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

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Legendary Roth IRA Conversion Expert, Bob Keebler
Jim Lange, CPA/Attorney
Special Guest: Bob Keebler, CPA, MST, AEP
Episode 23

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TOPICS COVERED:

  1. Introduction of Jim Lange and Bob Keebler, CPA, MST, AEP
  2. Reasons Why You Should Pay Your Taxes Up Front  
  3. Recharacterizations
  4. After Tax Dollars Inside of a Retirement Plan 
  5. Overcoming 401(k) Limitations for People Who Are Still Working
  6. Estate Tax Repeal

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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. Introduction of Jim Lange and Bob Keebler, CPA, MST, AEP

Nicole: Welcome to the Lange Money Hour, Where Smart Money Talks.  We are talking smart money this evening.  Thank you so much for joining us tonight.  I’m Nicole DeMartino, here with Jim Lange, nationally recognized IRA, 401(k) and Roth IRA conversion expert.  Jim is the author of Retire Secure!, with testimonials from Larry King, Charles Schwab, Jane Bryant Quinn, Ed Slott and sixty other financial professionals.  Jim has been a major player in the Roth IRA arena for thirty years now, and is currently on the national speaking stage talking about this very timely, very hot topic.  Tonight, we’re excited to have special guest Bob Keebler joining us.  Bob is a nationally recognized expert in estate planning and Roth IRA conversions.  Tonight, we have what we consider a legend here in the CPA community.  Bob has been named one of the top one hundred CPAs in America, four out of the six last years, and one of the top tax advisors to know during a recession, both accolades coming from CPA magazine.  Quite impressive.  Furthermore, Bob is the author of over seventy-five articles featured in industry publications, and has written two books, one being The Rebirth of Roth: A CPA’s Guide to Client Care, and his most recent, One Hundred Roth IRA Examples and Flow Charts.  Bob, we are so delighted to have you here this evening.  Welcome, and thanks for joining us.

Jim:  And I actually wanted to add one or two words about Bob because I have just admired him and admired his work so much for the last, I don’t know, probably fifteen years that I can think of, and I love his articles.  They’re so clear, so giving.  He is probably, if he’s not the top IRA expert in the country, he is certainly in the top two or three.  And we’re thrilled to have you.  And the other thing is, he is from one of the few places that is colder and gets more snow than Pittsburgh, which is Green Bay, Wisconsin.  Thank you for being on the show, Bob.

Bob:  Well, it’s great to be here, Jim.

Jim:  Bob, you’re known for two advanced Roth IRA conversion strategies.  Both you and I have actually published articles about these strategies.  I’d like to cover both of them on today’s show, and I know that you are also outspoken on your opinion on a good response to the repeal of the estate tax and the generation skipping tax repeal, and to me, if we do nothing other than those three issues today, I would just be delighted and I think our listeners would be also. 

But the first issue, which I think is very hot right now, and again, I loved some of your writing on it, is the idea o Roth IRA conversions and recharacterization.   We’ll get into the after tax dollars inside IRAs in a little bit, but if you could first maybe start with a, maybe a more basic explanation of why our listeners should pay taxes up front to do a Roth IRA conversion.  Then we’ll get into the recharacterization issues.

2. Why You Should Pay Your Taxes Upfront

Bob:  Well, thank you, Jim.  It’s really gonna vary from taxpayer client to client, but at the end of the day, what you’re trying to do is move dollars from a taxable environment into a non-taxed environment, and many people right now are in a position where they can move money into a Roth IRA without paying a boatload of taxes.  They might be having a bad year in their business, they might have lost carry forwards, they might have excess charitable deductions, maybe they have high basis in their IRA, so something is going on, Jim, that gives them, basically, a tax break when they move from a regular IRA or a Roth IRA.  Now, one important thing to understand, for your listeners to really focus on, when I switch from a regular IRA to a Roth IRA, I do have to pay taxes.  But, maybe I only have to pay at fifteen or even twenty-five percent, now, for people way at the top of the market, older people that have just accumulated quite a bit of wealth in their IRAs, they might be looking at saving a lot of taxes because the upcoming tax rates under the Obama administration’s tax increases.

Jim:  Well, I know that that is a big issue.  In fact, we’re often recommending that people make the Roth IRA conversion recognize the income in 2010, rather than spreading it to 2011 or 2012.  Well, let’s even take a more simple case, and let’s assume, for example, that tax rates are flat, or that you’re the relatively predictable tax rate, and you don’t have a net or operating loss, carry forward, or you don’t have any after tax dollars inside your IRA, and I know that, Bob, you’re one of the few guys who actually sits down and runs numbers, and I’m very impressed with your results.  For the average person, let’s say, in a predictable situation, is a Roth IRA conversion still a good thing to have?

