A Guide to the Backdoor Roth IRA, and Heirs Squandering Inheritances
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What are the benefits of a Roth IRA for retirement?
Getting money in a Roth IRA through the back door and the amazing Inheritance Disappearing Act. That and more on this Saturday personal finance edition of Motley Fool Money.
I'm Robert Brokamp, and this week I'm going to lay out the five steps to contributing to a backdoor Roth IRA and highlight a couple of potential landmines you definitely want to avoid. But first, let's look at some headlines from this past week or so. You know, the stock market has shaken off the concerns of war and rising oil prices and is now near all-time highs. In fact, the S&P 500 recently posted a 9.8% 10-day rally. According to the Carson Group, this was the 20th best 10-day return for the index since 1950.
What happened a year after the other 19? Well, the market earned a positive return in 16 of those instances, with the three instances of stocks being down a year later, all occurring during the dot-com crash of the early 2000s. The median 12-month return after all of those 19 essentially double-digit 10-day rallies was 20.8%.
In the Facts vs. Feelings podcast, the Carson Group's Ryan Dietrich, a previous guest on our show, pointed out that the market hitting new highs in April has nearly the same frequency as those exceptional rallies, it having happened 19 times.
And in all but one of those instances, the market ended the year in positive territory. As Ryan pointed out, a lot of this is just fun with numbers and not necessarily information you would use to make investing decisions, but the reasons underpinning the rally, namely growing corporate earnings and high profit margins, are good signs. Next up, what do people do when they inherit money? Apparently, a lot of people spend it. That's the conclusion of a recent study from Corey Thompson of the University of Alabama and Russell James of Texas Tech University. They looked at data from 2010 to 2018 to investigate how people handled inheritances compared to other infalls like gifts, lawsuit rewards, insurance settlements, things like that.
The headline finding is that inheritances get burned through remarkably fast. Each inherited dollar increased next wave net worth by only 61 cents when measured roughly a year later, meaning that nearly 40 cents of every inherited dollar had been spent and 42% of heirs had completely spent their inheritances. What makes this especially striking is the profile of these inheritors.
What is the significance of the recent stock market rally?
They averaged nearly $1 million in net worth, half had college degrees and 89% were homeowners. So this isn't a story about financially unsophisticated people. It happened across the wealth spectrum. Study also found that controlling for demographics and the amount of money received, people were more likely to spend down inheritances than other types of windfalls. The practical implication may be that the standard estate planning approach of a lump sum bequest at death may be the worst possible design since it delivers a large amount of money at precisely the moment beneficiaries are psychologically primed to spend it away. The authors argue for time-phase distribution, so maybe staggered principal releases or spendthrift trusts or annuitized beneficiary designations, and propose that advisors reframe the estate planning conversation from how much should I leave to how much annual income should my heirs receive.
And now the number of the week, which is 7.9%. That's how much costs for food companies jumped in March year over year, according to Bank of America Global Research and highlighted by Bloomberg. That's up from 4.2% in February, right before the Iran war. The biggest cause for the jump, of course, is the spike in fuel prices. But three to six months from now, we could see additional upward pressure from higher costs for packaging, fertilizer, and other items that are either made from petroleum or have seen their shipments significantly curtailed by the closing of the Strait of Hormuz. Next up, how to get money into a Roth IRA even if you earn above the income limits when Motley Fool money continues.
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