The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney

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Grow Wealth While Still Working
Jim Lange, CPA/Attorney
Episode 30

Please note: Some of the events referenced in our audio archives have already passed. Please check www.retiresecure.com for an updated event schedule.

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TOPICS COVERED:

  1. The Best Ways to Maximize Your Retirement Contributions
  2. Caller Q&A:  Transferring a 401(k) to an IRA and/or Roth IRA  
  3. Caller Q&A:  Clarification of the Five-Year Rule for Roth IRAs
  4. Caller Q&A:  Should You Borrow Money to Pay for Roth IRA Conversion?
  5. Final Q&A:  Taxation on Roth IRA Conversion

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. The Best Ways to Maximize Your Retirement Plan Contributions

Jim: The thing that I thought I would do is, I would talk to the people who are working now, and talk about what is the best way to save for your retirement.  Now, what I’m going to assume is that you have sufficient money that you can maximize your retirement plan contributions, and what I thought I would do is to go through, from beginning to end, what an employee should do. 

Nicole: Okay, great.

Jim: Alright.  So the first part, and part of this might be a little bit of repetition in that I talked about in “Retire Secure!,” but I’m going to probably emphasize tonight some of the Roth options.  The first thing that every employee should do is always, always, always take advantage of any employer match.  So, for example, if you work at the University of Pittsburgh, if you put in 8% of your salary, they’ll put in 12%.  So, that a 150% return on your investment in day one.  You don’t even think about that.  You steal from your mother.  You do anything to get the money.  You don’t really steal from your mother.

Nicole: No, of course.

Jim: But, you do anything you can to make sure that you at least put that much in.  So, I’m willing to assume that everybody’s going to do that.  Alright, so let’s say that there is still additional money.  Alright, in most cases, and we’ll talk about the exceptions, but most cases, I’m interested in getting into the tax-free environment.  I don’t want you to have to pay taxes ever on money that you’re going to eventually withdraw from those retirement plan contributions.  And the two types of tax-free investments in your retirement plan are Roth IRAs.  Alright, if you are 49 or younger, and you make more than $5,000, you qualify to put $5,000 into a Roth IRA.  If your spouse is working, and you have another $5,000 of earned income, you can actually contribute money for your spouse, so even if just one of you is working, you could put in $5,000 each for your Roth IRAs.  If you are 50 or older, that amount goes to $6,000.  So, that’s going to be the next place I’m going to look.  Then, the next choice, and by the way, there are income caps on that, I think it’s about $180,000, is going to start phasing out what the allowed contribution for the Roth IRA.  Then, I’m interested in if you have access to it, and here’s a big ‘if,’ I am a big fan of the Roth 401(k).  Now, the Roth 401(k) is kind of a unique beast.  It’s not a regular IRA, and it’s not even a regular 401(k) and it’s not a Roth IRA.  It’s its own unique beast.  It is an employer-sponsored plan, but unlike a traditional 401(k) where, when you make a contribution, you get a tax deduction, or looked at, you don’t pay taxes on the money.  With a Roth 401(k), you don’t get a tax deduction, but just like a regular Roth IRA, the 401(k) grows income tax free.  Now, what’s interesting about the Roth 401(k) for a lot of our listeners, is that there is no income limit on how much money you can earn, so even if you’re earning a million dollars, you can still put money in a Roth 401(k) where you would be precluded from putting money into a Roth IRA.  The other thing is, the limitations are pretty high.  You could put up to $16,000, or is it $16,500, I should know that, into the Roth 401(k) if you are 49 or younger and you have sufficient income that you could afford to do that, and if you are 50 or older, you could put in $22,000.  So, it’s really a substantial amount of money that you can contribute to these retirement plans, and what to me is, I can’t understand why more companies don’t offer Roth 401(k)s.  I don’t know why any company would not include that as one of the options for their employees.  So, for example, in our small firm, you know, we have ten to sometimes during tax season, maybe twelve people, and we offer all our employees, in addition to what I contribute, and the portion that I contribute is traditional IRA or 401(k).  It is not Roth 401(k), so my portion, there’s no choice on that.  My portion is traditional pre-tax 401(k).  The after-tax portion, though, the Roth 401(k), that’s up to the employee.  They can do the traditional 401(k) or the Roth 401(k), their choice.  I don’t know why more companies don’t offer Roth 401(k)s.

Nicole: Now, for a company to offer that, doesn’t it cost the company anything, or any more?  Is that why they don’t offer it?

Jim: Well, it’s going to be a minimal cost.  They have to do an amendment to their retirement plan document, which is no big deal.

Nicole: Okay.

