Are You Really Debt Free?
There is a substantial movement or mindset that the first stop on the road to real financial freedom is to become debt free. Good folks like Dave Ramsey and others before him have extolled the virtues of having no debt.
ARGYLE, TX, January 01, 2011
If you have not converted your IRAs and retirement accounts to Roth IRAs, you are still in debt. Your debt is getting worse instead of better the longer you wait to make the Roth IRA conversion.Please don't claim to be debt free if you have regular IRAs or retirement plans. Regular IRAs and retirement plans are pre-tax, which means that the taxes are deferred. The taxes will someday have to be paid on all of these funds and often at a much higher tax rate on a much larger amount. For example: if you have $100,000 in a regular IRA, the amount that you can actually spend is around $65,000. That is because you still owe the IRS up to 35% on all of your IRA money. Now if $35,000 sounds like a lot of debt on a $100,000 IRA, wait, because it will get worse.
Debt and procrastination go hand in hand. Assume that you could manage to come up with the $35,000 in non-IRA funds now, to pay off the debt that you owe to the IRS on your IRA. Let's call this the non-IRA side account. If you chose instead to invest this $35,000 and wait for 10 years, you will have unwittingly dug your debt hole deeper. If you assume an average 5% annual return before tax on all of your investments (including your IRA), your $35,000 has not kept up with your IRA debt. In 10 years, you will still have to pay all of the non-IRA side account ($35,000 including ten years growth) plus more. That side account with growth, will no longer be enough to satisfy your tax burden on the original $100,000 IRA. As a punishment for waiting, you will need to come up with approximately an additional 20% from other sources to satisfy this extended tax debt on your IRA.
Dave Ramsey is correct that being debt free is a fine thing. Just don't claim to be debt free if you have regular IRAs and retirement accounts that have not been converted to Roth IRAs.
John Bledsoe is the author of the bestselling book, The Gospel of Roth. If you would like more information on this topic, or to schedule an interview with John Bledsoe, please call Aimee Newman at 303-648-1201 or email: aimee@johnbledsoe.com.