2024-07-29_Fully_Fund_a_Roth_IRA
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00:00:30.000 | Welcome to Radical Personal Finance,
00:00:32.000 | a show dedicated to providing you with the knowledge, skills, insight,
00:00:35.000 | and encouragement you need to live a rich and meaningful life now
00:00:38.000 | while building a plan for financial freedom in 10 years or less.
00:00:40.000 | My name is Joshua Sheets. I'm your host.
00:00:42.000 | And today we continue our series on financial goals that everybody should set.
00:00:47.000 | This is the sixth goal in this series.
00:00:51.000 | And today I want to tell you why I believe that fully funding a Roth IRA
00:00:57.000 | for U.S. persons, of course,
00:00:59.000 | should be your foundational, most important accumulation goal.
00:01:04.000 | For my international listeners,
00:01:07.000 | everything that I describe in today's podcast
00:01:09.000 | will be relevant to your country's version of a retirement savings account.
00:01:14.000 | So please give this a chance.
00:01:16.000 | But there will be a few differences regarding the specifics that I will give of a Roth IRA.
00:01:21.000 | Quick recap, in today's podcast,
00:01:23.000 | this is where we start to turn the corner from things that are basically
00:01:27.000 | always appropriate for the youngest people to things that are more universally appropriate.
00:01:32.000 | I'm trying to give you goals that really are applicable to everybody.
00:01:36.000 | I'm trying to give you a set of very round, vivid, clear, simple,
00:01:42.000 | and yet enormously effective goals that if you set and achieve these goals,
00:01:47.000 | we'll see you on your way very quickly to financial abundance.
00:01:52.000 | But of course, since I like to begin from the beginning,
00:01:55.000 | the ideas behind many of these goals are most, up till now,
00:02:00.000 | have been most obvious for younger people.
00:02:03.000 | For example, goal one was get a job.
00:02:05.000 | Most 50-year-olds have accomplished that many years ago.
00:02:09.000 | But I wanted, for the sake of completeness, to start there.
00:02:12.000 | So goal one was the importance of getting a job.
00:02:14.000 | If you're broke, the first thing to do is get a job.
00:02:16.000 | When you have income, you can now start to adjust, make plans,
00:02:20.000 | accumulate, buy the things that you need to live.
00:02:23.000 | All of that is based upon having a job and having income.
00:02:26.000 | Goal two is set a priority to spend half, save half.
00:02:30.000 | Try to limit your personal expenses to no more than 50% of the income from your job.
00:02:37.000 | If you will engage in a little bit of frugality, a little bit of deferring of expenses,
00:02:42.000 | and you'll do that, then by being able to save half your income,
00:02:46.000 | you will put yourself in a situation where you'll have the abundance needed
00:02:50.000 | to quickly increase your income, quickly have opportunities for investments.
00:02:54.000 | And the cornerstone of good financial management is to exercise control over your expenses.
00:02:59.000 | So always try to keep your expenses structurally low.
00:03:04.000 | Limit them to 50% of your income.
00:03:06.000 | Goal three was give away 10% of your income.
00:03:08.000 | Of course, I understand that 50 and 50, if I say spend half, save half,
00:03:12.000 | where's the 10% coming from?
00:03:14.000 | You pick, take it out of the savings, take it out of the spending, depending on.
00:03:17.000 | But the idea is get used to giving away 10% of your income to people in need.
00:03:22.000 | This one habit, more than anything else, will develop in you an abundance mindset
00:03:27.000 | and will develop within you a huge amount of personal gratitude,
00:03:31.000 | and it will build the foundation of some of the most effective long-term work that you'll do.
00:03:36.000 | Goal four was to go back to your career and make certain that you are in a job
00:03:41.000 | or a career that has long-term potential.
00:03:45.000 | I encourage you to set a target to get yourself into the top 20% of earners in your country
00:03:52.000 | and that you're not going to achieve it today,
00:03:54.000 | but you want to be working in a field in which that is possible
00:03:57.000 | because it's very painful to wake up at 45 years old
00:04:00.000 | and realize that you've invested 20 years in a career that you've maxed out at,
00:04:04.000 | and it's not providing you with the kind of abundant lifestyle that you'd like to have.
00:04:08.000 | That's a very painful experience.
00:04:10.000 | So I want you to have the opportunity or potential for earning top 20% wages from your career.
00:04:16.000 | Goal five was get as much of the highest quality education that you possibly can as soon as you can.
00:04:21.000 | The best, most productive investment you can ever make is to invest into yourself,
00:04:27.000 | usually into increasing your earning ability.
00:04:30.000 | And this is obviously applicable in the beginning of life,
00:04:33.000 | but it's just as applicable in the middle and end of life.
00:04:36.000 | Always be focused on becoming as highly educated as possible.
00:04:41.000 | Now I want to talk about some of the more standard financial goals that really do matter.
00:04:47.000 | And goal number six is I want you to fully fund a Roth IRA.
00:04:51.000 | Your goal from the day that you start earning income should be to fully fund a Roth IRA.
00:04:59.000 | Now, what does it mean to fully fund it?
