Jim Lange's Top Lessons for Planning a Secure Retirement

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

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Jim Lange's Top Lessons for Planning a Secure Retirement
Jim Lange, CPA/Attorney
Special Guest: Barry Picker, CPA/PFS, CFP
Episode 12

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 Differences Between Traditional and Roth IRAs
  2. 2010: All Taxpayers Can Now Make A Roth IRA Conversion Regardless of Income
  3. Paying the Tax on a Roth IRA Conversion
  4. Required Minimum Distributions and IRAs
  5. Barry Picker's Own Roth IRA Conversion Story
  6. Jim Lange’s Own Roth IRA Conversion Story
  7. Potential Downsides of Roth IRA Conversions
  8. Recharacterizing a 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.

Beth Bershok: We are talking smart money and thank you so much for joining us this evening, I’m Beth Bershok along with Jim Lange, CPA, attorney, best selling author of the book Retire Secure! Pay Taxes Later, that’s available from Wiley. And we have another IRA expert tonight, Barry Picker who is a certified public accountant. He also happens to have the personal financial specialist designation from the AICPA, Certified Financial Planner and I should point out that CPA magazine in their April-May edition of this year named Barry as one of the top 40 tax advocates to know during a recession. So thank you so much for joining us tonight Barry.

Barry Picker: Thank you.

Beth Bershok: And Jim wanted to add something to your long list of accomplishments.

Jim Lange: Well, since this show was mainly going to concentrate on Roth IRAs and Roth IRA conversions I wanted one of who I considered the top if not the top IRA expert in the country. And for the last more than 10 years I have been reading Barry and Barry’s article at probably the most famous Roth IRA site which is RothIRA.com and Barry just cranks out article after article and they’re all excellent and they have such good content and I’ve just been reading him and admiring his work for years and I was very happy when he agreed to be on our show tonight, so I think we’re really in for a treat. You’re going to be hearing advice from people who were in the Roth IRA game very early and also has some quantitave skills to add to the conceptual skills.


1. The Differences Between Traditional and Roth IRAs

Beth Bershok: Well, Barry, and Jim I think we should start from the beginning because we’re going to be talking about Roth IRAs, Roth IRA conversions, and there is a big tax law change coming up in 2010; so this is August, we’re fast approaching that and we’re getting ready for Roth IRA conversions in 2010. Let’s start with first of all what is a Roth IRA? This term has been around for years, but I know that it’s been off of the radar for some people so, Barry, can you please explain the difference first between a traditional IRA and a Roth IRA.

Barry Picker: Well, the main difference is that with a Roth IRA if one takes a qualified distribution it is free of income tax, and that is really the main difference. Now with a traditional IRA for many people they can deduct the contribution that goes in initially to the traditional IRA whereas with a Roth IRA there never is an income tax deduction.

Beth Bershok: And Jim do you want to add anything to that as the differences between the traditional and the Roth?

Jim Lange: I think Barry has it. With a traditional IRA and I’ll even expand it with a traditional 401(k), 403(b), all these types of retirement plans. You get an income tax deduction going in, the money grows income tax deferred but then when you take the money out you have to pay tax. With the Roth IRA you don’t get an income tax deduction going in but when you eventually make withdrawals or even your heirs make withdrawals the withdrawals are income tax free including the growth. So with a Roth IRA what you’re in effect doing is you’re paying the tax upfront and you’re reaping the harvest tax free. And with a traditional IRA you get a deduction up front but you have to pay tax on the harvest.

Beth Bershok: Now we should explain that up until this point there has been an income limitation for Roth IRAs and what is that amount? Do you want to handle that Jim?


2. 2010: All Taxpayers Can Now Make a Roth IRA Conversion Regardless of Income

Jim Lange: Okay, well, the income limitation is I believe $166,000 for married tax payers. But I think what you’re referring to and the big change in 2010 that we’re going to probably be concentrating on even more during this show is that in order to make a Roth IRA conversion where you are taking your existing IRA or your existing retirement plan, paying income taxes on it upfront, and then converting it to a Roth IRA, the big change in 2010 and why income is so important is up until now if you had modified adjusted gross income of $100,000 or more you were not allowed to make a Roth IRA conversion. Starting the year 2010 that income limitation is going to go away so all of a sudden all of these people who have for years been with income of greater than $100,000 who were never able to get into the Roth IRA conversion world are now eligible for the Roth IRA conversion world, and I actually think there’s going to be a tax free revolution where we can start making some tax free dynasties.

Beth Bershok: That is what Jim always calls it too Barry he calls it tax free dynasties.

Jim Lange: I don’t know if he shares some of my excitement about 2010 coming, Barry, so maybe I’ll let you give your opinion on what’s coming in 2010. I know you have a good article on your website about that.