Bob:  For the average person, in a very predictable situation, if you can stay within your tax bracket, in other words, you’re in the middle of the twenty-five percent bracket, you just go to the top of the twenty-five percent bracket, you’re probably gonna be fine.  You won’t hurt yourself.  Now, the other thing we’ve been doing a lot of work with, Jim, is the sad reality that if you’re representing two sixty-five year olds, one of them will probably die five to ten years before the other one, forcing the survivor to be in a single tax rate, and of course, single tax rates are about half as broad as married tax rates, especially kind of in the $50,000-$100,000 range.  So, what we’re dealing with there is, if you can do a conversion, again, if you’re in the middle of the twenty-five percent tax rate, just convert up to the top of the twenty-five, or even to the twenty-eight percent rate, only a three percent increase, you generally can create either a neutral or positive result for your clients.  Now, it’s complicated, but the thing that people have to look at is, do they have outside money to pay the taxes, and will they need the money after seven and a half.  So Jim, for most people without an estate tax problem, the three things to deal with are A. Are my rates gonna be higher?  B. Will I need the money after seventy and a half or can I let it grow tax deferred in the Roth?  Or C. Do I have outside money to pay the taxes?  So, if I have those three things or any of those things going for me, I may be able to come out better.  But they really need to go to someone like you and have them run the numbers so that they know.

Jim:  Well, we’re both in agreement that the tax brackets are really critical, and I’m also glad that you said it’d be okay for a twenty-five percent taxpayer to perhaps go up to the twenty-eight percent bracket, but I think I would agree with you.  I don’t want to have somebody from the fifteen percent bracket make a Roth IRA conversion that’s going to push them into the twenty-five percent bracket.

Bob:  That’s exactly correct.  You can only move a little bit.  You can move from twenty-five to twenty-eight, and from thirty-three to thirty-five, but you can’t move beyond that. 

Jim:  Well, I would agree with that.  And I think that’s kind of a basic talk, although certainly in my workshop, I actually spend a little while on the basics.  But the way I’m thinking right now, Bob, your information, specifically some of your advanced information, is so valuable that I would actually like to get to that and talk about some of the strategies that you have been writing about and the strategies that you explain in your most recent workbook about making Roth IRA conversions and recharacterizing or undoing the Roth IRA conversions.  And I know I wrote an article in 2002 about this, and I think you did too, right around then, if I remember right, and now, recently, the work that I have seen from you, I haven’t seen anything better from anybody, so I thought I would, maybe, ask you to talk about the strategy that you’re using for a series of Roth IRA conversions, and then subsequent recharacterizations or undoing the Roth IRA conversion.

3. Recharaterizations

Bob:  Sure, we’ve done a lot of work on this.  Let me give everyone just a feel for this.  Under the law, if a person takes their IRA and converts in to a Roth IRA, and let’s say they do that today, they will have until October 15th of 2011 to recharacterize, or go back into the regular IRA.  So, Jim, let’s say you converted $25,000 and that fell to $17,000.  Almost undoubtedly, you would recharacterize and you would put that back into the regular IRA.  Okay, so that’s what you do.  Now, why would you do that?  Because you wouldn’t want to pay tax on twenty-five when something is only worth seventeen.  Now on the other hand, if that went from twenty-five to thirty-five, almost no chance you would recharacterize.  You would leave it in the Roth IRA and enjoy all that tax free growth.  Now, the interesting thing here is, the government really doesn’t regulate this decision, and what that means under a particular set of rules or treasury regulations that govern this, if it goes up, I can keep it in the Roth and if it goes down, I can recharacterize.

Jim:  I know.  That’s so beautiful and so favorable.  I was almost afraid they were gonna cut that off retroactively or not allow us to recharacterize, because right now, the law is so favorable for this.  Do you fear future government changes in this area, or do you think even if they do make changes, at least we will get some warning and we’ll be able to respond appropriately?

Bob:  I think we’re probably gonna have changes at some point in time, but I also do think they’ll have to give us some warning.

Jim:  Alright.  So just that everybody understands, let’s just talk about the basic recharacterization.  Using Bob’s number, if you make a $25,000 Roth IRA conversion, and let’s say you do it in March 2010, and now, it’s October 1st, 2011, and that $25,000 conversion, and by the way, it could be $100,000 or $200,000, same idea, is now much lower than it was the day that you converted.  If you do nothing, then you’ll be forced to pay taxes on $25,000 when the Roth is only worth $17,000, and what you’re saying, Bob, is it would be wise to recharacterize, or the simpler word is undo, that conversion.  Is that right?

Bob:  That’s exactly correct.

Jim:  Alright, and then you will be in the position as if you had never done the conversion in the first place.

Bob:  Again, correct.

Jim:  Alright, now you’re not gonna get us our $8,000 loss back, are you?  That’s gone, right?

Bob:  No, we can’t fix that.

Jim:  We can’t fix that.  Alright, well I think that is probably the perfect precursor, and base for the strategy that I’m really looking forward to, but I think that that strategy is going to take a little more time than we have before our break.  So, if it’s okay now, we could do a quick break and then we will come back and then get into some of the deeper recharacterization and conversion strategies.

Nicole:  You’re listening to the Lange Money Hour, Where Smart Money Talks.  We’ll be right back with guest Bob Keebler.