00:05:02.000 | Well, every year the amount of money that you can contribute to a Roth IRA changes slightly
00:05:08.000 | based upon the current numbers and based upon the inflation rate.
00:05:12.000 | For the year 2024, the maximum annual contribution amount is $6,500.
00:05:20.000 | If you are 50 or older, you get an additional $1,000 contribution amount for a total of $7,500.
00:05:28.000 | When I say fully fund or max out a Roth IRA,
00:05:32.000 | what I mean is try every year to make the maximum annual contribution to the Roth IRA.
00:05:41.000 | This should be the first place that you put your savings.
00:05:45.000 | Remember, the money that we're saving can be going into a variety of places.
00:05:50.000 | If we're limiting our expenses to about 50% of our income or we're working towards that,
00:05:55.000 | we're going to have some money in savings.
00:05:58.000 | And I'm going to argue that your first place to put savings should be into a Roth IRA.
00:06:04.000 | And I mean that even if we're talking about things like savings accounts.
00:06:07.000 | If you are young and you don't have much and you're going to make a $2,000 savings this year,
00:06:13.000 | instead of putting the $2,000 into your savings account at your bank,
00:06:18.000 | I want you to put it into a Roth IRA.
00:06:21.000 | Let me explain why.
00:06:23.000 | In a retirement account, the Roth IRA has a unique feature that many other accounts don't have.
00:06:30.000 | The feature is this.
00:06:32.000 | You can make a contribution to the account.
00:06:37.000 | Then at a later time, three months from now, three years from now, 30 years from now,
00:06:44.000 | if you need the money for some kind of other use that's different than retirement,
00:06:50.000 | you can take back out the same amount that you contributed to the account.
00:06:55.000 | So if you are 17 years old and this year you have an extra $4,000,
00:07:01.000 | if you put that $4,000 into your Roth IRA and make your contribution of $4,000,
00:07:09.000 | let's assume that it sits there for six months.
00:07:11.000 | Maybe it goes up by $100.
00:07:13.000 | There's $4,100 now in the account.
00:07:16.000 | If you need $4,000 to do something, to buy a car or spend money, whatever you need to do,
00:07:23.000 | you can withdraw the same $4,000 that you contributed to the account,
00:07:28.000 | and there are no taxes or penalties or fees for doing that.
00:07:34.000 | This is different than all other retirement accounts that have more rules than this.
00:07:40.000 | This is different than the 401(k).
00:07:42.000 | This is different than anything related to any other kind of workplace account.
00:07:47.000 | You can just put the money in and you can take it out.
00:07:50.000 | Now, the ideal is that you not take it out.
00:07:53.000 | The ideal is that this is an account that money goes into, goes into, goes into.
00:07:58.000 | However, it should still be an account that you use
00:08:02.000 | and that you try to maximize as much as possible.
00:08:05.000 | Why?
00:08:07.000 | Due to being a retirement account, the Roth IRA has certain benefits that no other account can have.
00:08:14.000 | It has the ability to grow tax-deferred, to come out tax-free.
00:08:20.000 | I'll go over all those rules later in the show.
00:08:23.000 | In addition, in many states, it is protected from the claims of creditors.
00:08:28.000 | Not all states.
00:08:30.000 | It depends on the exact rules of your states.
00:08:32.000 | But in many states, the money that's in your Roth IRA account is protected from the claims of creditors.
00:08:38.000 | It's actually exempt from bankruptcy proceedings.
00:08:41.000 | For example, in my home state of Florida, if I contributed money to my Roth IRA,
00:08:46.000 | and fast forward, I start when I'm young, and I'm 30 years old, and I have $100,000 in my Roth IRA,
00:08:53.000 | then something happens.
00:08:56.000 | Maybe I started a business and the business went bankrupt.
00:08:59.000 | And I had to declare personal bankruptcy.
00:09:02.000 | The money that's in my Roth IRA is money that will not be taken away from me in a bankruptcy proceeding.
00:09:09.000 | So if I emerge from bankruptcy court and all of my other debt has been discharged in bankruptcy court,
00:09:17.000 | or I've entered into payment plan, whatever the details are of the bankruptcy,
00:09:21.000 | I now have a nest egg to fall back upon that I can use to rebuild my life, to start again.
00:09:28.000 | I could withdraw from that Roth IRA all of the money that I've contributed with no taxes or penalties.
00:09:35.000 | And if there's gains, I could withdraw subject to penalties.
00:09:39.000 | This is enormously powerful.
00:09:42.000 | Now, here's the flip side of the Roth IRA.
00:09:44.000 | Why would we prioritize this over other types of things?
00:09:49.000 | Why wouldn't I say, well, just accumulate $10,000 in your savings account at your local bank
00:09:54.000 | instead of putting money in the Roth IRA?
00:09:57.000 | Well, every year that passes, you lose the ability to contribute that amount to the Roth IRA.
00:10:05.000 | Every year that goes by that you don't use that contribution amount,
00:10:09.000 | you will never be able to use it in the future.
00:10:13.000 | I want you to have a cornerstone habit and a goal every single year of fully funding a Roth IRA.
