Smart Talk About Roth IRAs/Roth IRA Conversions/New Tax Law for 2010

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

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Smart Talk About Roth IRAs/Roth IRA Conversions/New Tax Law for 2010
Jim Lange, CPA/Attorney
Episode 17

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TOPICS COVERED:

  1. What's the Difference Between a Traditional IRA and a Roth IRA?
  2. Caller Q&A: One-Person 401(k) Roth IRA
  3. Tax Law Change for 2010:  Eliminating Income Restrictions for Roth IRAs
  4. Caller Q&A: Roth IRA Contributions/Conversions

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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: Thank you so much for joining us tonight we are talking smart money. I’m Beth Bershok along with Jim Lange, CPA, attorney, author of two bestselling editions of the book, Retire Secure! Pay Taxes Later. Jim I imagine you were looking forward to this show because we are going to be talking about your absolute favorite topic in the world, Roth IRAs, Roth IRA conversions, and a big tax law change that’s coming up on January 1, which is hard to believe it’s two and a half months away. Now before we get into all of this, I do want to say we have the phones open tonight.  If you want to call in with a question we already have a couple of email questions that we’re going to be getting to a little bit later on in the hour. But if you have a question as the hour is going on feel free to call it in at 412-333-9385. That’s the studio line, it’s open now at 412-333-9385. Jim before we get into the essence of Roth IRAs and Roth IRA conversions, I want to give your background on this topic because you go back to the very beginning of Roth IRAs, and you wrote the very first peer reviewed article on Roth IRAs which was for the Tax Advisor, reviewed by CPAs, and they are a tough crowd. But explain what led you to write the article in the first place? This was 1998.

Jim Lange: Right, usually I ignore proposed regulations, so when there’s a tax law change that’s proposed, I usually ignore it.  The reason I ignore it is because I get it confused with what actually passes. But in 1997 when they proposed the Roth IRAs and Roth IRA conversions, and I took a look at it, my gut instinct was, boy this is going to be fabulous.  I got a spreadsheet out and with the help of Steve Kohman, a CPA in our office, we ran a bunch of numbers and realized this was going to be an unbelievable opportunity for our clients, listeners and readers to create gobs of tax-free wealth. And this was so exciting and then I realized that this was going to be an important part of my future. And then I thought, you know who the heck is going to believe Jim Lange and why should somebody pay income taxes before they have to? I’m going to have a huge burden of proof for somebody to voluntarily pay income taxes before they have to make a Roth IRA conversion. So I said the best way for people to actually believe me is to have the highest level peer review go through my numbers. So I asked the AICPA.  I said I would like to write the article on Roth IRA conversions, and I think they had no idea how powerful this was. They said okay go for it. So I reserved the topic, wrote the article and had these nit-picking CPAs just tear apart every single spreadsheet that I gave them. But when the final article came out, it was actually better than the one I had originally submitted, and it actually showed the benefits of Roth IRA conversions, and up to now from 1997 when I first wrote it, the law became effective in 1998. I’ve been a big advocate of running numbers and determining the right amount to make for Roth IRA conversions. But up to now, it has been limited to people with incomes of less than $100,000. As we’re going to find out later on in the hour, that’s no longer going to be the case.  The floodgates for virtually everybody with an IRA or a retirement plan to literally go to a tax-free dynasty are going to open in January, 2010. And I’ve been looking forward to this for years.


1. What's the Difference Between a Traditional IRA and a Roth IRA?

Beth Bershok: Now coming up we’re going to be talking about some of the tax law changes in 2010, but let’s start with what is the difference between a traditional IRA and a Roth IRA? A traditional IRA, first of all, you’re getting a tax deduction.

Jim Lange: And by the way, I’ll even expand the question to say a traditional IRA or a traditional 401(k) or 403(b) or SEP or Keogh or all those types of retirement plans where you make a contribution to a retirement plan and you get a current income tax deduction which ultimately is going to result in some money back or a reduction of your tax bill. That money grows income tax deferred, meaning that you don’t have to pay income taxes on that money or on the growth or on the interest or on the capital gains until you actually withdraw the money. At that point, you have to pay the tax. The Roth IRA is money that you do not get an income tax deduction for upfront which is the bad part.  But the good part is it grows income tax free for the rest of your life, the rest of your spouse’s life, the rest of your kid’s lives, and even the rest of your grandkid’s lives. So by being willing to pay the taxes upfront you end up in effect having the harvest, if you will, the total distributions income tax free.

Beth Bershok: But there are some other benefits as well, and one is with a Roth IRA, there is no required minimum distribution for the Roth IRA owner.