Nicole:  This is Nicole DeMartino.  We’re talking smart money with Jim Lange and Bob Keebler. 

Jim:  Okay Bob, I think we have a good base for talking about recharacterization.  Maybe you could talk about some of the strategies that are specifically on page twenty-four of your workbook, because, the first time that I saw that, I thought that was brilliant, and, by the way, later on, we’ll put in a little plug for that, but that page alone is worth ten times the cost of the book, and I mean that sincerely.  I just thought it was brilliant. 

Bob:  I wish I could take credit for it, and actually, a gentleman named John Bledsoe thought that up, and I probably refined it a little bit, but here’s the general concept.  The general concept is like with anything the IRS does, there’s gonna be a set of rules, and the set of rules here basically says once you convert to a Roth IRA, when you’re allowed to recharacterize, and then, deeper than that, a little bit deeper than that, not only when you’re allowed to recharacterize, but, for example, after you recharacterize, when can you get back into the Roth IRA?  In other words, Jim, if I go from a regular IRA to a Roth, and then I jump back into the regular IRA, how long do I have to wait before I can go back into the Roth IRA?  Now, what the rules basically say, putting aside all the legalese, if I convert today, and I recharacterize by Thanksgiving, I can do another Roth conversion in January 2011.  So, let’s just walk through this.  Now, in the chart, back six months ago, we were thinking that everyone would convert, and they would wait all the way until October 15, 2011 to determine whether they should go back to the regular IRA.  And that seemed like a very solid strategy.  Then, one day, it became obvious that what we should be doing is recharacterizing still in 2010 if accounts had gone down in value, so that we could then go back into the Roth IRA on January 1, 2011 and pay the tax in the following year, and pay the tax, quite frankly, at a lower value.  For example, in this case here, you know, I’m assuming that someone’s IRA fell from $100,000 down to a lower number, say $85,000, and then they would reconvert at a lower number.  They’d pay tax at that lower number.  That is very important to our overall planning.  So, Jim, maybe you could try and explain that in a little bit simpler terms, but if you could help me with, just for your listeners, maybe they can hear it a different way.

Jim:  Well, the thing that I think is important with this strategy is, what you did in that example, and by the way, I’m very familiar with John Bledsoe’s work.  In fact, he’s actually been on the show, and I like him a lot.  Let’s say, for discussion’s sake, you have a million dollars in a traditional IRA.  This strategy, as I understand it, is you are taking that million dollars and you are breaking that into ten separate IRAs.  So, now you have these ten separate IRAs, and, in your example, you have converted one of them, and let’s say you do that in March 2010, and now it is, let’s say, November 2010, and that particular IRA has gone to, let’s say, $80,000 or $70,000.  What I think what you’re recommending is don’t wait until October of 2011 to recharacterize it, even though you’re allowed to, but you’re saying maybe recharacterize that Roth IRA back to a regular in 2010, and perhaps make a conversion of a different IRA in 2010. 

Bob:  That’s, in essence, the strategy, Jim. 

Jim:  Yeah, so as I understand it, let’s say that you had ten equal $100,000 Roth IRA conversions, and you had them, theoretically, investments that might have negative correlations, that is, investments that when one is going up, the other one’s going down, and, as I understand, you’re not necessarily recommending converting them all on January 1st, but maybe let’s say seven out of ten, and that way, if you recharacterize them during the calendar year, you would still have some that you could recharacterize a particular Roth IRA, but if there is another IRA that you have not made a conversion of during 2010, you could make a conversion of that.  So, you could have one going down, and let’s even say one that you didn’t convert go down, you can make a Roth IRA conversion of the one that didn’t go down in 2010, and the result of that is that you would end up paying less tax on the same amount of Roth IRA conversion.

Bob:  That’s the heart of it, and even if somebody’s listening and this is all, this is very hard to see on the radio because you don’t have the numbers in front of you, but what you really want to do is think about what we’re saying.  What we’re saying is, by doing more than one Roth conversion, the ones that go up in value, you might keep in the Roth, the ones that go down in value, you’d recharacterize.  And the simple goal is to reduce your risk at a conversion by as much as possible by being able to recharacterize the ones that have fallen short of expectations, and keeping the ones that outperform.  Doing this over a period of time, the math is extremely powerful.  As a matter of fact, Jim, in analyzing all of the differences between things, we believe that this Roth recharacterization factor is by far the ones that CPAs running these numbers, financial planners running these numbers, really have to have their arms around.

Jim:  And I would agree with that.  Frankly, when John first proposed it, it just sounded almost too good to be true, and I thought boy, what are all the things that could go wrong if you’re, in effect, let’s say that you run the numbers, and we determine that $100,000 is the appropriate amount of Roth IRA conversion, going back to your idea of staying in the same bracket, or perhaps going from 25 to 28 or 33 to 35, or even if you’re in the 35, let’s assume that the appropriate amount to convert is $100,000, and let’s assume that your total IRA is $1,000,000, but what this strategy is saying is, convert multiple IRAs, far more than you actually intend to keep, as Roth IRAs, and then recharacterize, either during 2010 or before October 2011, the ones that have done well.  Do you think that this is too aggressive for many taxpayers, or do you think this is just sound planning?