Jim: I’m trying to think if it was, I don’t know if it cost us a couple hundred dollars, it might have even been nothing.  There’s a little bit more accounting involved, because now people can have two different types of accounts.  On the other hand, with today’s software, it’s hard for me to imagine that’s much extra time.  So, in fact, sometimes I’m in front of HR people and benefits people, and I’m telling them we really highly recommend that you offer the Roth 401(k), because the costs are really minimal and the difference to the employee over time can be quite substantial.  So, I think that that is the next area.  If you are an employee, you should check to see if you have access to it.  After you have maxed out the matching portion, after you have maxed out your Roth IRA, the next area would be the Roth 401(k), if that is available to you.

Nicole: So, do both if you can? 

Jim: That’s correct.

Nicole: Okay.

Jim: Alright, well, the matching portion, I mean, actually, it could end up being that you just put money, it’s the employer portion that it the traditional, so yours could just be the Roth if they have it.  What I have found, at least most of the companies in Pittsburgh, they do not offer it.  Now, the universities have just gotten around to it, so I was talking about that, and in that case, by the way, if you’re a university employee or a hospital employee, instead of a Roth 401(k), you will likely be offered a Roth 403(d), because your retirement plan is not a 401(k), it’s a 403(d), usually, not always, but usually with TIAA-CREF as your primary investment option.  That’s pretty typical of universities.

Nicole: Okay.  Alright, so those are the things that you can get from your employer.

Jim: Well, we haven’t talked about the traditional 401(k).

Nicole: Right, exactly, okay.

Jim: Alright, so, let’s assume that you are precluded from putting money into a Roth.  Then, if you can afford it, I want you to put the maximum into your traditional 401(k) plan, which is, you know, you don’t pay taxes on it or, looked at another way, you get a tax deduction.  The money grows tax-deferred, and then, when you eventually take the money out, presumably after retirement, you will have to pay taxes on it.

Nicole: Okay.

Jim: Alright, now, let’s say that you have maxed out those possibilities.

Nicole: Okay.

Jim: There’s still additional money you could put away, and this is very important for people in the upper income strata.  If your income is too high to qualify for a regular Roth IRA, you could put money in a non-deductible IRA.  In fact, you know, a lot of people, probably a lot of our older listeners remember when they made too much money to be allowed to put money in their traditional IRA, back then it was $2,000, they put $2,000 into a non-deductible IRA.  So, they have some non-deductible after-tax dollars, and that was better than not doing anything.  Well, it’s the same thing today, except the limits are even higher, so you’re allowed to put $5,000 in a non-deductible IRA, or if you are 50 or older, $6,000, and you can put $5,000 for yourself and $6,000 for your spouse.  So, I am a big fan of that.  Now, the other thing that we can do is, we don’t want to forget our self-employed friends.  Let’s say you are self-employed, and let’s keep it real simple, you have no employees.  A lot of my clients, before they come see and talk to me about this, they might have an SEP, or a simple plan.  Well, I think they can do a lot better.  I think that they can have their own one person 401(k) plan, and there are two big advantages to having your own personal 401(k) plan if you are still working, and by the way, these are the simple advantages.  I won’t get into the more sophisticated ones where you’re making Roth IRA conversions of non-deductible IRAs.  That’s another topic for another day.  Great topic, though.  The other thing that I like about it is you can put away more money and, even in your one person Roth 401(k) plan, you can have a Roth 401(k) in that one person Roth plan, and that’s something I don’t see a lot of, except for the people we advise to do that. 

Nicole: Now, if you are a business owner, and you want the single 401(k), who can set that up for you?

Jim: Well, probably just about anybody.

Nicole: Anybody?  Okay.

Jim: Yeah, obviously, our firm helps a lot of people with that, but I don’t want to say we’re the only game in town.  In fact, I would say that probably most, you know, whether it’s if you’re a Vanguard investor or if you’re a TIAA-CREF guy or you go to the local bank or maybe you’re a do-it-yourselfer, so most anybody’s going to offer a one person 401(k) plan.  It used to be a lot worse.  It used to be that you would have to go to an attorney and you’d pay him a couple thousand dollars and he’d set up a plan, and then, there was always, you know, changes to the plan.  You’d have to pay the attorney to do the amended plan document, and it was not insubstantial in terms of fees.  Now, they basically have off-the-shelf type plans.

Nicole: Okay.

Jim: The only thing that I would caution is, I do recommend that if you get that type of plan, you should get the type of plan that will accept an IRA to 401(k) rollover, but will not accept an after-tax or non-deductible IRA to 401(k) rollover.  And the reason for that is I alluded earlier to that strategy of making a Roth IRA conversion without having to pay the tax if the money that you’re converting is from a non-deductible IRA or after-tax dollars inside a retirement plan.  So, you do want to be a little bit careful about which particular type of 401(k) plan you choose.

