this tax-free income will not push you into a higher tax bracket or increase your Medicare premiums in retirement.

Potential Drawbacks

The Rich Person Roth sounds like a pretty smart strategy, right? Well, while it’s perfect for some, there are drawbacks to consider that may make it a poor strategy for others. For instance, one of the perks of contributing to other types of retirement accounts is that contributions are tax-deductible. There is no tax deduction available on Roth IRA contributions, nor is this an option with the Rich Person Roth. You will pay taxes on any income you contribute to your cash value life insurance policy, so if tax deductions are your main motivator for socking away more money, this tool won’t help you in the short term.

Since we’re talking about a life insurance policy here, it’s also necessary to point out that those in poor health may find this a troublesome strategy. Even if you never intend to use your Rich Person Roth as life insurance, you’ll still be required to undergo a medical evaluation that could disqualify you from the underlying coverage or saddle you with steep premiums. So, if you’re in poor health, a Rich Person Roth will be less advantageous for you.


SEE ALSO: Save Tax Money with Your Qualified Charitable Distributions


Other Considerations

Keep in mind that the longer you expect to live, the more time your money can benefit from the magic of compounding. However, because the cost of life insurance is so steep with these types of policies, it could lower your net returns.

It’s also important to carefully consider what percentage of your assets you want to place into this type of retirement planning tool. The optimal balance between your Rich Person Roth and your other tax-advantaged accounts will be a bit different for everyone, so you may want to enlist a trusted financial advisor for guidance in using this strategy to maximum benefit.

Final Thoughts

The Rich Person Roth won’t be right for everyone. Your money and your future deserve thoughtful, intentional strategy, and this tool can be a bit complicated to navigate. However, don’t let that discourage you from taking a close look at your retirement plan and determining whether the Rich Person Roth is a valuable step toward your personal financial freedom.

If you’d like professional guidance, please reach out to us. At Charles Carroll, we know that every client is unique, and we are committed to providing personalized financial planning on your path toward financial independence.

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