Bob:  I think it’s just sound planning.  There’s really not, I mean, in a worst case scenario, all the government’s going to do is adjust your taxable income.  It’s not like there’s some evil plot here.  It’s clearly allowed within the regulations.

Jim:  And what happens if you make the Roth IRA conversion and you die before you get the chance to recharacterize?

Bob:  Well, then, your personal representative is allowed to recharacterize.  So, in other words, if I die, my personal representative can take my regular IRA and turn it back into a Roth IRA if that’s indeed a good plan.

Jim:  Alright, so dying should not be a good reason not to do it.  In fact, some of the numbers that I’ve run in some situations is that, sometimes we call them “death bed Roth IRA conversions,” but that have saved both estate tax and an incredible amount of income tax for the survivors afterwards.

Bob:  And I would agree with that.  I mean, that’s the goal.  A lot of this has to be done for your beneficiaries more so than just for a husband and wife. 

Jim:  Well, that’s what we found.  Most of my clients are kind of conservative and tend to be savers rather than spenders, and for a lot of them, they might not even spend these Roth IRA dollars, but one of the strategies that I like about the Roth IRA conversion is that, for example, unlike life insurance or unlike other gifting strategies that are great for your kids or great for your grandkids, this is actually really good for you. 

Bob:  Absolutely.

Jim:  And the numbers that we’ve run, I don’t know if these numbers sound similar to anything you’ve run, but the numbers that we ran said if you make a $100,000 conversion, and let’s say you’re in the twenty-five percent bracket, that extra $100,000 will push you into the twenty-eight percent bracket, but in twenty years, you’ll be $40,000 better off.  If you and your spouse then die twenty years after the conversion, your children will be $700,000 better off, and if perhaps they don’t need the money, either because they have their own money or you left them other money or second to die life insurance, or for whatever reason, if some of the money goes to the grandkids, they would be $8.6 million better off.  So, I really like this both as something that is really good for the taxpayer and is wonderful for future generations. 

Bob:  I think that’s a good summary. 

Jim:  Alright, so you actually think it’s perfectly sound to separate your IRA into a number of IRAs, and then convert a whole bunch of them, even more than you anticipate that you want to keep.  Is that right?

Bob:  Well, that’s what a lot of people are doing, and what they would do is, if I had $100 in IRAs and I only wanted to convert $20, I might convert $60 or $80 knowing that I’m going to recharacterize a good part of that, I just don’t know which part I’m going to recharacterize, Jim, because it depends on what is the performance of those individual asset classes. 

Jim:  Right, and the only thing that I would add to that is, I assume that what you’re talking about is not saying I’m going to recharacterize this particular portion of an IRA, because then you get into all kinds of proration rules and problems, you’re actually going to separate them into different IRAs before you make the conversion.  Is that correct?

Bob:  That’s exactly what you would do.  That’s correct.

Jim:  Okay, good, good.  Alright, well, I actually think that’s a really powerful strategy.  It is aggressive.  You obviously don’t want to forget to recharacterize because that would be a pretty terrible thing.  It’s October 15, 2011 and you go into a drunken stupor and you forget to recharacterize.  That would be pretty bad, but other than that, I think that there’s a lot of benefits to learn from this.

Bob:  Absolutely.

Jim:  Alright, well, there are a bunch of other things that I want to cover.  Again, I think we are going to have to take a break, but when we come back, maybe what we could do is we could switch to after tax dollars inside retirement plans, because I know you have written extensively and have some great information on that topic.

Nicole:  You’re listening to the Lange Money Hour, where smart money talks.  We’ll be right back with guest Bob Keebler.


4. After Tax Dollars Inside of a Retirement Plan

Jim:  Well, welcome back, and we are talking with Bob Keebler about Roth IRA conversions and Roth IRA recharacterizations and specifically the issue that I want to address next is the issue of after tax dollars inside a retirement plan, and conceptually, I would say that that is, even though slightly mechanically different, but conceptually the same as a non-deductible IRA.  Is that a fair statement, Bob?

Bob:  That’s fair.

Jim:  Alright.  First of all, let’s just talk about the non-deductible IRA because a lot of my older clients, back in the days when the non-deductible IRA was, it was still available and back then, the maximum amount that you could put in was $2,000, where you did not get a tax deduction for that $2,000, but the money grew tax deferred.  And now you can put in $5,000 if your income is too high for a Roth IRA, or $6,000 if you are fifty and older. 

First of all, Bob, a basic question.  Let’s assume that your income is too high to allow you to contribute to a Roth IRA.  Are you a big fan of non-deductible IRAs?

Bob:  My wife and I have done non-deductible IRAs for probably ten or fifteen years now. 