Nicole: Okay.  This is great, because I know a lot of our listeners are definitely still working, and there are a lot of options here.  So, I think I’m almost going to put you on the spot here, and I want to ask you selfishly, well, I’m not going to give my age over the radio here, but I’m in my thirties.  What would be the best scenario for me with all of these options?

Jim: Well, as you know, we have a matching plan, so a certain portion of your contribution would be matched, or my contribution, so that’s free money, you always do that.

Nicole: I’m going to take that, absolutely.

Jim: Alright, then, and let’s assume, for discussion’s sake, we don’t want to talk about your salary, but let’s take two possibilities.  One,  that your salary is such that you are allowed to make a Roth IRA contribution.  I would certainly do that, because you’re younger than fifty, it’d be $5,000. 

Nicole: I’m writing this down, alright.

Jim: Alright, and the next issue that you have though, is do you put money in a Roth 401(k) or a traditional 401(k) because you have the choice.

Nicole: Right. 

Jim: Alright, my starting point is going to be the Roth 401(k).  Alright, you’re not going to get a tax deduction, so it’s not going to feel quite as good, but ultimately, you’re really actually contributing more money to your retirement plan.  Alright, so, let’s say, for discussion’s sake, that you think that you can afford $15,000.  Let’s also say that you’re in the 33% bracket, that way, in effect, if you did a traditional 401(k), you’re putting in $15,000, but you’re getting a tax deduction for it, so you get, in effect, a refund of $5,000.  If you think about it, you’re really only putting $10,000 into a retirement plan, because you get the tax deduction, you get that money back.  So, the only money that’s growing tax advantaged, even though it was the $15,000, you’re really not putting in $15,000 of purchasing power.  You’re really putting in $10,000.  If you do a Roth, on the other hand, a Roth 401(k), you’re actually putting in the full amount.  And, of course, the other thing that I really like about that is it is growing income tax free for you, and because you are so young, you’ll have many years of income tax free growth for that Roth 401(k) to build and build and build, and then, presumably, at retirement, you could take that money out income tax free.

Nicole: Alright, well, thank you very much.  I think we’re going to take a break now.  The studio phone line is open and we’re ready to take your calls.  The number is 412-333-9385.  When we come back, we’re going to switch gears.  We’re talking about accumulating money while you’re still working.  We’ll talk about more when we come back.  You’re listening to the Lange Money Hour, where smart money talks.

Nicole: Well, thank you, we’re back, and we are certainly talking smart money here.  This is Nicole DeMartino, and I’m here with Jim Lange, and we were just talking about when you’re still working, what’s the best possible places that you can accumulate your dollars.  Now, I’m looking here at the screen.  We do have a caller, so let’s see.  We have Tony from Baldwin.  Tony, are you available?

Tony: Yeah, I am.  Hi.

Nicole: Hi, how are you?

Tony: Good, fine, thanks.

Nicole: Thanks for calling in tonight.  Why don’t you ask Jim here, I’m looking at your question, but why don’t you tell him yourself?


2. Caller Q&A: Transferring a 401(k) to an IRA and/or Roth IRA

Tony: Okay, our company is splitting, the company I work for right now, and in fact, the money’s frozen right now, but next week, it’ll be released and I have the option to take  all of the moneys out, and I wanted to go and put them in my traditional IRA rather than the 401(k) they’re in right now, and then, I’m still working for them and it’s not going to be a problem, but I’ll still put my 6% in, and it’ll basically just start at zero.  I’m wondering if that’s a good strategy to do.  It’s with one company, and I like the performance better of the company that I have my traditional in.  Over the years, I think they’ve been better.  That’s one thing, and the other thing is should I convert my traditional IRA to a regular Roth?  So, I may have to come in and talk to you about all that.

Jim: Alright, let’s take them one at a time.  The first question is, you have the option of either keeping the money that’s in the 401(k) plan in a 401(k) plan or actually making a withdrawal and rolling it into an IRA.  Usually, employees of companies don’t have that option, because most companies say if you are an in-service employee, that is, if you’re still working, they’re not going to let you, particularly if you’re younger than 59 and a half, take a, what’s called, an in-service distribution.  In your case, this is an exception, so you have the choice.  You actually identified the key issue, is you said you like the performance of where your IRA is right now better than the 401(k) that you are being offered.  So, that’s a pretty easy call for you.  That would make a lot of sense to take the money and roll it into, technically, the word is trustee-to-trustee transfer.  By the way, it’s really important.  You do not want to get a check.  You want to arrange the paperwork so it’s like one computer blip to another computer blip.  You do not want to get a check and get into that 20% withholding mess and anything else.