00:10:22.000 | Every single year.
00:10:24.000 | Now, if you only do this, things will actually generally work out pretty well for you
00:10:30.000 | in terms of your long-term contribution amounts and your long-term growth rates.
00:10:36.000 | The amount of money that you can put into the Roth IRA is pretty substantial.
00:10:40.000 | And if you start it when it's early, it's just flat-out generous.
00:10:44.000 | Let me blow your mind with a couple of big numbers that I think are very reasonable.
00:10:50.000 | Let's assume that you begin making contributions to a Roth IRA starting at the age of 15.
00:10:59.000 | And let's assume that your first savings goal is to max out that Roth IRA.
00:11:05.000 | So you put in $6,500 that year.
00:11:09.000 | Now, I don't know what your total earnings would be at age 15.
00:11:14.000 | I don't think it's unreasonable for most teenagers who have part-time jobs,
00:11:20.000 | have a little business here and there, make a little bit of money on the side with various efforts.
00:11:25.000 | I don't think it's in any way unreasonable for a teenager to earn, say, $1,000 a month.
00:11:30.000 | That's not too difficult.
00:11:32.000 | It might be more significant in the summer when you could possibly work full-time or more than full-time.
00:11:37.000 | It may be less during the school year.
00:11:39.000 | But there are just dozens and dozens and dozens of ways that you could earn $1,000 a month pretty easily.
00:11:46.000 | So if you were earning $13,000 a year at the age of 15, 50% savings would give you about $6,500.
00:11:55.000 | Since at the age of 15, most of your expenses are still going to be being covered by your parents or guardian,
00:12:01.000 | that's a pretty reasonable assumption that you save that amount.
00:12:05.000 | Now what could happen in terms of your total portfolio value if you start saving money?
00:12:11.000 | Well, I'm going to project this for you.
00:12:14.000 | But the first thing that we would have to decide is are we going to keep and project a level $6,500 contribution to the Roth IRA
00:12:22.000 | or are we going to increase it each year?
00:12:25.000 | Now remember, the goal that I'm trying to establish for you is max out a Roth IRA.
00:12:31.000 | In general, just about every year, the IRS increases the amount that you can put into your Roth IRA to reflect the inflation,
00:12:42.000 | the increases in the consumer averages for inflation rate for the previous year.
00:12:47.000 | If we assume that your annual contribution amount increases by about 3%,
00:12:53.000 | which is more or less what the IRS has done since the Roth IRA was invented,
00:12:58.000 | then that means the amount of money goes up every single year.
00:13:02.000 | So at age 15, you would put in $6,500 that year.
00:13:06.000 | At age 16, your annual contribution amount would be $6,695.
00:13:12.000 | It would increase each year.
00:13:13.000 | At age 20, your annual contribution amount would be $7,535.
00:13:18.000 | At age 30, your annual contribution amount would be $10,127.
00:13:24.000 | And the numbers would just grow.
00:13:25.000 | It would grow at 3% at age 50.
00:13:28.000 | Then your annual contribution amount would be limited to $18,290.
00:13:35.000 | What would happen in terms of the total portfolio value?
00:13:38.000 | Well, if I assume that the portfolio value grows at 7% per year,
00:13:44.000 | the portfolio values get pretty exciting once you start to get into your 30s and 40s if you start at a young age.
00:13:51.000 | Assuming that we're making that maximum contribution each and every year of the total amount, $6,500 today, increasing at 3%,
00:14:00.000 | at age 30, you would have contributed a total of $131,000,
00:14:04.000 | but you would have a total account value of $218,000
00:14:08.000 | just by setting this goal of investing the maximum amount and putting it in stocks, earning a 7% return.
00:14:17.000 | At age 40, your total contributions would now be $250,000,
00:14:22.000 | but the total account value would be just less than $600,000.
00:14:27.000 | At age 50, you'd be contributing $18,290 that year.
00:14:32.000 | Your total contribution amount would be $411,000, but you would have $1.3 million in the account.
00:14:38.000 | At age 60, you would have $3 million in the account.
00:14:42.000 | At age 70, you would have $6 million in the account.
00:14:46.000 | You would have contributed about $917,000, and you would have $6.3 million in the account.
00:14:52.000 | Now, here's where the Roth IRA is really, really cool.
00:14:56.000 | Of course, at any point in time that you wanted to retire,
00:15:00.000 | you could retire and start to receive the money tax-free.
00:15:04.000 | However, the Roth IRA under current law does not have what are called required minimum distributions.
00:15:13.000 | Unlike other tax-deferred accounts, such as a traditional 401(k),
00:15:17.000 | you never have to start taking money from the Roth IRA.
00:15:25.000 | In addition to that, as long as you have earned income,
00:15:29.000 | you can continue to make Roth IRA contributions each and every year that you have earned income.
00:15:36.000 | So what I'm trying to emphasize here is if you retired,
00:15:39.000 | and you were just living on savings or investments or Social Security or whatever your income sources are,
00:15:44.000 | and you don't have what is called earned income, you can no longer contribute to a Roth IRA.