Jim:  Alright.  If you didn’t have the proration rules, could you then turn around and convert that non-deductible IRA to a Roth IRA, or is there a waiting period for that?

Bob:  Well, no, you can do that, but the problem is that you do have the proration rules.

Jim:  Right.

Bob:  I do believe that you can probably put money in a non-deductible IRA this year where the limitation is like $150,000 of income.  If you wait a month or two, that’d be the safe thing is to put a little bit of time between the steps, Jim.  Then, under the law, you could convert that over to the Roth IRA.  But, you just talked about the proration rules.  Can you go through that just a tiny bit and then I can fill in some blanks?

Jim:  Yeah, because the proration rules are gonna get us, and we’re gonna have this, and what I’d like to do is even expand the conversation to go beyond non-deductible IRAs, because the non-deductible IRAs, the balances that I have seen, are not really, generally, that high.  But where I have seen substantial balances, perhaps as high as $50,000 or $100,000 or more, is the non-deductible or after-tax dollars inside a retirement plan.  So, let’s say, for example, in Pittsburgh, I know Westinghouse is one of the old companies where a lot of the executives were making contributions to their retirement plans, but they weren’t able to deduct it because of the limitations on how much you were allowed to deduct, and I think that is still going on in many corporations all over the country right now.  So, let’s take a situation where, again, let’s use a nice, even number, you have $1,000,000 in your 401(k), or even in your IRA, and of that million dollars, only $950,000 was that you got a tax break or you didn’t have to pay taxes on, and let’s say that there’s $50,000 of after-tax dollars, that is money that you didn’t get a tax break on.  So, if you had a $950,000 traditional IRA or 401(k) and then $50,000 of after-tax dollars, let’s say or $1,000,000 total, what you would like to do, ideally, is make a Roth IRA conversion of the $50,000 and the after-tax dollars, and leave alone the $950,000 and the pre-tax.  Is that a good start?

Bob:  No, that’s a good start.  That is an almost impossible thing to do exactly like that.  But what the general thought is, is to try to isolate the basis, and in a complicated sort of way that can be done.  Let’s say, a person leaves employer ‘A’, they take out all their money, and they’re allowed, under the law, to move all of their pre-tax money back into their next qualified plan.  So, they leave Westinghouse and they go to work for General Electric.  They would be able to roll their pre-tax money back into the General Electric plan.  Now, Jim, that would isolate the after-tax money, and then, if desirable, that can be flipped into a Roth IRA without paying hardly any income tax. 

Jim:  Yeah, I’ve actually ran numbers on that, and if you make a $50,000 Roth IRA conversion from $50,000 of after-tax dollars, there’s no tax liability up front, and 40 years from now, you’d be $500,000 better off, or, if you’re not around in 40 years, your heirs would be $500,000 better off.  Let’s take an example of, maybe you’re not going from employer one to employer two, but let’s say that you are retired, and let’s assume the money is in the IRA, what do you think of the idea of, let’s say somebody has some self-employment income, maybe they do a little consulting from their old employer, maybe they help out around the golf course, maybe there’s a family business, and the family business provides them some income, and let’s say that they are provided, let’s say, $10,000 of earned income that they would report on a Schedule C, and that will allow them to create their own retirement plan, and I personally like the one person 401(k) plans in that situation, and what do you think of the strategy of, so you have this retiree who has $1,000,000 in their IRA, they have $950,000 traditional, $50,000 after-tax, they have a little bit of earned income, with that earned income, they set up a one person 401(k) plan, then what they do is they take the traditional IRA, and they roll that into their new one person 401(k) plan, but their new one person 401(k) plan has a provision that says we will not accept after-tax dollars, so then they are left with $50,000 of after-tax dollars inside an IRA, and then flipping that to, or converting that to a Roth IRA.

Bob:  Incredibly powerful, and that’s exactly what people should be trying to do.

Jim:  Alright, and to me, that is such a powerful event.  We’ve been doing this in practice for years, and people are just delighted to have Roth IRA conversions without having to pay the tax.  And the other little bonus about that is that the one person 401(k) plan, if you die with that, your heirs will be able to make a Roth IRA conversion of the inherited 401(k), but if you don’t do it, and you just die with an IRA, your heirs are not allowed to make a Roth IRA conversion of an inherited IRA.  That’s one I could never really understand.

Bob:  No, and the law’s not fair.  But, for the person that leaves their money back in the qualified plan, their children can still convert to the Roth after they die.  But, you’re right.  For the person who just has the IRA in the palm of their hands, their children cannot convert an IRA into a Roth IRA.

Jim:  Right, but again, I think that that’s actually, that, and some people argue that there’s better creditor protection for the one person 401(k).  I’m not quite sure if that’s true or not.  But, I think the idea of being able to make an after-tax money inside either an IRA or a 401(k) into a Roth, is just such a powerful technique.  I remember reading things that you had written about this, probably, eight or ten years ago. 

Bob:  Right, this goes back.

Jim:  Yeah, so this isn’t a new strategy, but I guess it probably has a second wind now that anybody can make a Roth IRA conversion, regardless of income.