Tony: Okay.

Jim: Alright, you’re going to have a couple of advantages doing that.  One, you’re going to now have control of your IRA and you can do anything you want with it.  Two, you said you like the investment better.  The only times that I would probably recommend that you keep it in the 401(k) is if you had an investment in the 401(k) plan that you liked better than in an IRA.  So, for example, some of the longstanding companies have a guaranteed income contract in their 401(k).  It’s basically a very good bond or a fixed income fund.  Some of those people have elected to keep the money in the 401(k) plan, but that doesn’t sound like that’s the case for you.

Tony: Yeah.

Jim: So, it sounds like doing a trustee-to-trustee transfer into an IRA is probably your best move.

Tony: Yeah, because I talked to them today and they were trying to say that they’d probably send me a check, and now that you say that, I guess I don’t want to do that.  It should be an electronic funds transfer.

Jim: Right.  The problem with a check is they’re going to have to have a 20% withholding, and now you’re going to get into all kinds of problems because you certainly don’t want to pay tax on the money, and if they withhold 20%, then that’s a certain amount that isn’t going back into your IRA.  So, no, you don’t want to have a check.  You want to get a trustee-to-trustee transfer.

Tony: Alright, I’ll tell them that. 

Jim: Alright.  Now, the second question that you posed is probably a more interesting question, is should you do a Roth IRA conversion? 

Tony: Yeah.

Jim: Alright, now, one of the problems that I’m going to have is that in order to give you a good answer, I have to ask you some confidential information, so you can tell me as much or as little as you want.

Tony: Okay.

Jim: Probably, the most important issue in terms of Roth IRA conversions and whether you should convert your traditional, what will be, an IRA into a Roth IRA, is actually based on tax brackets.  So, you’re working now, is that correct?

Tony: Yes.

Jim: Alright, do you know how many more years you’re going to continue working?

Tony: At least, no more than ten more.

Jim: Alright, ten more.  Alright, and when you retire, do you know if you’ll have Social Security or if you’ll have other types of income or minimum required distributions?

Tony: Yeah, I’m retired military, so I have a pension and I’ll get a little pension from this job after ten more years.  I don’t plan on touching Social Security until probably I have to, almost. 

Jim: Alright, well, I’m going to talk about that, too, but here’s what it sounds like.  I want to go on the assumption that you’re going to be at or near the same income tax bracket at retirement as you are right now, because perhaps, right now, your military pension hasn’t started, the pension from your company hasn’t started, and eventually, when you hit seventy, you’re going to have a minimum required distribution of that IRA.

Tony: Right.

Jim: In that case, it probably is going to make sense for you to do a Roth IRA conversion.  Now, the tricky part is how much and when?  Oh, by the way, the other thing I should mention is for it to be an intelligent thing for you to make a Roth IRA conversion, you should have the money to pay the income taxes on the conversion from outside the IRA.  Now, again, that’s private, so I really can’t ask you that on the radio.  So, let’s say, for discussion’s sake, that it’s going to make sense to convert $100,000, and I’ll tell you how we get to that number in a minute.  In that case, what’s probably going to make a lot of sense for you is to pay the income taxes on the conversion from outside the IRA.  Now, in terms of how much to convert there, and again, I would really have to ask you how much you make, which isn’t a cool thing on the radio, but it’s going to be based on your tax bracket, and one of the easy rules of thumb is to convert an amount that will keep you into your existing tax bracket.  Now, if you’re in the 25% bracket, I might not mind if you made a conversion that would go over and above the 25% into the 28% bracket, but I’d probably not be happy about going much higher than that.  If you’re in the 15% bracket, then doing a conversion that would take you up to the top of the 15% bracket might be appropriate.  I’m not a huge fan of going from 15% to 25%, and then, as I talk about my book at length, there’s a lot o tricks that you have to be careful of when you do the tax brackets, because, for example, you have to watch out for the fact that you get a tax break on qualifying dividends and capital gains.  So, it’s not necessarily a straightforward calculation, but basically, what might be your best strategy, if I had to guess, if somebody gave me no more information, put a gun to my head, and said “Okay, what’s Tony’s best strategy?”  I would most likely say a series of Roth IRA conversions over a number of years.

Tony: Oh, okay.

Jim: Okay?

Tony: Yeah.

Jim: Alright, thanks for calling, Tony.

Tony: Alright, I appreciate it.  Thank you.

Jim: Alrighty, bye-bye.

Tony: Goodbye.

Nicole: Alright, Jim, I see another caller.  Do you want to take the caller, or do you want to, what do you want to do?

Jim: Sure, why not?  We’ll take another caller.