Barry Picker:Well I think it’s very exciting for the reasons you mentioned and basically that the Roth IRAs have really not been available I would say to the people who could use it most. And that’s going to change next year and as a result, as you said, people who’s income was over $100,000 who could not move their IRA money into a Roth will now be able to do so and that also includes people who for whatever reason were married but filing separate returns that were under the law no matter what their income was were precluded from doing a Roth IRA conversion and that limitation also goes away. So there will not be anybody who will not be able to do a Roth IRA conversion starting in 2010.

Beth Bershok: So getting ready for 2010, have you been seeing in your practice Barry a lot of people coming to you getting ready, making plans to do a conversion in 2010 now?

Barry Picker: Well what we have been advocating since this law came out; the provision has actually been in the code for a number of years saying that starting in 2010. So we were suggesting to people that they fund their traditional IRA, in many cases with non-deductable contributions so that they would have that pool of money available starting in 2010 in order to move it into the Roth IRA. Now for these people the plan was, and obviously sometimes the plan and the reality don’t always match, the plan was that by making non-deductable IRA contributions when they would do the Roth conversion in 2010 they would only be taxed on the gross from the contributions. With the economy being what it is many of those people will not have growth but they will still be able to move the money into the Roth IRA.

Beth Bershok: And so for some of your clients you’ve been planning this for years.

Barry Picker: That’s correct.

Beth Bershok: Same thing for you Jim because Jim has actually been in the forefront of this Roth IRA for over a decade, actually.

Jim Lange: Yeah, I’m actually a fan also of the non-deductable IRA you don’t see a lot of people advocating that. I think one of the reasons why Barry and I both like it is because partly of our background, we are not from a sales or a financial product background we’re actually CPAs who actually run numbers and quantify these things and that’s frankly the type of guests that I wanted to talk about Roth IRAs. I like the idea of doing a non-deductable IRA but I guess in the big scheme of things the people that have IRAs or even deductable or non-deductable IRAs from what used to be the $2000 contribution now $5,000 or $6,000 contribution. In my mind yeah that’s very nice but I’m very interested in the big money. I’m interested in the people who have $100,000 $200,000 $1 million even more than $1 million dollars in their IRA and even 401(k) because I think that for people who have substantial IRAs that that’s going to really just be a huge paradigm shift and I think so many advisors again particularly people who are not as well versed in the tax code and don’t really understand the numbers behind it are not really talking about the power that the Roth IRA conversion is going to have for wealthy people particularly people who have big IRAs and have the money to pay the tax on the Roth IRA conversion from outside the IRA.


3. Paying the Tax on a Roth IRA Conversion

Beth Bershok: Now you just said pay the tax outside of the IRA, which is a big deal when we’re talking about Roth IRA conversions because Barry what would you say if somebody said, you know Barry, I’m interested in doing this Roth IRA conversion when we get to 2010 but I don’t have the money to pay the taxes, I’m going to take it out of one of my retirement plans, what would you advise?

Barry Picker: Well I’ve seen different scenarios and run numbers for that situation and obviously every situation is different but it still might pay for people if they’re lets say in their early 60s so that they don’t have to deal with what could be an additional tax penalty, do not plan on using the money in retirement so that they get the extra benefit of the compounding because Roth IRAs don’t have required minimum distributions at 70.5.  In some of these situations it works out that even if they have to tap into retirement money to pay the tax, in the long run it still comes out better.

Beth Bershok: Would you consider their age when you’re talking about that - is that a key factor?

Barry Picker: Age is a key factor yes.

Jim Lange: And I love what Barry just said because he said that he ran the numbers and this is so important in this Roth IRA world to actually run the numbers to determine what makes sense. And Barry’s absolutely right it’s going to depend on the circumstances. You see the old rule of thumb is if you don’t have the money to pay the tax on the conversion from outside the IRA don’t do it, but when Barry has run numbers and certain circumstances, the one he mentioned about people in their 60s, one of the advantages is that you’re not going to have a minimum required distribution. Another advantage is that you are getting money out of your estate, so one of the old strategies was to make a Roth IRA, I’m sorry was to make an IRA withdrawal before you die to reduce your estate that’s another benefit of doing a Roth IRA conversion even if you don’t have the money to pay the tax. And the other thing that is maybe on people’s minds in the background is will taxes go up in the future? And if you are paying income taxes at today’s rate to save taxes at tomorrow’s rates that would be another time when it would be useful. On the other hand I like the running numbers approach and I like Barry’s answer, in general it’s much better to make a Roth IRA conversion and pay the taxes from money outside of the IRA. And all of the numbers and I suspect Barry’s run the same numbers and maybe I’ll ask you about that Barry, that I’ve run indicate that people that get the biggest bang for their buck are the people who have money from outside the IRA.