00:15:50.000 | However, if you have earned income, you can continue to contribute into your very old age.
00:15:57.000 | You can make Roth IRA contributions at age 80, at age 90, at age 100, every year that you have income.
00:16:04.000 | And this account should probably be the cornerstone of your long-term accumulation planning
00:16:12.000 | for your children, your grandchildren, your great-grandchildren,
00:16:16.000 | all of the family dynasty that you're building.
00:16:19.000 | It has the best characteristics for long-term accumulation planning
00:16:25.000 | because your heirs can receive the money tax-free.
00:16:29.000 | It's enormously powerful.
00:16:31.000 | So let's say that you just used this one account,
00:16:35.000 | and let's say that you were a highly motivated young man or young woman,
00:16:39.000 | or you had a very intelligent father or mother that highly motivated you as a young man or young woman,
00:16:46.000 | and all you did was accumulate money in a Roth IRA starting at age 15,
00:16:51.000 | and all you did was make the maximum annual contribution
00:16:56.000 | and just put it into a stock market mutual fund.
00:16:59.000 | Well, if you did that every year from age 15 to age 80,
00:17:05.000 | you would have contributed $1,307,000 out of your income,
00:17:12.000 | and you would have $13 million in the account.
00:17:16.000 | At age 90, you would have $26 million in the account.
00:17:21.000 | At age 100, you would have $52 million in the account.
00:17:25.000 | And that would be $10 or $20 or $50 million that is completely tax-free under current law,
00:17:33.000 | assuming there are no changes in the law.
00:17:36.000 | That is money that, depending on your state law, is completely safe from all creditors,
00:17:44.000 | completely safe from bankruptcy court.
00:17:47.000 | It's safe from all creditors except super creditors.
00:17:50.000 | Super creditors include the IRS and a divorcing spouse.
00:17:54.000 | So it's not safe from a divorcing spouse.
00:17:56.000 | It's also not safe if you don't pay your taxes.
00:17:58.000 | But beyond super creditors, depending on the laws of your state,
00:18:01.000 | if your state protects Roth IRA values, then this one account is completely protected.
00:18:09.000 | And yet the flexibility of being able to make those contributions,
00:18:13.000 | and if you have to take money out, is enormously powerful.
00:18:17.000 | Now, I fully recognize it's obvious that most people, most of us didn't start at age 15,
00:18:23.000 | most of us aren't going to keep going until age 100.
00:18:26.000 | But I want you to see the power of just this one account.
00:18:29.000 | Because even though the contribution limits are relatively small, you can only put $6,500 in it at 2024,
00:18:36.000 | the power of it is in doing it every year.
00:18:40.000 | And because of the flexibility, it's my hope that you will do it every year.
00:18:45.000 | And in the first year that you can generate earned income for yourself
00:18:48.000 | or help your children to generate earned income, you can start making Roth IRA contributions.
00:18:54.000 | And these contributions are so powerful over time.
00:18:59.000 | Now, if you're older, is it too late?
00:19:01.000 | Does it just, "Well, I can't do anything"? No, it's not.
00:19:05.000 | Let's say that you're starting at 40, and you don't have any money saved.
00:19:09.000 | And your first goal is to put money into the Roth IRA after these other goals that you've done.
00:19:15.000 | And this is your first accumulation goal.
00:19:17.000 | And let's say you start doing it every year.
00:19:19.000 | Well, again, you get the same basic rules.
00:19:21.000 | So $6,500, but it increases at 3%.
00:19:25.000 | And now, in this analysis, I'm going to assume now the increase of catch-up contributions.
00:19:29.000 | In the previous scenario, I ignored the catch-up contributions.
00:19:33.000 | So age 40, you put in $6,500.
00:19:35.000 | Age 41, you put in $6,695.
00:19:38.000 | Age 42, you put in $6,895.
00:19:41.000 | So at age 49, you're putting in $8,481.
00:19:44.000 | Age 50, $9,735.
00:19:46.000 | And then we're going to bump it up to $11,028, just giving that 3% increase to your catch-up contributions.
00:19:52.000 | So let's fast forward to age 60.
00:19:55.000 | At age 60, your annual contribution is $24,548.
00:20:00.000 | Your total amount contributed is $259,465.
00:20:05.000 | And your total investment value is $463,000.
00:20:09.000 | You have almost half a million dollars at age 60.
00:20:12.000 | Now, if you're starting with nothing at age 40, and this is your only accumulation,
00:20:17.000 | you're probably not going to quit and retire.
00:20:19.000 | You're probably going to continue.
00:20:21.000 | But let's assume that you're able to continue from age 40 to age 70.
00:20:25.000 | You will now have been able to accumulate $1,379,000 under these assumptions.
00:20:31.000 | That's a pretty healthy amount.
00:20:33.000 | You're a millionaire.
00:20:34.000 | You became a millionaire, by the way, at age 67 with just this account.
00:20:37.000 | So at age 70, you're a millionaire, and you can keep on going.
00:20:41.000 | You can keep on contributing if you have earned income.