Nicole: Alright, we have Ed from beautiful Florida on the phone.  Ed, are you there?

Ed: I am here.

Nicole: Alrighty.  How are you this evening?

Ed: Okay, got some quick questions.

Nicole: Okay, go ahead.

Jim: Shoot, Ed, we’re all ready for you.

Nicole: Jim’s listening.


3. Caller Q&A: Clarification of the Five-Year-Rule for Roth IRAs

Ed: Okay, can you clear up the aspect of the Roth IRA or 401(k) with the five-year strip out rule?

Jim: Sure can, Ed.  First of all, a quick question.  Are you listening online?

Ed: I was listening online through the internet, which is coming in very well.

Jim: Okay, do you have something specific, or do you want me to talk about the five-year rule in general?

Ed: Well, my understanding is, if you convert to the Roth IRA, you cannot take anything out of the Roth IRA until it cooks for five years.  Is that correct, or incorrect?

Jim: Well, that’s actually not correct.  There is a five-year rule, and let’s talk about what it is.  Let’s assume, for discussion’s sake, that you’re 59 and a half or older, so that we don’t have that 10% penalty to worry about.

Ed: That’s fine.

Jim: Okay, so now, you’re always allowed to make a withdrawal, either from a traditional IRA or a Roth IRA.  You can do it the day after you put the money in, a year after, four years after, it doesn’t matter.  You’re allowed to take the money out.

Ed: You’re talking about using 72(t)?

Jim: No, no, forget 72(t).  You’re older than 59 and a half, you’re allowed to get to your money.  If it’s in a traditional IRA, you have to pay income tax.  Now, here’s what the five-year rule says.  The five-year rule says if you invest the money and the money grows, and you want to take a tax-free distribution of the Roth IRA and the growth on the Roth IRA, then you have to wait five years in order for you to take the money out and have the growth be income tax free.  So, let’s do an example.  Let’s say you have $100,000 in a Roth IRA conversion, and it’s four years, 364 days later.  Alright?  And let’s say that the $100,000 Roth went up to $150,000, and you take all of it out.  Well, you’re going to have to pay income tax on the growth of that $50,000.  If, on the other hand, you wait one more day so that whole amount has been in for a full five years, then you can take the entire amount out income tax free. 

Ed: Okay.

Jim: Alright, now, let me tell you why I think that the five-year rule is given more importance than I think it deserves.  I think, realistically, that most people who are doing a Roth IRA conversion are doing it with the intention of long-term tax-free growth.  So, if you make a Roth IRA conversion and you go into distribution mode, that is, well…

Ed: Yes, 70 and a half.

Jim: Well, that’s your required minimum distribution.  I’m talking about, you’re done working, or you’re working and you still need to take money from your portfolio, from your IRA, or from your Roth IRA.

Ed: Okay.

Jim: What I would typically tell people is, first, I’d like you to spend your after-tax dollars first, because you’ve already paid taxes on that and there’s no tax consequence except perhaps paying capital gains tax on appreciated assets.  Then, I want you to take your traditional IRA money, subject to some exceptions, and only then do I want you to take your Roth money, so it’s very unlikely for most people who I would make a Roth IRA conversion recommendation that it would make sense to take the Roth money out before the five-year period has lapsed.  So, that’s why, even though a lot of people want to have liquidity for their funds, and I’m not going to say that liquidity’s not good, liquidity’s a good thing, but I’ll say that it’s probably not as important an issue as a lot of people make it because, in general, the best strategy is to spend after-tax dollars first, then traditional IRA or 401(k) plan money, and then Roth money.

Ed: I agree.  Understood.

Jim: Okay.  Now, there is a little nuance with the five-year rule.  If you make a series of conversions, then each different series starts a new clock ticking.  So, if you did it five years in a row, you would literally have five different clocks. 

Ed: You’d ladder it.

Jim: Right.  On the other hand, if you make a Roth IRA contribution, let’s say you make it on year one, then year two, then year three, then year four, then year five, they all go back as if they were made in year one.  But, if we go back to my main premise, it doesn’t matter anyway, because you’re going to want to keep it there for longer than five years anyway.


4. More Q&A: Should You Borrow Money to Pay for Roth IRA Conversion?

Ed: Okay, let’s take another question.  If you have a substantial sum of money that you’re moving from an IRA or, in fact, a SEP into a Roth IRA, you’re over 59 and a half years of age, you’re in, let’s call it for the moment, the 33% tax bracket.

Jim: Okay.