Barry Picker: Oh there’s no question Jim because when you can pay the tax from money that’s outside the IRA that’s the equivalent in my way of thinking of making an additional contribution into the IRA. The reason why I say that is because for somebody who has let’s say $1 million in a traditional IRA if you figure that person is in the 40% income tax bracket that’s really the equivalent of $600,000 in after tax money. If you can convert that to a Roth IRA and pay the $400,000 tax from other money its as if you put that $400,000 into the IRA because now you have a million dollar account that’s worth a million dollars after taxes.

Jim Lange: I’ve never heard it put that way, but I love that, Barry, I really do. I don’t know if listeners really understand the power of what you’ve just said and I’ve never articulated it that way, but I love that and making an extra multi-hundred thousand dollar IRA contribution is just a fabulous thing.

Beth Bershok: And it goes hand in hand with something Jim you just said a minute ago which was if you think tax rates are going up and you can do the conversion at these tax rates, and I think if we got listeners everyone listening tonight to raise your hand if you think tax rates are going to go up I think most hands are going to fly up. So you can get in on your current tax rate and take a gamble that the rates are going to go up and it would be even more beneficial for you. There’s something I want to point out real quick because we’re talking about 2010 and that is we get a lot of questions at the office which is is 2010 this is opening up for all tax payers regardless of income in 2010 Roth IRA conversions, is it only 2010? And the answer is no right now it’s 2010 on. Now do either one of you think that could ever change?

Barry Picker: Well, we’re talking about tax law and you know the one thing that’s constant in tax law is change and so yes it can change. To be honest I’m kind of surprised that they didn’t change it ahead of time because of the way that this was set up and the reason why it was set up, which we don’t need to get into. So I’m very happy that we’re now in the second half of 2009 and there’s no movement in congress to change this before it goes into effect. So it’s clear to me that it will go into effect but I was not always sure of that.

Jim Lange: And that is such a really huge paradigm shift particularly for wealthy tax payers who’s income is more than $100,000. They’re literally going to be able to create a tax free dynasty with Roth IRA conversions and getting money to grow income tax free for the rest of their lives, their spouse’s lives, if they then leave money to their children for their children’s lives, and possibly even grandchildren’s lives.

Beth Bershok: You know when we talk about that Jim when you say they can create a tax free dynasty part of it is because there is no minimum required distribution with the Roth.


4. Required Minimum Distributions and Roth IRAs

Jim Lange: Right there’s no minimum required distribution which is terrific for the tax payer. In fact unlike a lot of long term estate planning ideas, so for example one response to if you think that the tax rates are going up and I think Ed Slot is a great advocate of this response and I think that he’s absolutely right is, he says that you should buy some life insurance and that way you’ll create a pool of income tax free money and maybe the beneficiary can be your spouse or your kids or your grandkids, or I actually prefer second to die in many situations. But the Roth IRA conversion while it is fabulous for your children and grandchildren, it’s also good for you. And I’ve run some numbers that indicate that using pretty reasonable assumptions that if you yourself make a Roth IRA conversion of say $100,000 that you not your heirs and not your kids and your grandkids, but you will be between $40,000 or 50,000 better off just 20 years after you make the conversion. And your children can literally be $800,000 or 900,000 or more better off and your grandchildren would be better off in the millions and millions even taking into consideration the money that you have given up. Barry I don’t know if you apply, I actually know you have because I’ve read some of your work but maybe you could expand on some of the number running that you’ve done to quantify some of the benefits of Roth IRA conversions if that’s something you’re looking for, for your wealthier clients.

Barry Picker: Well we’ve up to now been talking actually about people who are let’s call it slightly older, but even for younger people, people in their 40s who will be using this money in retirement for themselves, it’s a tremendous advantage to do the Roth conversion. And basically you just have to deal with the fact that if you’re even going to be using the money you don’t have the minimum distributions on the traditional IRA, and so they get to leave more money in the account for themselves as they go through retirement and it just seems to workout much better for them.  In some cases, it just gives them more spendable money because they don’t have to worry about a tax liability on the money that they do take out.

Beth Bershok: Barry did you get the same basic numbers when you ran them to the ones Jim just went through?

Jim Lange: Well to be fair I’d have to state a whole bunch of assumptions.

Beth Bershok: Oh you’d have to go through all of the assumptions.

Jim Lange: Yeah that would just bore people to tears.

Beth Bershok: Yeah let’s not go there.