Jim Lange: That’s correct and a lot of people say, oh I want to do a Roth IRA conversion so I won’t have to be forced to take money from my retirement plan once I turn 70. And I would say that that is a bonus. The real benefit when you run the numbers, which we obviously do on Roth IRA conversions, is the income tax free growth that you’re getting for your life, your spouse’s life, and the lives of your children and grandchildren.

Beth Bershok: But of course, if you plan to leave it to your grandchildren, the fact that you don’t have to take a required minimum distribution is extremely beneficial.

Jim Lange: Yes, it is because that way more and more money can continue to accumulate income tax free.

Beth Bershok: Now what happens to the spouse in that case, the spouse or the beneficiary if it goes to the children or the grandchildren.  Are they forced to take RMDs?

Jim Lange: Well, there is a difference if you make a Roth IRA conversion, you don’t have to take an RMD. If you then die and leave the money to your spouse, he or she doesn’t have to make a required minimum distribution of the Roth IRA. But then if you leave it to a non-spousal heir--someone who is not your spouse, so most likely it will be your children or your grandchildren but it could be a niece or a nephew or a friend or a partner or anybody you like-- that partner or friend or most likely child or grandchild will have to take a minimum required distribution. The way that minimum required distribution of the inherited Roth IRA is calculated is you take the life expectancy of that beneficiary--so let’s say the beneficiary is 30 years old and has roughly a 50-year life expectancy--you would take 50, divide that into the balance of the inherited Roth IRA.  So let’s say it’s $1 million, so that person would have a minimum required distribution of the inherited Roth IRA of $20,000.  The good news is unlike the minimum required distribution of an inherited traditional IRA, the minimum required distribution of the inherited Roth IRA is income tax free.

Beth Bershok: That’s huge.

Jim Lange: It is huge, and I’m really not exaggerating when I’m talking about a tax free dynasty that is now a possibility for wealthy tax payers.

Beth Bershok: We’ve been doing workshops on this all year long, and we have one coming up this Saturday. It’s in Monroeville at the Holiday Inn at Mosside Boulevard.  In fact, you can go online www.retiresecure.com and get all of the information on there. And we have one coming up also on November 21, These are absolutely free, by the way.  If you want to hear all of this from Jim in person, I would definitely recommend that you attend one of these workshops. And in the workshop Jim, you cover something that is difficult for a lot of people to grasp. You call it the secret to understanding Roth IRA conversions.

Jim Lange: So, we’re going to give them the good stuff, huh?

Beth Bershok: Well, we should. It is the key, because a lot of people I know will come to you and say Jim, that sounds great, but I am just too old to make a Roth IRA conversion, it just doesn’t make sense. But when you understand what Jim is calling the secret to Roth IRA conversions, it does make sense.

Jim Lange: And sometimes people say they’re too old. The other thing that sometimes people say is, well I would rather spend the money than pay the taxes on the conversion. When somebody tells me that, I know that they don’t really understand Roth IRA conversions because with a Roth IRA conversion, you--forgetting your kids or your grandkids and your spouse or anybody else--but you will have more purchasing power. You’ll have the ability to buy more goods and services. But anyway, here is the secret.  The key to understanding Roth IRA conversions-- and for that matter, it’s something that everybody should understand who has an IRA and a retirement plan--is that there is a difference between total dollars and purchasing power. So, let’s say you have $500,000 or a $1 million in an IRA, 401(k), 403(b), SEP, etc. You can’t go out and buy $1 million worth of goods and services with that $1 million IRA. The reason is because you have to pay income tax. So depending on your income tax bracket, you might have to pay 25-30% on the withdrawal of money from your IRA. So you really don’t have the same purchasing power as the face amount of the IRA. So let’s say you had $100,000 in an IRA and you had $25,000 outside the IRA. You have $125,000 total. But let’s say you want to go out and buy some goods and services. You’re going to have to cash in the IRA alright? Let’s assume again that the tax rate is 25%. You have to write a check to the IRS for $25,000. Now, in this example I conveniently assume that you have the $25,000 to pay the taxes on the IRA withdrawal from outside the IRA. You’re left with $100,000. The $125,000 total is really measured in purchasing power as $100,000. If you make a Roth IRA conversion, what happens is you pay the tax of the $25,000, because that’s the essence of a Roth IRA conversion.

Beth Bershok: So you’re paying the taxes up front.

Jim Lange: You’re paying the taxes up front, you’re taking $100,000 of traditional IRA, 401(k), 403(b) etc. and you’re paying taxes on it.  I’m going to assume that the tax rate is 25% so that you have to write a check to the IRS before you have to of $25,000. To tell a 30-year veteran CPA that it makes sense to pay $25,000 to the IRS before you have to---

Beth Bershok: Or to tell it to a client even.