Ed: Is there any efficacy of, if the tax is going to cost you $100,000 on your Roth, is there any efficacy of borrowing that $100,000 and paying a reasonable interest on the borrow of that, so that you can move the money over into the Roth, pay the interest rate on the borrowing and have the gain in the investment area of your Roth and doing it tax-free, going on, of course, the premise that, as we know, taxes are going up, and over the next ten years, they will go up substantially, borrowing the money to pay the IRS when you take the money out of the IRA and putting it into the Roth?  Any efficacy at all?

Jim: Okay, there’s a couple of facets to that question.  The first facet is, let’s assume that you are in the 33% bracket, and you will, without a change in the tax law, always be in the 33% bracket.

Ed: That’s okay, yes.

Jim: Okay?  In that case, your taxes are going up next year.

Ed: Absolutely.

Jim: Okay?  By the way, that’s a done deal.  That’s already passed, and your tax rate is going to go up by, I believe, 3%.  So, if that happens, it certainly does make sense to do a Roth IRA conversion.  Now, for the other gentleman, I wasn’t sure what his tax bracket was, but I was thinking it might have been 15% or 25%.  I was probably more interested in him doing a series of conversions, because if he was in the 15% bracket, or even 25% bracket, I didn’t want him to pay a big jump in his income tax bracket for the conversion.  If you’re in the 33% bracket, this year, the maximum tax bracket is the 35% bracket.  So, you’re not really hurting yourself very much in terms of income tax bracket by making a large conversion.  Now, what most people would do is if they had the money to pay the taxes from outside the IRA, they would use that money. 

Ed: Well, my question is, is that a proper, logical plan even if you had that money and it’s all after-tax money, is it better to go out and get a $100,000 loan and pay an interest rate that may be whatever you could get and pay that loan down while the largest chunk of money is moving in the Roth?

Jim: Well, basically, that’s known as arbitrage.

Ed: Yes.

Jim: Alright, that’s where you borrow money and you invest the money and you hope that your investment does better than the interest rate that you are paying.

Ed: Well, in this particular instance, I’m not saying that you’re going to invest that borrowed money, but you’re going to use that borrowed money to pay off the government, your taxation as you take the money out of the IRA.

Jim: Right, now, by the way, most of my clients would probably be too conservative to do that, but I would think that if you are a confident investor, it is a reasonable thing.  I would probably feel a lot more confident if you could afford to lose it, if you know what I mean.  In other words, if somebody is kind of on the borderline of whether they’re going to be able to retire securely or not, then I’d be a little bit more hesitant about doing an arbitrage because the cost of it not working out could make the difference between a secure retirement and an insecure retirement.  Usually, you see people borrow, or people who are interested in borrowing money, to pay the tax on a Roth IRA conversion, is when they don’t have the money from outside the IRA to pay the tax.  Now, in your case, let’s say you do, then that’s a pure arbitrage question, because, in effect, you know, you would have the choice of using the money that you have to pay the tax, or you’re just going to borrow the money. 

Ed: Okay, so, what you’re saying is it is not categorically insane to think in terms of the arbitrage, but what you’d have to do is, in fact, run the numbers on some projection along the way?

Jim: Well, I think, actually, it’s hard to run the numbers because you don’t know what the investment return that you’re going to get when you make an investment.  I will say this: now’s probably a pretty good time because interest rates are very low for borrowing, and hopefully, the market’s going to go up.  So, even though it’s not a conservative strategy, I would say that now’s as probably a good a time for that as I can imagine.  Where I would see this more often is in a situation where somebody wanted to do a Roth IRA conversion, they didn’t have the money to pay the tax from outside the IRA.  It doesn’t make a lot of sense, in most cases, to do a Roth IRA conversion and pay the tax from inside the IRA, so the alternative would be to borrow the money to pay the tax, and that would actually be a fairly reasonable strategy.  What you’re doing is a little bit aggressive, but I don’t have a problem with it if you understand the potential risk that you borrow at, let’s say, 5% or 6% and you invest money and you lose 30%, then you’re saying, “Oh geez, I wish I hadn’t done that.”

Ed: Yes, I fully agree, and in fact, I believe that ten years from today, taxes will be closer to the 50% bracket.

Jim: Well, if you believe that, then it’s going to make even more sense.  So, for example, some of the things that I do in a workshop because I’m a little bit of a, you know, Missouri type of guy, show me what are some real numbers.  I talk about some of the actual advantages.  So, let’s say for discussion’s sake, that you’re in a high tax bracket, and you’re interested in doing a Roth IRA conversion and let’s say it’s $100,000.  Twenty years from now, you’ll be $93,000 better off.  If you then die and leave it to your kids, your kids will be $890,000 better off.  If you die and leave it to your grandkids, they’ll be $12,000,000 better off.  That’s using an 8% rate. 

Ed: Sure.