Bob:  Right, that’s the key.  All this knowledge is being resurrected, and a lot of smart people are working very hard across the country.  Still, we’re on a very steep learning curve, Jim, because what we’re finding is, you know, every day we become smarter, just because there are so many people who are intrigued by this now.

Jim:  Well, yeah, I think that’s partly true, but to give credit where it’s due, you were one of the very early people advocating things like after-tax dollars inside an IRA to a Roth IRA conversion without having to pay the taxes, and you were also one of the very early advocates of doing multiple conversions and keeping the ones that have done the best.  So, maybe a lot of other people are playing catch up but, I know, frankly, you and I have both written articles on those two subjects probably eight to ten years ago.  So, I know you’re being nice, but I think you deserve a lot of credit.

Bob:  Well, thank you.


5. Overcoming 401(k) Limitations for People Who Are Still Working

Jim:  And the other thing is, now might be a good time to talk about your workbook, because I really think, if I’m one of our readers, again, if they did nothing other than look at page 24 of your workbook, and the name of the workbook is “One Hundred Roth IRA Examples and Flow Charts,” and you have written that, and, although, I guess, with a little help from John Bledsoe, which I didn’t know about, and it was also edited by Barry Picker, who is just a terrific IRA guy.  He is also been on the show.  But, the number for that is 800-809-0015.  And by the way, listeners, this is a no-brainer to get this workbook.  If you do nothing else, look at pages 19 and 24, and I think that you’ll agree that that alone is worth many times the cost of the workbook.  But, could we talk a little bit more about after-tax dollars and retirement plans?  Because, let’s say somebody is working, and, instead of having their money in a IRA, a lot of their money is in a 401(k), and let’s assume again that some of the money is after-tax, or maybe it’s even not, what are gonna be some of the limitations of people who are still working putting money into a 401(k) or doing a Roth IRA conversion?

Bob:  Well, first off, the income limitations are gone, and many people, if they can put, you know, strategically, if there’s the opportunity to put extra money on an after-tax basis, rather than a pre-tax basis, into a 401(k) or some kind of pension plan, and later, they can isolate that and convert it into a Roth IRA, that can be a very powerful strategy.  A lot of people have a lot of basis if they’ve done non-deductible IRAs for ten or fifteen years.  When you look at, from client to client, you’re gonna try to isolate this opportunity, and then take advantage of converting to a Roth IRA without paying hardly any tax.

Jim:  Right, and I think that’s great, but we also don’t want to forget the more simple play is, if people’s retirement plan has a Roth 401(k) component to it, that it might make a lot of sense to contribute money to a Roth 401(k).  So, for example, I’ll tell people what I did personally, and then maybe you can share what you did personally, if you like.  Back in 1998, our office suffered a fire.  My income was well below $100,000.  By the way, one of the lessons is, never put your office above a pizza shop.  A really bad idea.  But, anyway, my wife and I were under $100,000 at the time, and between the two of us, we had $250,000 of traditional IRA.  We converted all that, and then, I was part of a 401(k), and then when they allowed the Roth 401(k) component, then I switched all my contributions to Roth 401(k)s.  And then, I also think it’s wise to put in, and I’m over 50, I’m 53, I put in $6,000 of non-deductible IRAs on top of the Roth 401(k) for both myself and my wife, even though my wife doesn’t have earned income.  I don’t know if you’re doing something similar, Bob.

Bob:  Right, no, we’ve been doing a non-deductible IRAs, and there was a year when we merged with another firm, that I was able to convert to a Roth IRA.  So, it turned out to be a very smart move.  Now, the other thing that I’ve been doing is, I’ve been doing the Roth 401(k).  Many of your listeners are gonna have a choice of doing the regular 401(k) or the Roth 401(k).  I’ve run the numbers.  In my personal situation, I’ve come to the conclusion that the Roth 401(k) is better than the regular 401(k) and part of that, of course, is that later, when I retire, I’ll have more funds in the Roth which will help me hold my tax bracket down, you know, in those years.

Jim:  Right.  I think we’re gonna have to take a break now, but perhaps, when we come back, we can talk about estate tax repeal, and we can talk about generation skipping tax repeal, and what a good reaction would be for our listeners.  

Nicole:  You’re listening to the Lange Money Hour, where smart money talks.  We’ll be right back with guest Bob Keebler.


6. Estate Tax Repeal

Jim:  Welcome back to the Lange Money Hour, where smart money talks.  We’re here with Bob Keebler, who is one of the top Roth IRA conversion experts in the country.  And Bob, one of the things I always wanted to talk about in this final segment is the current estate tax repeal.  So, for years, the exemption was $600,000, that is the amount you were allowed to die with before you had to pay any federal estate tax, and then, plus, we had the unlimited marital deduction if your spouse was a U.S. citizen, and then what happened is, the exemption crept up until the point where last year, it was $3.5 million, and the law last year was $3.5 million, and then in 2010, it was going to be repealed, and then in 2011, it was going to go back to a million.  And we all assumed, at least I did anyway, that they would have some number, and I expected this to pass sometime in 2009, and I expected the number to be around $3.5 or maybe $4 million, but I thought that there would certainly be some type of estate tax in 2010, and that was never passed.  So, technically right now, there’s no estate tax, but let’s say that one of our listeners has a $5 million estate and let’s forget about the marital deductions, so let’s assume that there’s no spouse, and they have a $5 million estate, and then they die between now and the time that any future tax law is passed.  What do you think is the impact for that type of person?

