by Jeff Schneider, PassportIRA

Obviously, our goal is to pay the least amount as possible.  But often it becomes easy to miss out on the big picture if you focus on year to year tax planning.

A tax attorney we frequently work with often uses the analogy of having a ‘partner’ in everything we do.

The partner is the IRS.

They are a partner in business and your retirement accounts.

Now, a partner may potentially add tremendous value to a business.  Although, that’s not the case here.

Here, your partner feeds more when you work more by siphoning money off through taxes and lost time determining the tax code.

What do you do with a partner who adds no value?

Buy them out.

There are two scenarios commonly overlooked as opportune times to buyout the IRS as a partner in your Traditional IRA. No matter how much you try, the amount you see on your quarterly statements aren’t all yours.  Your partner is entitled to 20-30%.

Convert to a Roth

Roth conversion laws changed for the good in 2010.  Income restrictions have been removed from those wanting to convert from a Traditional IRA to a Roth.

Upon the conversion, the tax you pay is your buyout price, leaving you with tax-free gains into the future.

The tax liability is certainly daunting.  Money you’ve been saving in a 401k and IRA for years suddenly becomes earned income.  Converting smaller amounts over time will allow you to smooth out the cash flow and you can always recharacterize back to a Traditional if your funding situation changes.

Everyone can now benefit from the unlimited upside of tax-free gains.

It’s a calculation that is unique to everyone, but buying out your partner in one or two big conversions could result in you beating the tax increases the will arrive in 2013.

Required Distributions

We hate taxes.  Behavior shows that time after time.  That’s most often why contributions are made to a tax-deferred retirement plan in the first place.

A trap gets created though. Upon retirement, people live off their savings rather than pulling funds from IRAs because they don’t want to pay the corresponding tax liability.

Then, at 70 1/2, the IRS starts requiring a minimum amount and many people stick to the bare minimum.

That’s a mistake.

In the grand picture, a Traditional IRA is most beneficial to take the maximum amount of distribution each year after retirement that doesn’t hurt your tax rate.

Why?

Think about what happens to a Traditional IRA upon death of the account holder.

First, an IRA is calculated at face value (not subtracting how much is really owed to the partner) in estate taxes.  If you’re near the line, your estate will be taxed on money that isn’t even yours.

Second, your heirs, if aged between 18-55, are likely in a higher tax bracket than you.  They are required to take distributions immediately upon inheriting an IRA and will end up declaring more income during their working years.

Taking the maximum distribution each year after retirement is the equivalent of buying your partner out over time.

These two strategies are ways to make sure you pay the lowest tax over time.  Tax rates over the next 10 years seem to have one direction: UP.  Buy the IRS out now or it will only get more expensive for you or your heirs.

For updated information on taking your IRA offshore, see: PremierOffshore.com