Pass it On…And On…And On

The goal of investing for retirement is to have enough money so you will never run out for your entire lifetime. But how do you guarantee the cash you put away each month will flourish into a beautiful money tree that just keeps sprouting hundreds? And if it does grow forever, how do you ensure your family will have tax-free access in the future? Start by sitting down with your financial advisor to determine what you will need for your future, says Paul Palazzo, managing director of financial planning with L.J. Altfest & Company.

You may look at your portfolio today and think you have plenty of money to start giving out gifts to your children in tax-free amounts generally up to $12,000 per year if you are single and $24,000 per year if you are married. But your spending may change in retirement. For instance, while you are working, you may eat dinner every night at home and vacation twice a year. However, you may want to eat out three times a week and travel four times a year when you retire because you have unlimited time to try new restaurants and go on trips to exotic locales.

It’s generally best to give small gifts to your children now and let them wait until inheritance time to get more money, which may or may not require them to pay income tax. This is because there is more than one type of IRA or individual retirement account.

All your IRAs can house your buckets of investments set aside for long-term retirement savings. You have options to put money into traditional IRAs and Roth IRAs. With traditional IRAs, you pay taxes on your money when you start drawing the cash out in retirement. With Roth IRAs, you pay taxes now so you don’t have to pay taxes when you are retired and on a fixed income. Which one is better for you is determined by whether you plan on being in a higher tax bracket in retirement or while you’re working. For instance, if you are currently making $100,000 and you think you’ll make $55,000 from your investments and pensions in retirement, you’re best off deferring taxes to retirement. After all, your tax bracket is 8 percent higher now than it will be then.

But do you know what you’ll make at 70 when you’re 45? Diversifying your portfolio is similar to the way you diversify your portfolio for risk levels. This hedging-bets system allows you to decide what percentage you want tax-free later and what you want as income-tax-free now. Your children will be able to take out money from your Roth in their inheritance at a percentage based on their life expectancies. They won’t get all their inheritance income-tax free, but Palazzo says, "One of the best presents you can give your children is setting an example of how to be financially independent in all stages of life."

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