Barry Picker: I would like to mention something because I think Jim mentioned this earlier about tax deferral and income tax rates going up. We had run numbers over the years and it came out that if somebody let’s say would make a traditional IRA contribution and then would be in a higher tax bracket when they took the money out, the power of tax deferral is so great that the tax payer would still be much better off even if they were pulling money out at a higher tax rate than the benefit when they put it in. And when you realize that and the power of tax deferral and now we’re talking about not tax deferral but tax free, and how much more powerful that is, then you see the benefit of doing the Roth IRA even if you’re not getting you know on annual contributions a tax deduction which I will say unfortunately has been a sticking point for many people over the years over the last 10 to 11 years that we’ve had Roth IRAs, and people who have not taken advantage of it who could have because they were just so locked into the thought of a tax deduction.

Beth Bershok: Actually we’re going to get into some of those what we would call maybe the downsize or some of the controversies about Roth IRAs in just a minute. We are going to take a quick break. It is the Lange Money Hour: Where Smart Money Talks.

Beth Bershok: We are talking smart money tonight and it’s about Roth IRAs and Roth IRA conversions. I’m Beth Bershok and Jim Lange, CPA, attorney, and author of Retire Secure!. Jim seriously you have been at the forefront of Roth IRAs since 1998. I want to point out this is really impressive, you wrote the first major peer reviewed article about Roth IRAs in 1998, it was for the Tax Advisor. And peer reviewed by CPAs those guys are pretty picky we know. So he wrote the first peer reviewed article, he’s been talking about Roth IRAs and Roth IRA conversions ever since, and we talk about Roth IRAs and conversions always on the Lange Money Hour, but we’ve never done an entire show on it. So we wanted to take it really in depth today because we’re getting close to the tax law change in 2010 and when we said we need a guest for this show, Jim said we have to get Barry Picker who is a CPA, an IRA expert.  By the way CPA with the personal financial specialist designation from the AICPA. So we were talking about Barry 2010 and the tax law change what’s happening there is that there are no income restrictions, you can do a Roth conversion. If you have been unable to contribute to a Roth IRA because of the income limitations in 2010 the income limitations are off and you can do a Roth IRA conversion. So the million dollar question is what are you planning to do in 2010?


5. Barry Picker's Own Roth IRA Conversion Story

Barry Picker: I will take my IRA and I will convert it into a Roth IRA.

Beth Bershok: There you go. Now are you going to do a big conversion all at once or a series of small ones?

Barry Picker: No I will convert everything I have and the reason for that because we have not mentioned this but there’s a little sweetener in the law I’ll call it that, that says you don’t have to pay the tax with your 2010 tax return. So if you do a conversion in 2010 we said that it becomes taxable income, but the law says that if you do the conversion in 2010, you have the option paying tax on half of the conversion with your 2011 tax return and the second half with your 2012 income tax return.

Beth Bershok: So that’s sort of like an added bonus for 2010.

Barry Picker: Yes it is.

Beth Bershok: And have you been preparing in some way to do this conversion? I know you’ve been advising clients but have you yourself been doing something to prepare for 2010?

Barry Picker: Well basically in my situation I was going to move my IRA money into my company plan and when this provision came out and said that we can convert it directly to a Roth IRA in 2010 then I just held the money in the IRA and did not put it into the company plan.

Jim Lange: You mentioned a company plan and I know that you’re not part of a huge multi-national CPA firm but rather a partner in a smaller firm where you might get some say in what kind of a retirement plan you have. Are you an advocate of the Roth 401(k) plans for people who are still working and if so have you taken advantage of the Roth 401(k) provisions in the retirement plan that you have at work?

Barry Picker: The simple answer to both questions is yes and yes. I am an advocate of it for the same reason we have been speaking about with Roth IRAs and that is it is tax-free growth. And I do as you mentioned I’m in a smaller accounting firm and I have a very large say in how we set these things up, and when the Roth 401(k)s came into effect we put that into our plan and I do participate and contribute to that.

Jim Lange: And it’s probably also interesting to note for listeners that you can be contributing to a Roth 401(k) regardless of your income even now and I assume, Barry, let’s assume for discussions sake, I don’t want to ask you this, but let’s assume for discussions sake that your income is too high for a Roth IRA contribution, you’ve still been able to put money into a Roth 401(k).

Barry Picker: That’s correct Jim and that’s the beauty of the Roth 401(k) is that anybody who is working for a company whose 401(k) has the Roth component can contribute to that regardless of their income and will then be setting themselves up for this tax free growth which they can take out later.

Beth Bershok: Well I think it’s only fair Barry you told what you’re doing in 2010, we should get Jim to chime in with his own Roth story.


6. Jim Lange's Own Roth IRA Conversion Story

Jim Lange: Well, mine’s a little bit different because I actually had an opportunity in 1998 our office suffered a fire, if those of you who were with me back then or knew me you knew that my office was above a pizza shop.