00:20:43.000 | Or at any point in time, you can, of course, stop, start withdrawing money,
00:20:48.000 | and use it as retirement income, and it all comes back tax-free.
00:20:52.000 | Or you could continue on.
00:20:54.000 | Let's say that you're a legacy builder, and you don't get started until age 40.
00:20:58.000 | But all you do is contribute to the Roth IRA,
00:21:00.000 | and you see that as part of your children's inheritance
00:21:03.000 | or your grandchildren's inheritance or your great-grandchildren's inheritance.
00:21:06.000 | By age 100, if you continue to contribute, you could accumulate potentially $17.7 million
00:21:12.000 | using the assumptions that I described.
00:21:15.000 | So the Roth IRA is never anything to sneeze at.
00:21:18.000 | It's a very simple, doable account.
00:21:21.000 | There are many people out there who are earning money
00:21:24.000 | who are not going to be able to fully fund a 401(k).
00:21:28.000 | If you're earning $50,000 per year, and you're supporting a family, children,
00:21:35.000 | it's going to be difficult for you to max out a 401(k).
00:21:39.000 | But you can absolutely still max out a Roth IRA.
00:21:43.000 | This account will give you the foundation that you're looking for
00:21:49.000 | with your long-term financial accumulation goals.
00:21:52.000 | It's so powerful. Don't despise it.
00:21:55.000 | Don't ever despise the day of small beginnings.
00:21:57.000 | The first beginning you should make is to make contributions to the Roth IRA.
00:22:03.000 | And your annual goal each and every year should be to fully fund the Roth IRA.
00:22:10.000 | Let's go over just a couple of rules that you need to understand about the Roth IRA.
00:22:14.000 | The first key feature of the Roth IRA that makes it different than other retirement accounts
00:22:19.000 | is that you make your contributions with after-tax dollars.
00:22:23.000 | Meaning, unlike other accounts where you put the money in before you pay tax,
00:22:27.000 | with the Roth IRA, you first pay tax, and then you contribute.
00:22:32.000 | The downside is you don't get that upfront tax deduction.
00:22:35.000 | The upside is you have more money that goes in because you've already paid the tax.
00:22:40.000 | Then, as long as there's an eligible distribution, which I'll go over in just a moment,
00:22:44.000 | the earnings grow tax-free and they can be withdrawn completely tax-free.
00:22:49.000 | So all of your earnings can be received with no taxes.
00:22:54.000 | To be eligible to contribute to a Roth IRA, the key thing to know is that you must have earned income.
00:23:02.000 | If you do not have earned income, you cannot make a Roth IRA contribution.
00:23:07.000 | You must have earned income.
00:23:11.000 | There are income limits that apply.
00:23:13.000 | So if you earn too much money, then you're not allowed to make Roth IRA contributions.
00:23:19.000 | In 2024, for single filers, your modified adjusted gross income can't be more than--
00:23:24.000 | I think it's 150-something, $153,000.
00:23:28.000 | And for a married couple filing jointly, your household income can't be more than about $228,000,
00:23:35.000 | something like that.
00:23:37.000 | So think about $150,000 and $230,000 as round numbers.
00:23:40.000 | If your household income is above that, you can't contribute directly to the Roth IRA.
00:23:45.000 | Now, that rule has not really been particularly relevant for the last number of years
00:23:51.000 | because there still exists what's called the backdoor Roth IRA.
00:23:56.000 | If your income is more than $150,000 as a single individual, more than $230,000 for a married couple,
00:24:03.000 | then research the backdoor Roth IRA and do that because basically these income limits are a joke
00:24:10.000 | ever since we discovered that we could do a backdoor Roth IRA,
00:24:13.000 | ever since the government removed the income limitations for converting traditional IRAs to Roth IRAs.
00:24:20.000 | But I don't want to get sidelined into that.
00:24:22.000 | So the point is you must have earned income.
00:24:24.000 | And basically in today's world, with the caveats that I've just stated,
00:24:27.000 | if you have earned income, you can make contributions to the Roth IRA.
00:24:31.000 | Now, how do you get the money out tax-free?
00:24:34.000 | Well, any money that comes out after age 59 1/2,
00:24:38.000 | as long as your account has been open for at least five years, comes out tax-free.
00:24:43.000 | In addition, if you're buying your first home, you can take out up to $10,000 from the account.
00:24:49.000 | So once again, if I'm coaching a teenager, I want the money in the Roth IRA.
00:24:53.000 | Teenager says, "Well, at 23, I'm going to buy my first home."
00:24:55.000 | Great. Take out $10,000 from the Roth IRA and use it.
00:24:59.000 | Or if you need more than $10,000, you can take out additional contributions.
00:25:02.000 | The point is that you can use the money to purchase a first home if you need to.
00:25:08.000 | If you are disabled, there are exceptions where you're able to take the money without any penalties or taxes due to that.
00:25:15.000 | And then if you die, then the money will go to your beneficiary or to your estate,
00:25:21.000 | however you're set up, without any taxes or fees.
00:25:25.000 | So this is great.
00:25:27.000 | Now, if you don't have a qualified withdrawal, then we come back to the idea that you may pay taxes or fees.