Jim Lange:  Or to tell it to a client which is 100 times worse, you really ought to make sure you’re going to provide tremendous value. So after you write that check for $25,000--which remember Mr. Status Quo didn’t have to write that check, he was just sitting on it. Mr. Roth IRA conversion is going to have only $100,000 total where Mr. Status Quo has $125,000. Now, what a lot of the analysts and a lot of the advisors who don’t really get it say is  it’s going to take Mr. Roth IRA a lot of years to make up for that $25,000 in taxes that he paid. So, therefore Roth IRA conversions are good for young people but not for old people. But that’s not right, because measured in purchasing power, we have the same amount of purchasing power on day one because there’s no tax on the Roth IRA conversion.

Beth Bershok: So day one you’re even.

Jim Lange: You’re even.

Beth Bershok: So day two you actually start to inch ahead, and I know you’ve done all of these calculations, but going down the road what is the benefit if you are the Roth IRA owner?

Jim Lange: Alright, let’s for the moment forget the kids and forget the grandkids and let’s take two people, Mr. Status Quo and Mr. Roth IRA Conversion. They each have the exact same amount of money inside and outside the IRA. They both invest identically and spend identically. Everything is identical about them. Mr. Status Quo has money in his IRA that’s going to grow, but he’s going to have to take money out with minimum required distribution, and he will have to pay income tax every time he takes a distribution from his IRA. But he also has the $25,000 outside the IRA. Mr. Roth IRA conversion, on the other hand, only has $100,000 total but that money’s growing income tax free. If you take Mr. Roth IRA conversion and Mr. Status Quo and project them forward into the future for 20 years, Mr. Roth IRA conversion is going to have $40,000 more than Mr. Status Quo.

Beth Bershok: Which is nothing to sneeze at.

Jim Lange: So think about this--you make $100,000 conversion right now, and you and or your spouse live for 20 years.  You will have an additional $40,000 at the end of the 20 years, and you will have more purchasing power practically the whole way along.

Beth Bershok: You know, there’s a question mark on Mr. Status Quo which is what will the tax rates be when he starts to withdraw that money?

Jim Lange: If you assume that the tax rates are going to be higher than they are today, then the benefits would be considerably more than $40,000. I’ve more or less assumed a flat income tax rate.  If you think tax rates are going up, then it is wonderful to make a Roth IRA conversion while the tax rates are at basically historical low and have that money grow tax free.

Beth Bershok: Well, it takes the tax rate out of the picture when you make the Roth IRA conversion if the rates would go up.

Jim Lange: That’s right, because there’s going to be no taxes on the distribution. The thing that would happen if the tax rates went up is you would be that much happier if you had a Roth IRA conversion.

Beth Bershok: What if they go down?

Jim Lange: If they go down, then I’m wrong. So I’ll tell everybody right now if you make a big Roth IRA conversion and all of the United States has a huge tax decrease--or I’ll tell you the other way I’m wrong is if they eliminate the income tax. I would be wrong if they eliminate the income tax, and you pay the taxes upfront, then you would be worse off. On the other hand, you have to compare that to more than likely that they’re going to eliminate the income tax or is it more likely that they’re going to have a tax raise? If you think it’s going to be a tax raise, then you’re probably even more inclined to make the Roth IRA conversion.

Beth Bershok: Okay, so we said that $40,000 was the benefit to the Roth IRA owner after about 20 years. Let’s talk about the benefits to the children and the grandchildren over time because the money continues to grow tax free if it’s passed on.

Jim Lange: Right, so let’s assume that Mr. Roth IRA Conversion makes this $100,000 Roth IRA conversion, and let’s say he and his spouse live 20 years. In a different talk, I talk about which assets to spend first, and I say first spend your after tax dollars--that is, not your IRA, 401(k), 403(b), etc., and that’s the subtitle of my book, pay taxes later. Then, I recommend spending your IRA or retirement plan, 403(b) etc., and then only last do I recommend the Roth IRA that you should spend. There are a few exceptions but in general spend first your after tax, then your IRA and then your Roth. If you do that, what’s going to happen is you are almost certainly going to end up with some money in a Roth IRA. So then the next question is--let’s say that you do this $100,000 conversion-- you and your spouse live 20 years, then you die and leave the Roth IRA to your child. How much better off is the child of Mr. Roth IRA conversion versus Mr. Status Quo? And the answer is over that child’s lifetime, he will be $700,000 better off than the children of Mr. Status Quo. So you could talk about a lot of great estate planning techniques and a lot of people who think life insurance is a wonderful way to distribute wealth and to pass wealth onto generations.  I frankly would agree with that, but with a life insurance policy, it’s ultimately costing you money.  That is it’s ultimately some form of a gift where you are making a gift of the premium of the life insurance policy that will ultimately go for the benefit of your heirs. With the Roth IRA conversion, you are better off, but you’re only better off by $40,000. Your heirs are better off--in this case, children--by $700,000.