Beth Bershok: Maybe not the best idea there.

Jim Lange: I’d say that that’s the worst idea because the pizza shop had an electrical fire and Barry you could picture this, with about 400 tax returns still to be done on February 16th our office suffered a fire and we had to move the next day and to make a long story short I didn’t get the insurance proceeds until the following year. So all of a sudden I had an opportunity where my income was below $100,000. Now at the time I was 42 years old and between us my wife and I had $250,000 in traditional IRAs and I was very interested in Roth IRAs then and my wife actually has a master’s degree in electrical engineering from CMU and she’s quite quantitave herself and we ran numbers and determined the appropriate thing to do was make a Roth IRA conversion of the entire $250,000. So we bit the bullet, we made a Roth IRA conversion of $250,000 and originally the plan was well you know when we get in our 60s, 70s and older we’ll have this really nice chunk of money that will have grown income tax free and we’ll be able to draw on that later. As good fortune would have it’s very possible even likely that we might not need that money, that that money can continue to grow in which case that money might end up going to our daughter who at the time was I believe 3 years old. And it is also possible through second to die life insurance and other things that we will likely leave our daughter that our daughter might not need it and that might end up going to our grandchildren. Now this is the grandchildren of at the time when we only had a 3 year old daughter. So we might get 80 or even a 100 years of income tax free growth out of this and I think that literally our family will be enriched by millions and millions of dollars more than if we didn’t do this. Now since then, like Barry, I have been contributing the maximum in a Roth 401(k).

Beth Bershok: Now you two talk about creating these dynasties and like you said your grandchildren may be able to get his money eventually. How long can that go on?

Jim Lange: It can go on for the life of somebody who was born at my death.

Beth Bershok: Somebody who was born at my death.

Jim Lange: Before I die. If I have grandchildren or even great-grandchildren, that’s not likely, but even just say grandchildren while I’m alive.

Beth Bershok: That’s where it ends.

Jim Lange: And then I die, they can have the Roth IRA for their life expectancy.

Beth Bershok: Now again they get this all tax-free so whatever is in that Roth IRA that’s what they get.

Barry Picker: Well, what happens you know we’re talking about that individuals don’t have mandatory distributions, that does not extend to the beneficiary of an inherited account.

Beth Bershok: Oh, okay, this is a good point so explain that.

Barry Picker: So what Jim is saying is that he will name is grandchild or possibly a trust set up properly so the grandchild as the beneficiary and then it would have to come out over that beneficiary’s life expectancy but if that beneficiary is very young we’re talking about something close to 80 years and you know normal growth says that if you have 80 years to pull this money out it’s probably going to be growing rather than diminishing for close to the first 70 of those 80 years I would think. So whatever is there at the time of the inheritance is going to continue to grow even after death. So it could be multi-millions of dollars.

Jim Lange:  Right and to be even more specific I’ll even tell you what is in my will and what will be in my will after we have grandchildren and it’s something that I’m a big advocate of and it’s something that’s a very flexible approach that I call Lange’s Cascading Beneficiary program. Where the primary beneficiary of my IRA and for that matter the rest of my money is my wife and I am her beneficiary. The second beneficiary is the B trust sometimes known as the unified credit trust. The third beneficiary is our daughter and eventually the forth beneficiary will be any grandchildren that we have. So there will be in effect four levels of beneficiary, my wife, the B trust, children, and grandchildren, and it will be up to the survivor to decide who gets what. So for example I die and my wife says hey gee I don’t need this Roth IRA it can go to our daughter or even our grand-daughter that’s where it would go. If my wife says hey guess what for all your great intentions it turns out I actually need it myself, she can keep it or it can be split where she can keep some and some will go to a child and some will go to a grandchild. For me one of the beauties of Roth IRAs and Roth IRA conversions is even know it is very good for the people making it it’s great for the heirs but I live to see the survivors have some control of who gets the money and I like to see it set up properly. So I personally would be reluctant to name a grandchild as the primary beneficiary of a large IRA or a large Roth IRA, but I do like the idea of the possibility of it going to either the spouse or the B trust or the children or the grandchildren.

Beth Bershok: So in Jim’s case you’re basically using this as a tool, as an estate planning tool

Jim Lange: Partly as an estate planning tool but also like I said before I myself and my wife will be much better off because we will literally be hundreds of thousands of dollars better off because we did that in 1998.

Beth Bershok: Alright Barry and Jim we’ve been talking about the benefits of Roth IRAs here for the past 40 minutes or so. I think it’s only fair that we look at some downsides or some potential downsides.