00:25:35.000 | You'll never pay on your contribution amount that you withdraw.
00:25:38.000 | So the amount that you put into it, you can always turn around and take it out without any taxes or penalties.
00:25:44.000 | If you're going to take out earnings, meaning the increases, the earnings before 59 1/2,
00:25:49.000 | then you're going to be subject to taxes and a 10% penalty.
00:25:55.000 | So it's a very flexible account.
00:25:57.000 | It's not ultimately a flexible on the earnings, but it is extremely flexible based upon what I have described.
00:26:05.000 | In addition, just the way that the Roth IRA works is really convenient.
00:26:09.000 | So for example, the contribution deadline is the tax filing deadline for your current tax year.
00:26:16.000 | So basically usually April 15.
00:26:18.000 | So this is one of those nice things where even if you didn't get it done during the calendar year,
00:26:23.000 | you can still make these contributions quickly.
00:26:28.000 | What about if you have this as part of your estate?
00:26:31.000 | Let's go over quickly how that works.
00:26:33.000 | So what happens to the taxation of a Roth IRA if you die and the money goes to your beneficiaries?
00:26:39.000 | Well, if the IRA was held, the Roth IRA was held for at least five years before the original owner's death,
00:26:46.000 | then all distributions to the beneficiary are tax-free.
00:26:50.000 | So this is an account that can always be received tax-free as long as it was held for five years before death.
00:26:56.000 | Then the rules change just a little bit depending on who is the beneficiary.
00:27:01.000 | If the beneficiary is your spouse, then your spouse can basically inherit all of the characteristics of the Roth IRA.
00:27:09.000 | So the Roth IRA basically gets treated as belonging to your spouse.
00:27:13.000 | The spouse can continue to make deferments, so there's no distributions that have to come out,
00:27:20.000 | or start taking money out tax-free, all kinds of benefits there.
00:27:25.000 | If the beneficiary is going to go to a non-spouse beneficiary,
00:27:29.000 | or excuse me, if the distribution after your death is going to go to a non-spouse beneficiary,
00:27:33.000 | then they have to start taking required minimum distributions out of the account based upon a life expectancy annuity,
00:27:44.000 | or they can just decide that they're going to withdraw the entire balance within ten years of the owner's death
00:27:51.000 | and receive the money income tax-free.
00:27:55.000 | So it is still a very flexible account and a very advantageous account to inherit.
00:28:00.000 | Now, note, it used to be better.
00:28:04.000 | Because the Roth IRA rules are so generous, what has happened is, generally speaking, the tax code has tightened up on the generosity.
00:28:12.000 | So that's where the ten-year rule now that applies to non-spousal beneficiaries now applies.
00:28:18.000 | But it's still really good.
00:28:21.000 | And so if you wanted to do a scenario, just imagine that you die,
00:28:26.000 | and you've got $10 million in your Roth IRA, and you leave it to your grandchildren.
00:28:30.000 | Maybe they're 10, 12, and 14 when you die.
00:28:33.000 | Well, they can keep it around and just basically just sit in the Roth IRA for another ten years.
00:28:39.000 | That $10 million could potentially double in ten years, depending on what the rate of return is.
00:28:44.000 | And then after ten years, the full amount of it can be distributed to your grandchildren income tax-free,
00:28:50.000 | which would be just astounding.
00:28:52.000 | Another huge benefit of the Roth IRA has to do with the actual assets that are allowed in the account.
00:28:58.000 | So first and foremost, you don't have to invest the account dollars into any kind of risky or volatile assets.
00:29:07.000 | As long as you choose a custodian for the account who will permit it and give you access to these types of assets,
00:29:13.000 | you can purchase CDs or banking products in the account, so you can have the money that's totally stable.
00:29:20.000 | In addition, though, to other kinds of more aggressive or more volatile assets.
00:29:25.000 | You can own all of the standard investment assets of stocks, bonds, mutual funds, ETFs, exchange-traded funds.
00:29:32.000 | You can purchase real estate investment trusts. You can invest in private equity.
00:29:38.000 | Basically, you can invest in just about anything if you set up a self-directed Roth IRA.
00:29:44.000 | You can own real estate within a self-directed Roth IRA. You can own precious metals.
00:29:49.000 | You can buy cryptocurrencies. You can invest in annuities.
00:29:54.000 | You can buy foreign currencies. You can make private loans.
00:29:58.000 | All you have to do is avoid any disallowed assets.
00:30:02.000 | So what's most important is to acknowledge that there is a list of investment assets that you cannot own inside of a Roth IRA.
00:30:08.000 | What are they?
00:30:10.000 | First, you cannot own collectibles. You cannot purchase collectibles inside of a Roth IRA.
00:30:17.000 | So no artwork, no antiques, no stamps, no collectible coins.
00:30:22.000 | Note that in the United States, some officially issued U.S. currency coins is exempted.
00:30:30.000 | But here we're talking about collectible coins or not.
00:30:32.000 | So if you wanted to buy American gold eagles, you can do that in a Roth IRA.
00:30:36.000 | You can't, however, buy Krugerrands.