Bob:  So, a person that dies today?

Jim:  Right, they die today with a $5 million estate and no spouse.

Bob:  Right.  It’s a mess, to be blunt and to not use very professional words.  But, here’s what we have.  The law, right now, someone would not have a tax.  However, congress might come along and try to fix this retroactively.  Now, if that is the case, then what we need to do is you need to be prepared for either scenario.  You need to say, “Well, we might owe an estate tax, or we may not have received a step up in basis of some of our property.”  Remember, Jim, the other side of law is that if there’s no estate tax, that means that you probably did not have a step up in basis when you died, you know, on the income tax side.  So, anyone in that situation really needs to reach out to a very capable law firm and a very capable CPA firm and force them to collaborate on where do we go from here.  And also, you have to be prepared to watch the battle that will eventually ensue all the way up to the Supreme Court on whether or not there’s an estate tax burden right now, because professional fiduciaries, a Northern Trust, a Mellon, someone like that, if I die, and they’re my personal representative or trustee, they have almost no choice but to litigate this.  And eventually, it’s going to make its way to the Supreme Court.  We are not going to know the answer to this for five to ten years.

Jim:  Well, I’ll tell you what I’m doing in my law practice.  I’ve actually been doing this kind of planning for more than twenty years.  What I have been doing is, rather than having the traditional, fixed-in-stone classic AB trusts that force a significant, sometimes all the money that the first person to die has to the B trust, which basically says income to spouse, right to invade for health maintenance and support, and at the second death, to the children equally, what I do is I change the assumptions, because most of the clients I see, when they come in, they say, “Hey, the first goal is to make sure that we have enough money for the rest of our lives.  If something happens to one of us, I want to make sure that the survivor has enough money for the rest of his or her life.  Then, and only after we’re taken care of both spouses, are we interested in saving taxes or money going to the kids.  So, what I do in my estate practice is, I kind of reverse the assumptions, and by the way, I’m assuming that we have a situation where you can trust the surviving spouse, I’m starting by naming the surviving spouse as the primary beneficiary.  Then, I’m naming the B trust as the secondary beneficiary.  Then, I’m naming the children equally as the third, or the second contingent beneficiary.  Then I have different sets of trusts for grandchildren as the last contingent beneficiary, and I guess that if somebody had great-grandchildren, I would even have one additional set of options, and then through a series of posthumous, or after death, disclaimers, disclaimers being the legal word for “I don’t want it,” we are then having the money go to where it might make the most sense, both from a need of what the family need is, in terms of what the estate tax is, in terms of all of the factors that we can’t predict.  To me, that is a better solution than trying to predict the future, and then making decisions on who gets what today based on factors that we don’t know.  I don’t know if you have seen that type of planning.

Bob:  That’s very advanced, but it gives you a great deal of flexibility, and that’s the kind of creativity that we need right now, because we really don’t know what we’re gonna end up with. 

Jim:  Well, that’s my thinking.  You know, we don’t know what the federal estate tax is gonna be.  In fact, it’s kind of ironic, but we don’t even know today, if you died today, if there’s a federal estate tax or not.  We don’t know how much the investments are gonna be, and certainly recent times have proven tremendous volatility with investments, so we don’t know if we’re gonna need the money, if we’re not gonna need the money, maybe we only need the income from the money.  The other thing is, sometimes it’s very hard to predict what the needs of the surviving spouse are.  Maybe the surviving spouse will be perfectly healthy, will live twenty years and will want to spend a lot of money.  Maybe they’ll want to leave some money to their grandkids, maybe they’ll want to help the grandkids with their education while they’re still alive.  So, my big thing is, if you have the luxury, and this is still the majority of my practice, I suspect it’s gonna change in the next ten to twenty years, but the majority of my practice is probably what I’d call couples that are, I characterize them as Leave it to Beaver clients.  That is original husband, original wife and the same kids.  So, in that situation, I really like the flexible plan. 

Bob:  I think that’s the proper way to approach it, Jim.

Jim:  Alright, now I also understand that you are doing some interesting planning regarding generation skipping, and the current status is the, there is no generation skipping tax.  So, maybe you could tell us a little bit about what you are doing for your clients who are wealthy and have grandchildren?

