The Completely Tax Free Roth IRA: Strange Ways to Save

SavingAdvice is starting a new column that’s going to look at strange, offbeat ways to save and make money. Anything that’s a little odd, uncommon, or contrarian is fair game – as long as it’s legal.

You probably already know about Roth IRA’s. These are IRA’s that you fund with after tax dollars and then, when you retire, your withdrawals are tax-free. In contrast, regular IRA’s are funded with pre-tax/tax deductible dollars but you pay taxes on your withdrawals when you retire. The big draw of a Roth IRA is that you pay your taxes now, at what is likely to be a lower rate than will be in effect when you retire, and then during retirement you don’t have to worry about taxes. But what if you could figure out a way to avoid taxes on both ends? Is it possible to create a Roth IRA that carries no tax burden whatsoever?

I have a friend who is trying just such an experiment. He is funding a Roth IRA with money that is not subject to taxes. He’s putting in all his gifts, money found in the street, rebates, credit card cash back, and other money that isn’t taxable income into this Roth IRA. He’s funding the account with money on which no taxes have been taken out. When he retires, he will not pay taxes on his withdrawals, either,
making this account completely tax free. So far he’s managed to accumulate about $5,000 in this IRA, including the interest he’s earned from his investments. With about twenty years to go until retirement, he could have a nice chunk of money in this tax-avoided account.

Is such a thing ethical? You could argue it both ways. You could say that he is cheating the system by operating against the spirit of the Roth rules. However, I would say he is being smart. He is careful to make certain that the money he puts into this account is not subject to taxes, so he’s not breaking any laws to my knowledge. He’s putting his gifts and found extra money to good use. Rather than dropping this non-taxable money into a regular savings account where the earnings are subject to taxes, he’s using it to best advantage, protecting any earnings from future taxes.

Now, obviously my friend does not intend to retire on just this money alone. It would be nearly impossible to gather together enough tax-free money to provide a comfortable retirement. Unless you have a lot of people giving you big gifts, you need another plan. My friend has other retirement accounts that will provide the bulk of his income. This is merely his attempt to “stick it to the man” by avoiding taxes on his retirement income as much as possible. When he retires, he will have a least a small amount of money on which he has never and will never pay taxes.

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10 Responses to The Completely Tax Free Roth IRA: Strange Ways to Save

  1. To me, this attitude represents an unhealthy view of savings and taxes.

    The amount of untaxed income he has in a year does not change based on the fact that he carefully misers away only the untaxed dollars and cents into his Roth. There would be nothing different in this situation if he put all his gifts and non-taxable income into his savings account (or any account for that matter), and then making standard, regular contributions from that savings into his Roth. He’d probably be more apt to contribute more (even some *gasp* taxed dollars) into this Roth and thus reap a much larger gain for retirement, if he wasn’t so focused on ‘sticking’ it to someone. (When, ironically, he’s not really sticking it to anyone…)

  2. snshijuptr says:

    This also represents an unhealthy view of taxes. Taxes are not some horrible punishment or burden, they are our dues for belonging to this amazing, modern, welfare-d country. You wouldn’t complain about a gym charging you to be a member nor the girl scouts charging for your daughter to join, so why do you complain about your taxes like they do nothing for you?

  3. Miki says:

    I would not consider the source as tax-free income. Cashback cards are usually a small percentage rebate on purchases. So in order to get this “income”, he has to spend close to 100 times more.

    So this whole idea is stupid.

    He IS paying taxes on his deposit income, even if he thinks he’s not.

  4. Joan says:

    I was thinking that with rebates (cash-back) you have already paid the income tax. They are simply giving you back a portion of your money; you paid income tax on it when you earned it. If it is not your own money being returned, then it seems to me that it is new income and that one is supposed to report it and pay income tax on it. Money found on the street? I have no idea! Gifts? I guess in some circumstances they would be taxable to the recipient, but nobody gives me gifts anyway, so personally I could build no account of any kind with gifts. How long has it taken your friend to build up $5000 in such money? It would take me more than a lifetime, I’m afraid.

  5. Monkey Mama says:

    I think it’s smart! (Cheating? Pfffffft).

    I do hope anyone would consider maxing out their ROTH, rather than *just* putting tax-free money in, is all.

    To the above poster – credit card rewards are not taxable, and gifts are never taxable to the recipient.

  6. dfeucht says:

    Well if the user put this “tax-free” money into a Traditional IRA, he/she could then deduct the money from their income taxes this year. So is it really tax-free? No it’s just semantics. If it makes them feel better and helps them save, more power to them.

  7. Gail says:

    I think if it means he is putting more money away for retirement, it doesn’t matter. It isn’t unethical in the least as long as he stays within the income guidelines for these contributions. Any trick that gets an American to put away more money for retirement is a good idea. We are given brains to think up solutions and I think that this guy is making sure he doesn’t waste money that comes his way. Kudos to him! Not sure why everyone thinks he is nuts. What difference if he saves his spare change in a jar or in a bank account (other than the account will gorw and the jar will get dusty). I have long wondered how much money a person could collect from those types of sources were it all saved in one place, so this was very interesting to me.

    I personally am toying with the idea since I am older of maxing out my IRA before my husbands so that we can access the money, if needed, sooner than dividing amounts equally and possibly having to pay a fee if we have to tap his.

  8. Imtos says:

    This post makes no sense. Money is fungible, so what you do with a particular amount of money does not matter.
    In other words, once you “earn” a dollar, what you do with that particular dollar is unimportant since that particular dollar can be replaced by any of your other dollars, and most importantly, your economic situation would not change!
    If you take a dollar from your left hand and buy candy and take a dollar from your right hand and invest it in a Roth IRA is no different from doing the opposite.
    The economic principle here is that by investing his “found” money in a Roth IRA, your friend has freed up resources that he can now allocate to something different.

  9. jaine says:

    I think it’s smart as long as it’s not his only retirement saving strategy.

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