00:30:38.000 | So art, antiques, stamps, coins, fine wines, those are all disallowed assets in a Roth IRA.
00:30:48.000 | Next, you cannot invest into life insurance contracts in a Roth IRA.
00:30:53.000 | So all life insurance has to be outside of retirement accounts.
00:30:57.000 | You cannot own shares in an S corporation.
00:31:01.000 | You can own shares in C corporations and some partnerships, but you cannot own shares in an S corporation.
00:31:09.000 | You cannot own real estate that you personally use.
00:31:13.000 | Any property that the owner of the IRA or a family member personally uses is disallowed.
00:31:20.000 | And you cannot invest in derivatives contracts, so futures, options, etc.
00:31:24.000 | You can't invest in those kinds of contracts.
00:31:26.000 | Those are the things that aren't allowed.
00:31:29.000 | If it's not on that list, basically, probably you can put it into a Roth IRA.
00:31:33.000 | For the more exotic things, you have to find a custodian who will help you do a self-directed Roth IRA
00:31:39.000 | that allows you to make certain kinds of investments.
00:31:43.000 | But it's generally possible.
00:31:44.000 | There's a lot of custodians out there that offer enormous flexibility if that's what you're looking for.
00:31:50.000 | You also want to be aware of the specific kinds of transactions that are prohibited.
00:31:54.000 | You can't engage in self-dealing.
00:31:55.000 | You can't do transactions with disqualified persons, family members.
00:31:59.000 | You can't borrow money from the IRA or use it as collateral.
00:32:03.000 | Those are prohibited transactions.
00:32:05.000 | But there's quite a lot of flexibility if you understand the rules that many people,
00:32:10.000 | with the exception, again, of self-dealing, buying your house that you live in,
00:32:15.000 | many people can use a Roth IRA very effectively and follow all of the rules.
00:32:20.000 | And for most things that people want to do, there's a way around it.
00:32:24.000 | Now, the trick with Roth IRAs has to do with the idea of how much is in it.
00:32:29.000 | The basic problem with most Roth IRAs is due to the low contribution amount limits,
00:32:35.000 | most people can't accumulate enough money in the Roth IRA in order to do big transactions,
00:32:41.000 | buying real estate, buying significant shares of companies.
00:32:45.000 | But they are still available in the fullness of time.
00:32:49.000 | And, in fact, you can accumulate literally billions of dollars in the Roth IRA.
00:32:53.000 | We have the example of Peter Thiel's $5 billion Roth IRA as a beautiful example of a well-built,
00:33:00.000 | well-structured Roth IRA strategy that is just an amazing account.
00:33:06.000 | When I was younger and when I was a younger financial advisor,
00:33:09.000 | I was super obsessed with finding all of the loopholes, finding all the secrets.
00:33:14.000 | I was fascinated with the world of offshore planning and trusts and family trusts
00:33:21.000 | and all that kind of like fancy-sounding stuff.
00:33:24.000 | It's just exotic to me.
00:33:25.000 | Same reason why I never wanted to just sell boring life insurance.
00:33:29.000 | I wanted to do investment management, right?
00:33:31.000 | It's exotic. It's kind of sexy.
00:33:33.000 | And so I spent all this time digging into all that stuff.
00:33:36.000 | Then after years of that, I came back and just kept on considering all of the basics.
00:33:41.000 | And for the vast majority of people, you have no need for any of those exotic things.
00:33:46.000 | It's just all that adds enormous cost and complexity to your life
00:33:51.000 | and all of this kind of weird rules that now you have to follow.
00:33:54.000 | And it raises your profile and it's super strange stuff.
00:33:57.000 | It has its place, as with anything.
00:34:00.000 | But don't despise the humble everyday Roth IRA.
00:34:04.000 | It is an amazing account.
00:34:06.000 | And it's an account that the rules are so favorable.
00:34:09.000 | And as you get money into it, you could do so many incredible things with it.
00:34:12.000 | It should be a cornerstone of your strategy.
00:34:16.000 | And that's why I list it here as goal six.
00:34:19.000 | Your goal from the very first paycheck that you earn should be to fund a Roth IRA.
00:34:26.000 | And as quickly as you're able to get there, you should fully fund a Roth IRA to the max.
00:34:36.000 | As quickly as you can fully fund it, get to the point of fully funding it.
00:34:39.000 | In future episodes of this series, we're going to talk about other goals like buying a house.
00:34:43.000 | You should buy a house.
00:34:45.000 | For young people, though, fully funding a Roth IRA should be the first thing before the house.
00:34:50.000 | It's more flexible, provides more opportunities for long-term growth.
00:34:53.000 | It's safer than just buying one house.
00:34:55.000 | And it doesn't tie them down to a specific piece of real estate.
00:34:58.000 | And so teach your children, teach your grandchildren, fully fund a Roth IRA and help them.
00:35:06.000 | Remember, you cannot make a Roth IRA contribution until you have earned income.
00:35:13.000 | That's why I use the example of the 15-year-old because any 15-year-old can generate enough earned income to start making Roth IRA contributions.