7. Potential Downsides to Roth IRA Conversions

Jim Lange: By the way I should mention that Barry is literally an expert on this. He has more articles on re-characterizations then anybody I know so you might be talking to the country’s preeminent expert on what happens if like in 2008 our investments went down, so I think I should just let Barry talk about that one.

Beth Bershok: Let’s talk about that first, which is a potential downside? Let’s say you make a conversion and then your investment goes way down. In the meantime you’ve paid the taxes on it, you paid them upfront, so now you’re really sorry you did this what can you do?

Barry Picker: Well what Jim mentioned is re-characterization basically is to undo the conversion. There is a time limit for doing this and the time limit is basically October 15th of the following year. So for anybody who does a conversion in 2010 they would have until October 15th 2011 to decide that this was a mistake or that there was a tremendous downturn in the economy and the value of the assets and that they don’t want to pay income tax on what is now phantom value. There are a few things that we suggest for people one thing we suggest is that for people who are going to be doing a series of conversions and we do advocate that in a lot of cases not converting everything all at one time, but we have them segregate each conversion so that if there’s a downturn in the value of that they can do a re-characterization which is a lot easier to do if you have a segregated account. Another thing that people can do is that they can do a series of conversions in the same year let’s say by asset class and put those into separate Roth IRAs so that you now have a series of Roth IRA accounts running and some of them could be winners and some of them could be losers and you basically keep the winners and re-characterize or undo the losers. This way of course you now have some benefit of hindsight.

Jim Lange: I’m smiling right now because I actually wrote an article on that years ago and I thought it was my own little pet-idea but apparently not. And actually it makes so much sense that it’s a good idea. The other thing that I will throw out on that area is I’m sometimes an advocate of doing the Roth IRA conversion early in the year. So let’s say for discussions sake and we’ll keep it real simple, you have two you segregate your IRA into two accounts and let’s again to keep it simple you have two $100,000 accounts. And you do a $100,000 conversion early in the year and then later in the year it looks like it’s not working out very well the conversion is way down in value, you can re-characterize that conversion and then make a Roth IRA conversion of the other account. So let’s say that the one account is in bonds and it more or less broke even and the other account was in stocks and it went down 40%. So the $100,000 Roth IRA is now $60,000 after the market goes down, you re-characterize it which means it’s as if you had done nothing, and then you make a Roth IRA conversion of the other account. So in effect your Roth IRA value is starting at $100,000 by that conversion and re-characterization as opposed to just making the conversion and not doing the re-characterization and subsequent conversion.

Barry Picker: I would just add to that and that’s what I advocate also except that when you do the second conversion I would do the second conversion into again a new separate brand new Roth IRA before I even re-characterize the first one. That’s just in case again because you have until October 15th to do the re-characterization. Of course the conversion deadline is December 31st of the year. But now again the account that went down maybe that was just a temporary blip in the market and maybe that comes back and again this way you have more time to make that decision. So my feeling is you know I agree with you 100% about segregating into in your case you were talking about your example two accounts but I would just do the second conversion but I would wait to do the first re-characterization.

Jim Lange: Do you have mechanical problems in that, I would imagine you’ve been recommending conversions and re-characterizations in your practice for years, and since you’re the CPA you’re not only doing the advice you also have to live with the consequences. Are you getting lots of notices from IRS saying hey where’s the tax on the money and then you have to write letters explaining that you re-characterized or have the mechanics gone relatively smoothly or a little bit of both?

Barry Picker: We’ve basically had it gone pretty smoothly I don’t remember too many letters from the IRS but I gather from your question that you have.


8. Recharacterizing a Roth IRA Conversion

Jim Lange: Well we’ve had a few. On the other hand we have not it hasn’t been a timely or difficult process you know we’ve just written a letter to the IRS saying we’ve re-characterized and here’s the appropriate paperwork. But the ability to re-characterize to me is critical because it is an obvious answer to the objection of what if the market goes down and I think we’ve been emphasizing 2010 but in 2008 a lot of people were making Roth IRA conversions and then the market went down you know maybe 30-40% and they’re sitting here now in August 2009 and what they probably should be thinking about is oh my goodness I only have until October 15 to re-characterize the Roth IRA conversions I made in 2008. So if you made a conversion in 2008 I think that you should be thinking seriously of re-characterizing and using the re-characterization rules as further fuel for the benefits and the reduction of detriments of making a Roth IRA conversion.

Beth Bershok: And again that deadline is October 15th so we only have a couple of months for that. I want to Jim and Barry I want to bring up one of the other big objections to Roth IRAs and see what you two have to say about this. People will say well you know guys that’s just great we’re going to pay the taxes upfront and then we can take it out tax free, but what if down the road Congress changes their mind and they decide after all to tax Roth IRAs, do either one of you think that could actually happen? What would you tell a client who said that to you?

