For older individual with large Roth IRA accounts, rising interest rates present a major tax-advantage. Because distributions from Roth IRA accounts are tax-free, retirees can reap the benefits of 100% tax-free interest income. This should make individual Treasury bonds an appealing option for those looking to generate passive cash-flow from their Roth IRA accounts.
The tax ramifications of distributions
Unlike distributions from a Traditional IRA account, distributions from a Roth IRA accounts are tax free and do not increase an account holder’s taxable income. Consider the following example for a married couple filing taxes jointly, with $50,000 in regular income and $50,000 in retirement distributions:
The Roth IRA account holder ends up with $6,000 (or 6.50%) more in annual cash flow as a result of tax savings. The savings are even more pronounced when you start dealing with larger numbers:
In the example above, a household with $100,000 in income and $100,000 distributed from a Roth will see $21,830 (or 12.85%) more in net cash flow than the same household who has a distribution from a Traditional IRA.
A cash flow example
Because distributions from a Roth IRA account is tax-free, interest earned in the account is effectively tax-free as well. Retirees can use this to their advantage to generate passive cash flow on a monthly, quarterly, or semi-annual basis. For example, to receive monthly cash flow, an individual could buy the following six US Treasuries:
Doing so would result in regular monthly interest payouts throughout the year on the following payment schedule:
Thus, if someone wanted to guarantee themselves an extra $12,000/year in tax-free passive income from their Roth IRA, they could take $250,000 and weight their investments accordingly:
They would then end up with the following payout schedule:
Keep in mind, because Roth IRA distributions are tax-free, the investor could withdraw the interest immediately and have zero tax liability. This can help fund vacations throughout the year, or charitable giving (or anything!).
Flexibility at a premium
We shared just one example of how you could structure a portfolio to create passive cash flow. But keep in mind we are specifically advocating for this strategy for retirees who have Roth IRA accounts. That’s because the nature of Roth IRAs will allow for 100% tax-free distributions. This means you are keeping 100 cents on the dollar of every interest payment received, as opposed to 75-85 cents after tax.
If you have over $1 million in Roth IRA assets then this strategy is something you should consider. Especially if you have a lot of stock market exposure and have benefitted from rising stock markets over the last 30 years. Shifting your allocation to include Treasuries will reduce the risk in your retirement account and allow for greater cash flow flexibility. Whether you are looking to compliment social security or a pension, or just like the idea of extra cash with low risk, the current environment provides you with a lot of flexibility.
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