Beth Bershok: And the grandchildren, you need to sit down for this number because it’s really large.

Jim Lange: Let’s say you say to heck with the children or perhaps what you’ve done is you’ve said, well I’ve set aside other monies for the kids or maybe the kids have their own money. So let’s assume that the kids do not need or don’t want your inherited Roth IRA, and that Roth IRA or inherited Roth IRA ends up going to grandkids.  By that I mean kids who are probably in their 20s when you die as opposed to in their 50s for your children.  If you leave the money to a grandchild, the grandchild’s minimum required distribution of the inherited Roth IRA is very small in the early years leaving the bulk of that inherited money to continue to grow income tax free for the rest of the grandchild’s life. The grandchild will be better off by $8.6 million over his lifetime.

Beth Bershok: Now we should be fair. If Steve were here--Steve he does all of the analysis on the Roth IRAs at our office and he’s just incredibly technical--he would say that is not in today’s dollars so we need to be fair.

Jim Lange: He’s right. So the question is, yes in actual dollars the children will be better off by $700,000, so how much is that in today’s dollars? If you include inflation, the kids will be better off by $161,000. The grandkids will be better of by $816,000. I didn’t state all my assumptions, by the way, but I think they’re pretty reasonable, but in today’s dollars the grandchildren will be better off by $800,000.

Beth Bershok: But it’s a huge difference.

Jim Lange: It’s a huge difference, so you are literally talking about an income tax free dynasty that is good for you, better for your children, and wonderful for your grandchildren.

Beth Bershok: And Jim, we are going to take a quick break. When we come back I want to talk about the tax law change that's coming up January 1. We are getting very close. It is the Lange Money Hour: Where Smart Money Talks.


2. Caller Q&A: One-Person 401(k) Roth IRA

Beth Bershok: We are talking smart money, I’m Beth Bershok along with Jim Lange, and I did mention earlier that we are taking calls in the studio tonight, 412-333-9385. It’s all about Jim’s favorite topic tonight--Roth IRAs, Roth IRA conversions.  A little bit later in this hour we’re going to be telling you about the big tax law change that’s coming up on January 1. And we do have a call coming from Texas.  John is on the line. Hi, John.

John: Hi.

Beth Bershok: What part of Texas are you from?

John: Dallas-Fort Worth.

Beth Bershok: Great to have you listening tonight. Obviously, you’re listening online at KQV.com. What is your question for Jim?

John: I have set up as he recommends in his new book a one-person 401(k) Roth IRA, and I’m trying to make sure what income can fund that when you have a limited partnership. Can it be 1099 income? And specifically, I have an installment sale where I sold some assets.  Can I use that income to make contributions to 401(k)?

Jim Lange: Okay first, I’ll start with a couple things. First of all, I think you’re a very smart guy because you bought my book. So, that’s the good news.

John: I’m smarter now than I was actually.

Beth Bershok: The book is Retire Secure! by the way.

John: The book is incredible.

Jim Lange: Oh, well thank you.

John: I’ve read about 15 books on this topic, and yours is the encyclopedia I use.

Jim Lange: Oh, I didn’t quite hear what you said there.

John: I’m sold on it.  I actually just bought some more copies to give to some friends.

Jim Lange: Well that’s really good. The only thing that really isn’t such a positive note is that you should know that Dallas is not America’s team. That is a misnomer. It is well proven that there are more Steelers bars and more Steelers supporters throughout not just the country, but the world and that is just a marketing ploy that somebody in Dallas came up with.

John: Well, you’re not going to get much argument with me, not just the Cowboys but the Mavericks and everybody else out here.  We play the best in the regular season and choke when the playoffs get here. I don’t have much to brag about down here lately.

Jim Lange: Okay, so first let’s talk about you obviously have some self employment income. I’ll get to your question even more specifically but first let’s talk for the benefit of all our listeners who have access to not even just a one-person 401(k) but even a 401(k) plan at work. And the 401(k) plan most 401(k)s or the traditional 401(k) is like I’ve been talking about like the traditional IRA you make a contribution, you get a tax deduction, the money grows income tax deferred and when you take the money out you have to pay income taxes. Recently the IRS now allows a Roth 401(k) so that means people on a 401(k) plan if their employer has implemented this plan, which is a big if because most employers have not.  But if they have the employee share of the retirement plan you have a choice of either putting money in a traditional 401(k) or a Roth 401(k). so the employee portion which if you’re over 50 years old can be up to $22,000, can go into a Roth 401(k), and I’m guessing that that is if it is available to them.  What most people who are working should do if they can afford it is to put money in a Roth 401(k). Now what you have is a one person 401(k) meaning that since you’re not working for a company or an entity that has a retirement plan you set up your own retirement plan, which I applaud you for. Now the Roth 401(k) like any retirement plan whether it’s an IRA or a 401(k) or a 403(b) or a SEP, OR Keogh or anything else calculates that amount of money that you’re allowed to contribute using earned income as a base. So let’s say in your business you earned $100,000, well that can be the base and from that there’s a little bit of a complicated formula, and by the way the answer is probably about $35-40,000 of how much money you can contribute to that retirement plan. Now you mentioned that you have some earned income, but you also said that you sold some things on the installment basis.

