With the introduction of the Individual Retirement Account (IRA) by the federal government in 1974, the innovation was heralded as the road to prosperity for the general public. For the very first time the average middle class, middle income citizen possessed a pathway to join the affluent in capitalizing on the bounty of the investment world. The system was presented to America in the following manner: “The individual retirement account is a defined benefit pension plan which offers individuals an opportunity to save for retirement in a tax-advantaged account. Once your money is in the account, there are no taxes levied on the dividends or capital gains the investments earn. One of greatest advantages to saving for retirement is the tax benefits you get when investing in an IRA.”
The program was sold on the premise your income after retirement would be minimal, so income taxes then paid would be lower than during your working years. However, for persons who actively invest over the decades, this is not likely. And in particular, much of the taxable profits for an investor outside an IRA may be long term capital gain, taxed at a more favorable rate, but all profits within the IRA are taxed at the higher ordinary rates. It was this realization – after my wife and I had been contributing to our accounts a half-dozen years – which led us to cash out and permanently close our IRAs. Though the tax bite hurt at the time, it more than paid off over the long run.
With this said, what exactly is the long run? It’s that tax law requires individual IRA holders to begin taking out taxable amounts from their accounts, known as required minimum distributions (RMDs), once they reach 70½. The exact distribution changes with age, based upon an actuarial table established by the IRS. I’ll give you an actual example: An 81-year-old friend’s account contains $675,000 in assets. The RMD at age 81 is 17.9. He must divide the IRA asset value by the RMD to determine the taxable income to report, or $675,000 / 17.9 = $37,709. His tax return must include this amount in addition to all other annual taxable income he receives.
I’ll share my conclusions with you. Had my wife and I not bailed out of our IRA accounts some 25 years ago, we would have incurred tens of thousands of dollars in taxes which we avoided. Although each of us will experience different results, if one day you become truly prosperous, you’ll be better off never opening an IRA.