00:35:23.000 | If you have excess money as a parent or a grandparent and you are looking for something to do with it,
00:35:30.000 | most certainly your first strategy should be to fund your children's and your grandchildren's Roth IRAs.
00:35:37.000 | Remember that unlike some other assets, a Roth IRA account is an account that is not listed as an asset
00:35:47.000 | when it comes to things like the Federal Forms for Student Aid that every college student has to fill out.
00:35:57.000 | So if that college student, if you have a million dollars in your Roth IRA, it's not listed as an asset the way that money in the bank account is.
00:36:04.000 | If your student is listing assets and your student at age 20 has $100,000 in his savings accounts,
00:36:11.000 | well, that all counts against him for the purposes of student aid forms.
00:36:15.000 | However, if the student has $100,000 in his Roth IRA, that money is not listed on the FAFSA documentation.
00:36:23.000 | So perhaps the very best thing for you to do is to help your young children, grandchildren, great-grandchildren to create earned income
00:36:33.000 | and then do a matching program.
00:36:35.000 | One thing that is very effective that many parents do with their children is they require their children to earn income.
00:36:42.000 | And then when they're doing their taxes, the parent makes basically a matching contribution to the child's – to a Roth IRA for the child.
00:36:53.000 | If your child earns – let's do $6,000.
00:36:56.000 | If your child earns $6,000 from his summer job, he now has $6,000 of earned income.
00:37:03.000 | Now you, of course, would want to teach him to save some, spend some, all the stuff that is obviously necessary.
00:37:09.000 | But you as a parent can now gift your child $6,000, which goes directly into the child's Roth IRA,
00:37:18.000 | and now you've made a $6,000 Roth IRA contribution.
00:37:22.000 | And the numbers again on this, when starting early, are just absolutely astonishing.
00:37:26.000 | I just, for the sake of fun, I ran a chart and I said, "All right, let me not be totally crazy and assume that you've got a modeling contract for your 3-year-old."
00:37:35.000 | I know if you do have a modeling contract for your 3-year-old, you still should do Roth IRA contributions.
00:37:40.000 | Let's start at 10, and let's assume that going from the age of 10 onward, you're a wealthy grandparent and you can match your child's earnings.
00:37:50.000 | So 10-year-old earned $6,500, so now you can make a $6,500 earned income contribution.
00:37:56.000 | By the way, earned income is earned income.
00:37:59.000 | Earned income can be earned working for family members.
00:38:02.000 | There's no reason in the world that you can't have a contract with your 10-year-old to perform lawn maintenance services on your house and then pay your grandchild the amount that's an appropriate amount for those lawn care services, and now your grandchild has earned income.
00:38:19.000 | You will pay that money.
00:38:21.000 | It's, of course, not tax-deductible to the grandparent any more than it would be tax-deductible for you to stroke a check to a big corporate lawn maintenance company, but the child will now have earned income.
00:38:31.000 | There will basically be almost no taxes on it due to the basic standard deduction amounts, things like that.
00:38:37.000 | There will be a little bit of taxes, self-employment taxes, but very low taxes on it, and you can gift your child the amount to pay the taxes, your grandchild the amount to pay the taxes.
00:38:48.000 | You just need that earned income, but once the grandchild has earned income, you can now gift and match the Roth IRA contribution.
00:38:56.000 | Let's say you started at age 10 and you fully funded it.
00:39:01.000 | What would be the account values at, say, age 100?
00:39:05.000 | Well, it would be $74 million just by maxing out a Roth IRA contribution with 3% increases per year with 7% increases.
00:39:14.000 | Do I think the Roth IRA account's going to be around in 100 years?
00:39:17.000 | I doubt it.
00:39:18.000 | I doubt it.
00:39:19.000 | There's going to be some significant changes, but there's something that'll be around, and unless all of the tax benefits are removed from the account, it's still going to be around in some way, shape, or form.
00:39:31.000 | If you had 100 years of contributions because you modeled out your baby and the baby lived to 100, then we're talking almost $150 million tax-free in the account for a long-lived baby model.
00:39:45.000 | The point is just that the numbers can get big, and there's really nothing better.
00:39:49.000 | Again, this money doesn't show up.
00:39:51.000 | It doesn't harm anything for student aid on federal forms.
00:39:56.000 | The money is protected from the claims of creditors in many states, not all states.
00:40:01.000 | The money is an asset that's clearly in the name of the child, so although a super creditor, it's not protected in the way that money in a trust may be from a divorcing spouse.
00:40:11.000 | If you are living in a state where a divorce law would protect assets that were held prior to the marriage and separate those in some way, then this is an asset that is clearly labeled as such, and the flexibility is enormous.
00:40:25.000 | The child can take out the contributions, all the stuff that I have said.
00:40:29.000 | The first account to fully fund should be the Roth IRA, and these are the reasons why.
00:40:36.000 | If you're not making any other accumulation goals, set a goal to fully fund a Roth IRA.
00:40:42.000 | Do it each and every year using the backdoor Roth IRA if it still exists when you're earning more income than the income limits, and you will be happy with that decision for the rest of your life.
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