Barry Picker: I’ve heard that question so many times and I’m going to guess that Jim has also. Obviously we can’t know what the future is going to bring what I tell people is first of all with tax law I can only deal with what I know now. It’s difficult enough knowing what’s in the tax law today without having to worry about planning now for what might be in the tax law later. First of all I tell people that once there is that I will pay tax now and then I will pay tax on the same money later.

Beth Bershok: Right which would be double tax.

Barry Picker: And I tell people that that itself cannot happen, that would just be I maintain totally illegal to tax it a second time. What could conceivably happen is a number of things not that I think they will but I think that let’s call it the most likely scenario, and of course this is just my opinion, it’s that if Congress were to look at this and decide that they don’t like it anymore is that one of two things. One is that they will basically freeze the accounts and say okay all of you people who have your Roth IRAs you have them, you have the deal but there’s no new accounts, we will not allow the creation of any new accounts.

Jim Lange: In other words people who are already in the system will be grandfathered.

Barry Picker: Yes. The other possibility I think less likely is that they will basically freeze them as of a certain date and tax the growth beyond that date, but again would grandfather existing values. I do not think that they will go back and say that we decided that you know way back when  that old year of 2010 when you converted $1 million and now it’s worth $3 million that we’re going to tax that $2 million. I think that that you know I view it in my mind as a violation of in implied contract which says, the contract says you give us the money now and we won’t bother you with this later. So that’s my opinion that they will not do it.

Beth Bershok: Because this is currently part of the tax code?

Barry Picker: Yes.

Beth Bershok: Okay we’re going to take a quick break. We’re talking about Roth IRAs and Roth IRA conversions with Jim Lange and Barry Picker. It is the Lange Money Hour: Where Smart Money Talks.

Beth Bershok: Talking more smart money it is the Lange Money Hour: Where Smart Money Talks. We’re talking about Roth IRAs and Roth IRA conversions and a quick note, we have another workshop coming up and if you’re really interested in getting more details about this the workshop is called Two New Tax Laws, Create Shocking Opportunities for Wealth Preservation. We go through a lot of this information in depth in the workshop. It’s coming up Saturday August 29th at the Pittsburgh Golf Club in Squirrel Hill. And we have two different times, 9:30-11:30 and 1:00-3:00 in the afternoon. So if you’d like to attend one of those events here’s the toll free number it’s 1800-748-1571. Make sure you tell us which of those events you want to go to, 1800-748-1571. You can RSVP and again that’s coming up on August 29th. By the way you can also get details on our website which is retiresecure.com. Now we have as a guest IRA expert Barry Picker with us today and we were just dealing with one of the big questions about Roth IRAs and Roth IRA conversions and I know both of you have heard this a lot, I want Jim’s response on this one which is Jim what do you say when people say well I’m a little nervous about doing a Roth or a Roth conversion because I have to pay the taxes up front how do I know down the road Congress isn’t going to say guess what we’ve changed our minds you have to pay more taxes.

Jim Lange: Them rascals in Washington they promised we’d never pay tax on social security and now we’re paying tax on social security, how do we know that they’re not going to do the exact same thing with Roth IRAs and Roth IRA conversions? And it’s a good point and here’s the way I would address it - I’m going to put my attorney hat on for a minute. It is part of the Internal Revenue Code that the Roth IRA and the growth on the Roth IRA conversion will never be subject to income tax. It was never a part of the Internal Revenue Code that social security would be not subject to income tax. The legal word for it is dicta, which means it’s non-legally enforceable language. Barry mentioned implied contract. I would just say as part of the internal revenue code and to change it retroactively would be in legal parlance an expo facto or after the fact, it’s a violation of due process, a violation of our constitution and I don’t see it happening. The one potential fear is if they eliminate the income tax or replace it with some kind of sales or value added tax, theoretically you could have paid the tax on the IRA doing the Roth IRA conversion and not have a benefit. On the other hand I think if you do a relative weighing of what the odds of eliminating the income tax on the trillions and trillions of dollars in the IRA system right now versus which I consider relatively remote, versus the more likely event of an increase in income tax in which case the Roth IRA conversion is going to be even stronger, I would say that in general I would tip the scales saying that changes in the future tax laws will be favorable to people making Roth IRA conversions.

Beth Bershok: One thing to consider when we’re talking about these potential downsides of a Roth IRA, I doubt that either one of you would say to a client put every cent you have into a Roth IRA.

Jim Lange: That’s a good question I want to see what Barry says about that.