Jim: Now, if you are right, and taxes go up way beyond how much we already know they’re going to go up, then all those numbers are actually conservative.  So, it could be a great move to do a Roth IRA.  Now, the only thing I should tell people is, when I give people those high numbers, I should say that that’s total dollars.  If you were to bring that back into 2010 dollars, the benefit of making a $100,000 Roth IRA conversion would be $52,000 in 2010 dollars.  If you then die and it goes to your kids, your kids will be better off by $235,000 in 2010 dollars, and grandkids by $1.1 million in 2010 dollars.  But, if you are right and taxes are going to go up even more, then locking in that money is going to be a very good strategy for you. 

Ed: Right, okay.  I appreciate that insight.  I’ll listen to your program, and I know that you’re having a workshop, and I will check to see if USAir flies direct from south Florida to Pittsburgh.

Jim: Well, you would be most welcome.  The other option for you, by the way, the best way to do it, really, is to come live.  But, for whatever it’s worth, we did tape one of those workshops and we are selling that.  So, that’s on our website too, so you could actually buy the workshop, if you wanted.  Of course, we always encourage people to come in.  By the way, we actually do have a lot of people coming in from all over the place, and I enjoy that.  What we typically do then is we accommodate people, and we tend to do the workshop and have the free consultation (for PA residents only) in the same trip.

Ed: But you’re outside Monroeville, you’re a fifteen or twenty mile run from the airport?

Jim: Yeah.

Nicole: Probably.

Jim: It might be right around there.

Nicole: Probably fifteen.

Jim: Somewhere around fifteen miles. 

Ed: Okay, there’s no provision for being picked up at the airport to come to your workshop?

Jim: I’m afraid not.  Maybe that’s something we ought to start.

Ed: Well, listen, when you get to Ed Slott’s point of view, or level, I imagine you’ll be able to do that as well.

Jim: By the way, I really like Ed.  He’s been on the show twice.  He’s done a fabulous job.  I very much enjoy him.  I enjoy his books, I like him personally, I think of him more as an advisor to advisors, and there is a component to that in my business because I know a lot of advisors who might buy my books and a lot of advisors actually buy this workshop that I do.  I sell a done-for-you kit for advisors, but primarily, I’m actually an individual practitioner.  That’s what I do most days.  I get up, I have a seven minute commute to the office.  I think that one thing that Ed and I do have in common, though, is that we both think about this stuff all the time.  We go to workshops ourselves, we read ourselves, we write ourselves, but I think that one of the differences between Ed and I is, I think Ed is probably spending more of his time on advisors, and while I do a lot of that, I still spend my primary time with clients.

Ed: Tell me, would you announce your office telephone number over the air?

Nicole: Sure, I’ll give that to you.

Jim: We just hate doing that, but we’ll do it anyway.

Nicole: Ed, it’s 412-521-2732.  Now, do you have Jim’s book, “Retire Secure!”? 

Ed: No, but I have two of Ed Slott’s books.

Nicole: Well, we have to get you Jim’s.  My name is Nicole.  If you send me an e-mail, Nicole@paytaxeslater.com, I’m going to get one right out to you.

Jim: And then, we’re going to ask you which one you like better.

Nicole: That’s right.  We’ll have you back on.

Jim: They’re different.  You probably have “The Retirement Time Bomb.”  Is that right?

Ed: Yes, and the soft green one, as well.

Jim: Yeah, those are both very good books, and I obviously like mine better.  Ed’s a great storyteller, and he puts things in a way that people can understand.  I tend to be a little bit more quantitative and there’ll be a few more graphs and charts and things like that.  What I really think people should do is to read both.  But, you’ll see which ones you like and I think probably, in terms of looking for a practitioner, somebody who could actually do the work and help you with it, I think that Ed is probably not really geared for that as much. 

Ed: No, I understand that.  Okay, I’ll go back and listen to the program.  I thank you very much.

Nicole: Thank you.

Ed: And I will listen intently and get in touch with you.

Jim: Very good, thanks for calling, Ed.

Ed: Thanks again.  Appreciate it.  Bye now.

Nicole: Good night.  Well, Ed seems like a lot of fun.  You know what, Jim?  Before we get back into it, I know we have ten minutes left.  This is flying.  I promised our friend Bob from Penn Hills, I have to read his question; it’s a quick question, though.

Jim:  Okay.

5. Final Q&A: Taxation on Roth IRA Conversions

Nicole: Okay.  Both he and his wife have an IRA.  Here’s his question: if we each make a Roth conversion this year, can I pay the full tax on one of our conversions and split the tax in two years on the other IRA conversion?

Jim: I like his idea.

Nicole: Creative.