John: Yeah, I know that I can do it if I had W2 income, but I have an installment note that’s coming in and 1099 miscellaneous income, and what I’m trying to make sure is that those qualify as earned income so that I can make contributions.  It’s a limited partnership that has those. Because it flows through to me on the K1, I think that’s earned income, and I can put it on there. But I’m trying to make sure because my CPA says that flows through to you, and I’m trying to maximize what I put into my 401(k), Roth and non-Roth.

Jim Lange: Well I think that’s good. You might have a complication because the partnership is the entity that would have the 401(k). It must be the employer. Now here’s the deal, if you sold something on an installment basis and you have capital gain or a capital loss or that sale is a capital sale then the income or the gain on that is not income for the purpose of income for the Roth 401(k). And the reason for that is because it’s not earned income so if you sold a house or if you sold stock or if you sold a piece of land or something like that normally that would not be earned income. Now if you are in the business of selling houses or whatever you sold, so in effect a house isn’t a capital asset to you it’s just plain old inventory, then that would qualify. So I’m guessing, though, that most likely that is a capital asset, on that installment sale you’re probably reporting a capital gain.

John: Yes, that’s correct on the part that’s interest and long term capital gain.

Jim Lange: Yeah, and unfortunately the interest doesn’t fly in the capital gains.

John: So what about the 1099 miscellaneous?

Jim Lange: Yeah the 1099, that would be earned income because that is a result of your labor. So one of the things I love to do is set up these one-person 401(k)s, but the problem for a lot of particular retirees is, you do need earned income to make a one-person 401(k) contribution whether it’s a Roth or regular.

John: Now, can you give me one more question?

Jim Lange: Sure, go for it John.

John: Because part of what I do through the 401(k) is try to buy real estate and sell it especially in this market. If I do that in other states as an individual, you have to worry about the dealer status. You don’t want over five properties.  Does a 401(k) even have to worry about that?

Jim Lange: Well again, I think the issue is, is it going to be a capital gain or loss or if you’re a developer, and you buy and sell land all the time, that’s actually not a capital gain or a loss when you buy or sell that because—

John: When you do it a lot.

Jim Lange: Right, because that is your normal business, and it’s just like selling widgets for a widget store that’s just plain old inventory. Inventory and it’s a capital issue, if it’s an inventory and not a capital asset, then that is earned income.  If it is a capital gain though, then you can’t do it. For the specifics of whether it’s five properties or whatever I’m not sure. I’ll tell you what my gut instinct is as much as I like Roth 401(k) contributions. My gut instinct--and particularly if you’re a smart guy because you like my book better than the 15 other books so I’m assuming you’re going to be making money on this transaction unlike the guy from Texas who emailed us and he lost $500,000. If you’re making some money here my instinct is if you have a choice.  I would prefer that it be a capital gain, because that way you’re paying taxes at the capital gains rate, and even though you won’t be able to make a Roth IRA contribution from that money, you’re going to be better off paying the lower capital gains rate and then the good…

John: Unless you’re doing it within 12 months, which if you had the same option and it’s a property you can flip within 12 months, don’t you want your 401(k) to buy something that could flip in 12 months and your personal you buy something to hold for 12 months?

Jim Lange: Alright, well now you bring up a completely different issue, which I assume you’re talking about actually purchasing real estate in your retirement plan.

John: Oh yes, absolutely.

Jim Lange: Alright, that’s a whole other set of complications. Very interesting idea, so the idea there is let’s say you have money in a retirement plan, and you’re interested in investing in real estate. If you jump through enough hoops, you can actually have your IRA or your retirement plan purchase that real estate. Now as a fair warning, the hoops are considerable, and there are a lot of restrictions. You’re obviously not going to get a deduction or you don’t do that with property.  The idea is to get a tax deduction or to have losses flow through to you, you do that with property that you think is going to appreciate in value and is going to throw off taxable income.

John: Which is what I’m doing.

Jim Lange: It’s a whole other area. I really like that idea and I’ll tell you what I think works really well which is kind of like the home run.  So let’s say right now your IRA or your retirement plan buys a piece of property that is presumably valued relatively low right now because that’s where real estate is. And then using a relatively current evaluation or appraisal you get a value on it, you make a Roth IRA conversion of that much, then over the next 5-10-20 years the property appreciates considerably. Then let’s say you ultimately sell it, the sales are going to go into your Roth IRA or your Roth 401(k) and…

John: Without paying taxes.