Barry Picker: Well when you say every cent you have we will do that for some clients but if they have large accounts we won’t necessarily do that in one shot. Depending again on their situation and everybody’s situation is going to be different, we can have them do a conversion in 2010 that they will pay tax on in 2011, 2012, and you can opt out from that so that’s another thing that we will have to keep in mind as we go through the years. And then after they do a conversion 2010 we may wait a few years and then when we get to 2013 and beyond continue doing a series of conversions. But I would have no problem with converting all of the IRA money into a Roth.

Beth Bershok: And Jim how about you?

Jim Lange: Well, first I love that Barry is doing gradual conversions that is not all at once and the mathematical benefit of that is that you might stay in a lower tax bracket. So for example if you’re thinking of converting $1 million if you do just even keeping it simple $100,000 a year for 10 years you could end up doing with a smaller tax bracket each time you do the conversion. So the tax brackets are important, also I think that helps with the psychological shock of not having to write as big a check so that’s a real consideration. The one exception I might make to doing, and usually over time what most of our clients, particularly people who have $1 million plus traditional IRAs usually Roth IRA conversions are not going to be the major impetus of their plan, it’s just going to be one supplement to a many multi-faceted financial plan. One other reason why I might not convert it even if the numbers might indicate it’s best to convert more is I might want to preserve some traditional IRA money for charity. So we have a lot of listeners who have, and I would describe myself in this category, as having mixed intentions that is our primary goal is to provide for our family but we still have some charity in our heart whether it’s a church or a synagogue or an environmental group or whatever it might be. And it might make sense to preserve some of the traditional IRA, leave that money to charity because the charity doesn’t care if they get an IRA or a Roth IRA or after tax dollars they just want the most money. So sometimes I like the idea of the charity getting the IRA, in fact I’m actually doing some talks for charitable organizers and charitable fund raisers and what I’m saying to those groups are well one of the reasons why you might not want to leave a lot money to charity is your kids will get less. Why don’t you do a Roth IRA conversion with part of the money that would substantially increase the value of the money going to your children and that creates some money in your traditional IRA that you can leave to a charity.

Beth Bershok: And we are down to our last couple of minutes here it’s just been amazing we’ve covered so many strategies. A quick reminder that you can get the audio at retiresecure.com in about a week or so but there’s so much more to cover. If you’re considering  a Roth IRA conversion in 2010 obviously I’m assuming both of you would say please go to a financial professional. We do Roth analysis at our office and I’m going to cover that in just a minute. But Barry has a very good article on his website, Barry can you give your website address?

Barry Picker: www.PWACPA.com.

Beth Bershok: And there’s an article on there called Be Ready for Roth Conversions in 2010 that’s very comprehensive and you can take a look at that. Also Barry has something called Barry Picker’s Guide to Retirement Distribution Planning and that is also available on your website. So real quick the address again for that?

Barry Picker: www.PWACPA.com.

Beth Bershok: Hey Barry thank you so much for joining us.

Barry Picker: Thank you for having me.

Beth Bershok: It’s been great information. We again have another workshop coming up on August 29th, Pittsburgh Golf Club, 9:30-11:30 or 1:00-3:00 and you can RSVP at 1-800-748-1571. Jim goes through all of these strategies and something else that’s very great about the workshop you giveaway the book. So we’ve been talking about the book Retire Secure! Pay Taxes Later, if you attend the workshop you get a free copy of this book and you get all of these not just the information that Jim’s been going through tonight but we have it you can actually look at it because we have these great graphs that show you exactly how this works so please plan on attending the workshop it’s 1-800-748-1571. And Jim also wants to make an offer for a financial physical which includes a Roth IRA conversion analysis. Jim I swear I think we have the best analyzer of this situation on our staff, Steve.

Jim Lange: Steve is pretty tough. On the other hand to be fair Barry’s pretty tough too.

Beth Bershok: Both of them.

Jim Lange: So if you’re in New York I’d go to Barry.

Beth Bershok: If you’re in New York yes. Well, we have an offer for Pennsylvania residents and here’s our office number it’s 412-521-2732. And if you call that number tonight and you ask for my extension which is 219 just give me your name and contact information and we will get you hooked up with a free financial physical that doesn’t just include the Roth analysis it also includes I mean Jim likes to look at everything so we have to look at estate planning and your retirement plan and your insurance needs and where your investments are. He will go through this whole analysis in the free financial physical. This is a great chance but it’s just for the first 5 people tonight, Wednesday night and also for the rebroadcast on Sunday. So call the office at 412-521-2732, go to my extension 219, or you can also email which is Beth@paytaxeslater.com and I’ll get back to you and we can arrange that free financial physical. Again our next workshop is August 29th. Get more details on our website which is retiresecure.com. We’ll be back again in two weeks, it’s the Lange Money Hour: Where Smart Money Talks.

 

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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