Bob:  Basically, what we’ve been trying to do is, for clients whose children already have significant wealth, one of the better techniques is to push property down to grandchildren.  However, the law puts a limitation on that at $3.5 million a person, which seems like an awful lot of money, but, on the other hand, people do exceed that.  So, what we’re trying to do during this gap period, right now there’s no estate tax, nor is there a tax called the generations can be transferred tax.  So, we believe that there are certain transfers that can be accomplished right now that weren’t available 45 days ago, that may not be available six months in the future.  So, basically, it’s complicated planning, but it’s something that people with a fair amount of wealth will want to talk to their clients about.  If you’re a client in that situation, you really need to reach out to your lawyers and CPAs and say, you know, what do you think about this, is there something I should be doing?

Jim:  Well, let me ask you this.  We talked about retroactive reintroduction of the estate tax, let’s say that somebody’s listening, and they say, “Hey, you know, he’s really right.  This is a great time to make a $2 million transfer to my grandson, little Johnny.”  And they are under the impression that there isn’t a generation skipped tax, and then perhaps, what happens is, six months down the line, congress makes a generation skipping tax retroactive.  Do you think that somebody like that could get hurt?

Bob:  No.  If the documents are drafted correctly, you can’t get hurt, because we’re gonna use multi-path documents, Jim, so what that means is if I end up with the result I’m hoping for, it goes to my grandchildren.  If I end up with a lesser result, it goes to my children.

Jim:  Alright, now when you say documents, I assume you’re talking about when you die.  I’m talking about, let’s say that everybody’s alive.

Bob:  No, no, I’m talking about a GRAT, or a technique like that, a very advanced technique called a GRAT, sometimes we call it a freeze trust, but these techniques will allow the same kind of flexibility.

Jim:  Oh, okay, so what you’re gonna do then is, rather than giving a direct gift to a grandchild, you’re going to do it through a grantor retained annuity trust.  It’s going to have some flexible language that basically says if you’re allowed to do it, do it.  If you’re not, then not.  Is that correct?

Bob:  Precisely, yes.

Jim:  That is really clever.  I hadn’t heard that.  I knew that you were a big fan of doing this, and rankly, I couldn’t understand the response to the issue of what happens if they make it retroactive, but now you’re doing it through a GRAT.  That’s very clever.

Bob:  Well, I think it’s probably the best way to approach this, certainly the safest way. 

Jim:  Yeah, I had not thought of that.  You are full of good ideas today.  So, I think some of the things that we’ve talked about are Roth IRA conversions, in general that you are a fan of, and by the way, on that note, do you have an opinion if people should make a Roth IRA conversion if they don’t have the money to pay the tax from outside the IRA?  So, let’s say for example, I have a lot of clients like this because I have a lot of clients that they started with not much, you know, they got a job, they worked very hard, they had their car payments, they had the house payments, and they had, you know, they put their kids through college, and they put braces on their kids and everything else, and it was very hard to save money, but they were steady savers and they kept accumulating money in their retirement plans.  So, let’s say today that they have a house that’s paid up, maybe a couple of cars, maybe $10 or $20,000 in investments, but maybe $1,000,000 in their retirement plan.  Do you think that somebody like that is a good candidate for a Roth IRA conversion?

Bob:  It depends on how much other, how much of this money they’re going to need to spend during their lifetime, that’s A.  It depends on tax rates going forward, and it depends on the health of the husband and wife, if there’s a big difference in health, that would lend itself more to a Roth conversion.  And it would also depend on what happens from the time they convert to the time when they’d recharacterize.  For example, if I converted $100,000 and it jumped to $140,000, almost no doubt, I would leave it in the Roth IRA even if I was over sixty and I had to reach into the IRA to pay the taxes, because, for example, Jim, let’s say you convert $100,000 and you get lucky and it jumps to $140,000.  They money you’re gonna take out to pay the taxes is going to come out of the growth on the Roth, and you’re gonna be a big winner out of that, because now what you have is $100,000 left in a Roth IRA rather that $100,000 in a regular IRA.  So this could be a very powerful idea.

Jim:  Alright, well, that’s great.  I’m afraid we’re wrapping up.  I will mention to the listeners that we explore all the issues we’ve talked about today in the workshops that we are presenting.  In fact, the next workshop is February 20th at 9:30 am and 1:00 pm in Monroeville at the Doubletree.  I’m afraid we’re gonna have to wrap up, so maybe I’ll give it to Nicole to wrap up.  But Bob, before we do that, I wanted to thank you so much.  You have been a wonderful source of the highest caliber information, and thank you so much, and actually, if we have time, I’d like to put in one more plug for your book One Hundred Roth IRA Examples and Flow Charts, and you can get that by calling 800-809-0015.

Nicole:  Alright gentlemen, thank you very much.  That was an excellent dialog you had this evening.  You certainly offered our listeners a lot of great strategies tonight, and for those of you listening out there, thank you for carving out the time for the Lange Money Hour, where smart money talks.  Portions of the audio you just heard will be posted online at www.retiresecure.com.  You can also find a list of upcoming guests and topics at that same website.  To seek Jim’s advice personally, or to speak to a member of his dedicated staff, the Lange Financial Group here in Pittsburgh, please call 412-521-2732 and join us again when we talk more smart money.  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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