Jim Lange: And you will have created gobs of tax-free wealth. Very advanced technique, lots of caveats on that.  There’s a whole bunch of rules and a whole bunch of hoops you have to go through. Thank you for your question, John.

Beth Bershok: Thanks, John checking in from Texas tonight, 412-333-9385. And the original question that he brought up which is a one person 401(k) which is a strategy that is in the book, Retire Secure! Pay Taxes Later the second edition. I want to point out that we have a link on our website and it will take you right to where you can purchase it. So if you check out retiresecure.com you’ll find a link and you’ll be able to get that. And all of these strategies we’re talking about tonight are in the book, Retire Secure! Pay Taxes Later. Now coming up Jim in a few minutes, we are going to get to the big news, the huge news for 2010.  But let’s talk about 2009 for one more minute and why for seniors this year is a particularly good year to do a Roth IRA conversion.

Jim Lange: Sure. A lot of seniors already know that there’s no minimum required distribution this year in 2009. Most seniors that don’t need the money to live and have other sources of income are saying great, I don’t have to take a minimum required distribution. By the way, recently there was a law passed that said if you already took it, you can actually put it back.

Beth Bershok: And actually, we’re going to be covering that in the next show, that’s one of the topics.

Jim Lange: Which is very nice. So you don’t have to take a minimum required distribution in 2009. Now if you think about it, you want to make a Roth IRA conversion which is adding income to your existing income so you want to do that when you’re in the lowest tax bracket possible. I used to tell people, do the Roth IRA conversion after you retire so you don’t have your income from your job or wages from your job or you don’t have self employment income from your business.  But do it before age 70 ½ so you don’t have the income from your minimum required distribution, and that was usually the best year. Now if you think about it, in 2009 if your income is less than $100,000, then what that means is that you will presumably be in the lowest tax rate you’ll ever be in the rest of your life. That’s going to be the best year for seniors to make a Roth IRA conversion.  So all the hype--which we’re going to get to--is well deserved for people who have income over $100,000 in 2010, but the sleeper is doing the Roth IRA conversion in 2009 for seniors who are going to be in the lowest tax bracket they will ever be in for the rest of their lives. So we’re going through all of our clients who are seniors that have IRAs, and we are examining whether and how much to do of a Roth IRA conversion, not just for 2010 for people who have over $100,000, but for people who make less, then we’re saying let’s take a look at doing that conversion in 2009.

Beth Bershok: And the deadline for that is the end of this year, it’s December 31. Has there been any talk at all about extending that for RMDs or Roth for 2010. Has anybody been talking about that at all?

Jim Lange: They have been talking about that as a distinct possibility.  On the other hand, nothing is definite and at this point I think we have to assume that the minimum required distribution is coming back for 2010, and that seniors who are interested in doing a Roth IRA conversion should be thinking about doing it in 2009 if their income is less than $100,000.

Beth Bershok: Okay, we are going to get to the big tax law change that’s coming up January 1.  We’re going to tell you what it is next, how it’s going to affect every tax payer. We’ll be back in just a minute. It’s the Lange Money Hour: where Smart Money Talks.


3. Tax Law Change for 2010 - Eliminating Income Restrictions on Roth IRAs

Beth Bershok: Talking more smart money, and tonight the focus is Roth IRAs, Roth IRA conversions and the big tax law change that’s coming up in 2010. Listen, if you have a question for Jim Lange, we still have about 20 minutes, and you can get that in. We’re taking them live in the studio tonight, 412-333-9385. January 1-- I swear Jim that you’ll stay up to celebrate New Year’s not to ring in the new year but to ring in the tax law change that’s going to be happening on January 1. What the tax law change essentially is doing is eliminating the income restrictions that have been on Roth IRAs. So we’ve had this limitation for individuals-- it’s been $100,000 and for couples, it’s what $166,000?

Jim Lange: No, it’s also $100,000.

Beth Bershok: Oh, it’s $100,000. So if you made more than that, you couldn’t get into a Roth IRA. But now it is unlimited, any tax payer can get in on a Roth IRA. You can do a Roth IRA conversion. Can you do it on January 1?

Jim Lange: Well first, the type A part of me means that we have to be accurate. You can make a Roth IRA contribution if you have earned income of somewhere around $160,000 or less. So you can do a Roth IRA contribution with earned income even if your income is over $100,000. You can make a Roth 401(k) contribution regardless of your income even now in 2009.

Beth Bershok: That is if you have the opportunity.

