Most IRA Accounts Are a Scam: Here's What the Wealthy Do Instead

You're probably throwing money into the worst retirement account possible and not even know it. I'm going to tell you how and why most IRA accounts are trapped. My name is Stefan. I'm the founder of Whitwell & Company, we're a nationwide wealth management firm, and I'm here to help you not fall into the trap. What most people are told is: contribute to your IRA, that's a good thing. And that's half true. It is a really great stepping stone for you to ultimately get money into a Roth account. But if you leave your money in an IRA, you are literally putting it into the worst type of retirement account possible. Why? A couple of reasons. Number one, you're going to be forced to take that money back out. And when you do, it's going to be taxed at ordinary income tax rates. So that's one of the reasons why it's really smart to figure out the right time and the right way to do a Roth conversion and maximize the money that you have actively working for you in your tax-free bucket, aka your Roth or long-term permanent life insurance. Now, as an interim step, putting money in an IRA is awesome. Why is that? Because the IRS is smart. They realize that once you get your money into the Roth, they don't get to touch it ever again. That's one of the big benefits to you: once you get your money into the Roth, you never pay taxes on that again. Number one. But number two, it makes tax season that much simpler for you, because with rare exception, anything you're investing in, if done right inside your Roth, is not taxable to you. So you don't have to put it on your return. You don't have to worry about K-1s. You're good.

The backdoor Roth

The IRS, though, realizes that once they lose control of your money, once it's in your Roth, they don't get to touch it. So what do they do? They're smart. They erected a bunch of barriers and things to make it harder for you to get your money into the Roth. So common examples of that are: if you make too much money, they say you can't put money into your Roth. Well, you've got to thank Congress, because all of the rules are long and complex and say one thing on the first page and have exceptions, and one of those exceptions is that you can do what's called the backdoor Roth, where you put money into an IRA first and then move it over, either immediately or later, into your Roth. Now, if you make too much money, as being defined by the IRS, not me; I want you to make a lot of money, then you lose the ability to deduct your IRA contribution. But that's okay. You're investing into your retirement account with after-tax dollars, and then when you move those over, because you've already paid taxes on them once, you don't need to pay again. And that helps you get around the 'you make too much to contribute to your Roth' rule that the IRS has in place. So that's just one example. The other example is when you have a 401k, you may decide to roll that over to an IRA. That's, again, a really great stepping stone for your money, but it's not a good place for it long term. This idea that some people have that, no, no, no, IRA is great, but they don't think and do the math on the taxes in the future.

Giving your kids an IRA is such a tease

And it's not just about you. But if you have children, and if you have other assets you can use in retirement, and you end up passing away one day having IRA accounts, giving your kids an IRA account is such a tease. Why? Because if you're giving them a $100 IRA account, they're not really getting $100. They're getting $100 minus the taxes they're going to have to pay on that. And it's taxed at ordinary income tax rates. So if income tax rates are 40%, then that means they only get $60. That's a massive reduction from the gift that you gave them. So whether it's for use of your assets while you're alive, in which case you can grow your money and have, potentially, depending on the age at which you start the strategy, more money to support you in your later years with the strategy than you will by keeping it in an account that's constantly going to have a cash trap, the other thing is that if you end up not using it all in your lifetime, it becomes a really valuable gift to your children. And doubly so, because usually, and the rules may change, they change every year, but under the current set of rules, if you give, on your passing, a Roth to one of your children, they have up to 10 years to pull that money out. So not only do they get to pull that money out tax-free, but, get this, they can continue to invest and grow that money for 10 years tax-free before they're then required to take that out. And of course, when they do, it's tax-free. But you're giving them not just all that money as a gift tax-free then, but you're giving them a vehicle that they can then use for the next 10 years to keep growing their money tax-free. So again, if you're not careful and you don't have a plan in place and you think an IRA is the way to go, think twice. You've got to do the math on taxes, and it's not always intuitive. The math is not always linear, but it is just math. So if you're adventurous enough, bust out the spreadsheet and do the math yourself, or you reach out to us, we'd be happy to help you do that. But it's really, really important that, as part of your planning, given how hard you work, you've got a plan to keep more of what you make. And part of that means not leaving assets in a tax-deferred account forever. You've got to have a plan to get those out into your tax-free bucket in a smart way.

By way of recap

So just by way of recap: short-term, put as much money as you can into your after-tax bucket directly. If it's better for you today because you need the extra cash flow to make a contribution pre-tax, fine, do that. Then, once you've maxed out your contributions to your after-tax bucket, put as much as you can into your tax-deferred bucket, I know, it's your IRA, or your 401k that one day you can roll over to your IRA. But don't be complacent. Don't just let it sit there. You've got to have a plan on how to ultimately get it out and into your tax-free bucket. There's some other techniques too. If you have any questions on it, reach out. We love this stuff. We're happy to talk to you. And again, take advantage of this as a stepping stone. Think of it as a way to cross the river, but you don't want to stand in the middle of the river too long. You want to go to the other side of the shore, and that means getting your money into your tax-free bucket.

Your homework: your three tax buckets

When I do dinner seminars or speak to a group and I ask the audience, 'How many of you have a clear sense of the percentage of your net worth that is in your tax-free bucket today?', most people's percentage is really small. Yet if I first ask them, 'You've got three tax buckets: a taxable bucket, a tax-deferred bucket, and a tax-free bucket. Which of those three buckets do you think is going to be most valuable to you long-term?', without any hesitation, 99.9% of the time people say, 'Well, clearly, your tax-free bucket,' and they're right. It's just a clear intuition that if I don't have to pay taxes, that's got to be a powerful account, that's the best place to have my money, and they're right. But you've got to ask yourself: why is it that if everybody intuitively knows that's the bucket you want to be filling up, most people's tax-free bucket is the smallest percentage of those three buckets across their assets? So your homework right now is to think about your own net worth, your own investments. What percentage of your investable net worth today is in your taxable bucket, your tax-deferred bucket, and your tax-free bucket? And if you find that your tax-free bucket is a very, very lonely, small single-digit percentage, or a low double-digit percentage, that is a clear red flag, but also a big opportunity for you. Because now that you know that, it can become an intentional goal of yours to work on finding ways to fund that bucket so it can keep working for you every year, growing your money tax-free.