Jim: Yeah.  I would have to say that Bob has what I would call larceny of the heart.  He wants the last drop from the code, which is the absolute right attitude to have.  Let’s say, for discussion’s sake, that Bob wanted to stay in a certain tax bracket, let’s say he wanted to go to the top of the 28% bracket, and let’s simplify and not even talk about the tax increases.  It might be to his advantage to recognize some money in 2010, some in 2011 and some in 2012, and what he’s saying is, since in 2010, if you make a Roth IRA conversion in 2010, you have a choice.  You can either recognize all the income in 2010, so let’s say, you do a $100,000 conversion, you recognize a $100,000 in 2010, or you recognize $50,000 in 2011 and $50,000 in 2012, and I think what Bob wants to do is go 33, 33, 33, or he wants to mix and match however he wants.  Could he do that?  Good try, Bob, but the answer is no.  It’s either all 2010, or half 2011 and half 2012.  Now, normally, the rule of thumb is don’t pay taxes now, pay taxes later.  In fact, Jane Bryant Quinn says that that’s my mantra, like I meditate with that, but here, I go against that rule because for at least a lot of people in the 25% bracket and higher, they’re going to be in a higher tax bracket in 2011 and 2012.  So, the quantitative projections that we have run, we are indicating that it usually makes sense to recognize the income in 2010. 

Nicole: Okay, thank you.  Alrighty, there’s Bob’s question.  Thank you for answering that.  I think, why don’t we take a quick break?  Alrighty, we’ll take a quick break.  We’ll be right back.  You’re listening to the Lange Money Hour, Where Smart Money Talks.


6. Final Thoughts

Nicole: Thanks, we’re back.  You’re listening to the Lange Money Hour, and we only have a few minutes left here, Jim.  Let’s go back to what we were talking about originally.  Before we took our callers, I left with the question of what I should do.  I’m in my thirties, obviously, I’m still working, I work for you.  Let’s just talk about, how does that change for people on the cusp of retirement?  A little older?

Jim: Alright.  There, I’m going to go against my rule of thumb, that I like Roth 401(k)s better than traditional 401(k)s, because let’s say, for discussion’s sake, you’re in your sixties and you have, maybe, just two or three years more to work, and then, after you retire, you’re not going to have income from your wages, you’re not going to have a job, and you’re not going to have income from your minimum required distribution.  So, it’s very easy to predict that you’re going to be in a lower tax bracket later.  So, what I would rather you do is to do the traditional 401(k) now while you’re in your high tax bracket.  Then, when you retire, look to do a Roth IRA conversion, and then, presumably, have at least a bunch of low income tax years before you hit seventy and a half, in which case, your income is going to go up, because you’ll certainly want to take Social Security by then and you’ll also have your minimum required distribution.  Alright?  Now, for retirees, then it’s another interesting issue.  Now, again, if you’re a retiree and you have the luxury of having a low income because you have not yet hit seventy and a half, that’s probably a great time to make a Roth IRA conversion.  2010, by the way, is the best year.  First, it’s the first year if your income is more than $100,000, and the second thing is it is a great year because income tax rates are lower now than they will be in future years.  So, a lot of times for a lot of the retirees that we’re seeing, a series of conversions over time makes a lot of sense.  By the way, if you are about to retire or you’re retiring, you should be really careful about two things that you have to check on, and by the way, I stress this when I talk to financial advisors.  You have to look for two things, and don’t let these fall into the cracks.  You have to look for number one, after-tax dollars inside your IRA.  They get treated differently, and we have some, well, I don’t want to use the word tricks, but we have some tax planning techniques that, in certain circumstances, we can convert those after-tax dollars inside an IRA to a Roth IRA without having to pay the tax.  The other thing you have to look for is something called NUA, which is Net Unrealized Appreciation, which, to make a long story short, in many cases, we can treat as capital gains income as opposed to ordinary income that would be in a regular 401(k). 

Nicole:  Alrighty, and on that note, Jim, I think we’re going to have to close the show.  Everybody out there, thank you for listening to us and participating tonight.  As Ed from Florida said, he gave a great commercial, you can get these shows, you can get these archives on retiresecure.com.  We’re going to be putting up the transcripts very shortly.  We’ll see you back here in two weeks.  We’ll be live in two weeks.  John Bledsoe will be joining us, the author of “The Gospel of Roth,” and if you want to check out his book, you can jump on Amazon.com.  That’s all for us today, and we’ll see you here in two weeks.  We’ll be live again, so certainly feel free to call in.  You’ve been listening to the Lange Money Hour, where smart money talks.  Good night.   

 

James Lange, CPA/Attorney

Jim is a nationally-recognized tax, retirement and estate planning attorney with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, will and trust preparation and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

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