Jim Lange: If you have the opportunity because you have either created your own or you work for a company that offers--an enlightened company--a Roth 401(k) such as our company. But with a Roth IRA conversion--the technical word is modified adjusted gross income of more than $100,000 up and to January 1st 2010-- you have not been able to make a Roth IRA conversion. By the way, it’s the same income limitation for married people and for single people.  In fact, before if you tried to say I want to file a separate return, that didn’t fly. You weren’t allowed to make the conversion at all. Well in 2010, all of those income limitations are right out the window, and anybody regardless of income is going to be eligible for a Roth IRA conversion. That means there are a lot of wealthy people that either are or should be just salivating going, oh man, I’m going to be able to create a tax free dynasty.  I’ll be better off by hundreds of thousands of dollars, my kids and grandkids will be better off by millions of dollars, when can I do it, when can I do it? Unfortunately, January 1 falls on a Saturday so you might have to wait a couple days, but really I think that this is just a fabulous opportunity.

Beth Bershok: Jim, when you see all the people in Time Square jumping up and down when the ball drops, it will be because it’s time for Roth IRA conversion.

Jim Lange: That wouldn’t be logical, but I think what happens is there isn’t anywhere near as much press on this, and it’s not part of mainstream financial advice for wealthy tax payers, and it should be.

4. Caller Q&A: Roth IRA Contributions/Conversions

Beth Bershok: We have another question. This is coming from Bloomfield tonight. We have Dave in Bloomfield. Hi Dave.

Dave: How are you doing?

Beth Bershok: Great. You have a question for Jim about Roth IRAs.  What is your question for Jim?

Dave: Basically, how would I get started, like where would I go and usually what is the minimum required to get started. Is it $10,000 or $5,000 or what?

Jim Lange: Alright, with a Roth IRA contribution--again I’m assuming that you have some earned income--and if your employer doesn’t offer a Roth 401(k) or even if they do and you want to start your own Roth 401(k), you can go virtually anywhere where you could make an investment. So you could go down to the local bank, you could go to Vanguard--I’m not here making recommendations for different funds or money managers etc.--but I would say that virtually anybody that invests money will offer a Roth IRA. And I think then it becomes an issue of how do you want the money invested.

Dave: Is there usually a minimum that you have to get started?

Jim Lange: Yeah, there probably will be.  I know if I was a company like that I wouldn’t take a two cent contribution to a Roth IRA. I certainly wouldn’t take it because the paper work would cost them more. So I would imagine that most of these companies are going to have some kind of minimum whether it’s $100 or $200 or whatever it is. I know that a lot of times what happens is people make contributions that are withheld from their paycheck at work, and that way you maybe put in $100 a month or something like that. But the rule for you if you have a job is first put money into a retirement plan that your employer is willing to match. Then do Roth IRAs or Roth 401(k)s, then do traditional retirement plans. But as far as where to go that’s really not my role on the radio here tonight, but I would say wherever you like to invest the money.

Dave: Okay. You say start off with the employer 401(k).

Jim Lange: No, start off with what the employer is willing to match. So, in other words, for example, if you work at the University of Pittsburgh--and by the way, we don’t talk about it much but I’m actually doing a workshop tomorrow for University faculty and TIAA-CREF participants. We don’t talk about that much because there aren’t that many professors listening. But anyway, if you are working for the University of Pittsburgh, if you put in 8% they will put in 12% of your salary. If you don’t put in anything they won’t put in anything. So you get 150% return on minute one, so you should always put in what any employer is willing to match even before the Roth and before anything else. You literally steal money from your mother before you don’t put money into the match. You just always do that. Then do Roth and Roth 401(k)s, then do traditional IRAs.

Dave: What I’m trying to understand is at what point do I start the Roth 401(k)-- once it builds up to $10,000 or $20,000 or you know?

Jim Lange: No, you start it tomorrow morning unless there’s a good reason not to and start it with whatever you can afford. You want to start early with regards to retirement plan contributions. You want to make sure that you have enough money for a rainy day, but after you have some rainy day money put aside, I’m a big fan of Roth IRAs. Alright, I think we’re going to move on.

Beth Bershok: Does that help you, Dave?

Dave: That’s what he says is when I have some put aside, I’m trying to get a more clear understanding is how much is some.

Beth Bershok: Anything.

Jim Lange: $100 a month is a starting point.

Beth Bershok: Sure anything is beneficial. Thank you, Dave. We have another question here from Bob.  He’s from the South Hills. He has a question about 401(k) Roth conversions. Hi Bob.

Bob: Hi. Yeah, I’ve been listening to you guys, and my company started offering a 401(k) Roth. Truthfully, I think they did it in accordance to the fact that they are no longer going to match on the 401(k). If I’m right to understand you now, I already have a Roth. Can I also establish a 401(k) Roth, or do I only have the capability of contributing to my personal Roth?

Jim Lange: Alright, are you married or a single guy?

Bob: I’m married.

Jim Lange: Alright, so let’s assume that your income is less than $166,000, then you’ll be able to put in. Are you older or younger than 50?

Bob: Just a couple years older.

Jim Lange: A couple years older. Well, the good news is you can put in more money in your Roth 401(k), you can put up to $20,000 in your Roth 401(k). You can put away $6,000 in your Roth IRA. You can put away $6,000 for your spouse in her Roth IRA. So total you could put away is $32,000 in these Roth IRAs, and even though your employer doesn’t match it, it’s money that if you can afford to put away, that much will grow income tax free for the rest of your life, spouse’s life, children’s lives, grandchildren’s lives.

Bob: Jim, would you recommend doing that before just putting it into a 401(k)?  I mean establishing a 401(k) Roth if they’re not matching the 401(k) contributions?

Jim Lange: Well, that gets into the issue of are you better off with a traditional retirement plan or Roth? All of the numbers I’ve shown are in most cases you’re much better off with the Roth. Let me tell you the exception. The exception would be if you’re going to be in a much lower tax bracket after you retire, and your retirement is imminent. So let’s say you’re 65 years old, you’re at the height of your earning power, you’re making $200,000 and then next year you plan to retire, and you’re not going to have very much income at all. For that person, I would say do the traditional retirement plan, get the full deduction on the 401(k) and then wait until after you retire and you’re in a very low tax bracket to make a Roth IRA conversion. On the other hand if you’re in your 50s, early 50s particularly, and you’re going to be working another 10-15 years or more, then the Roth 401(k), even though you don’t get the tax deduction, is going to do much better, and I actually analyzed that exact question in my book.

Bob: Fabulous. Thank you, I appreciate it.

Beth Bershok: Thank you, Bob. The studio line is 412-333-9385. And the book is Retire Secure! Pay Taxes Later. It’s the second edition. There’s a link on our website which is retiresecure.com if you want to buy that book. Jim, we talked about January 1 when the income limits are off, but there’s an extra little bonus benefit for 2010 which involves 2011 and 2012, and as a matter of fact, I had an email question today, so I want to go through this question, and you can explain how this is working. This comes from Steve who is listening tonight in Austin, Texas, and Steve said that he understands 2010 is a great time for Roth conversions, and then you can choose to either pay the conversion taxes in 2010-- this is what Steve is saying--or spread the conversion income over 2011 and 2012?  Since we have no clue what Congress is going to do with tax rates, how would you determine the best way to pay for a 2010 conversion?

Jim Lange: Alright.  Well first,let’s take a look at what the law is, and by the way, I just wrote an article for Bottom-Line Magazine, and I had to clarify this point for the editor. You actually don’t have the option of paying the tax for a 2010 conversion in 2011 and 2012. You have the ability to defer half the income. So let’s do an example. You make a $100,000 Roth IRA conversion in 2010. If you want to, you can add that $100,000 to your existing income for 2010 and file the return presumably some time around April 2011 and pay the taxes at that time. Or what you can do is make a special election to say I’m going to add $50,000 of income in 2011 and $50,000 of income in 2012. So what you’re really doing is you’re not spreading the tax per se, you are spreading the income to those two additional years. Now for most middle income tax payers, I like the idea of spreading the income and the reason I like the idea is A. - I like the idea of paying taxes later rather than now, and B. - By spreading the income you might end up staying in a lower tax bracket or perhaps what you do is you make a small conversion in 2010, another one in 2011, and another one in 2012. And by the way guys, that is a great hint on what’s a great strategy which is not necessarily making a huge conversion one year but doing multiple conversions over a number of years. Now, let’s say you’re a higher income tax payer and you fear tax increases in 2011 and beyond, and by the way, the Bush tax cuts are set to expire in 2011, so existing tax law has the tax rates go up in 2011. In that case, and particularly if you’re a high income tax payer, you are probably better off recognizing all the income in 2010.

Beth Bershok: We do have another question. This is from Ingram. We have John from Ingram and John, what’s your question for Jim?

John: Hi, how are you tonight?

Jim Lange: Good, thanks. How are you?

John:  Ok. I just came in the house and turned you on, and I thought I’d give you a call. I’m a retired teacher, and I’ve been retired since the year 2000. I had rollover money, and I had invested that in a diversified fund, so I don’t plan on taking anything out until I’m 70 ½  when I’m forced to. But more importantly here, I received money through an inheritance not that long ago, and I was told to put it in a Pennsylvania tax-free fund. I was just wondering what you thought about it. The amount of money was about $40-50,000.

Jim Lange: Well, first of all, there are a couple things there. First, one of the things that I like about your situation is as a retired teacher, are you part of the SCRS or PSR system?

John: Yes.

Jim Lange: Okay, so you have a guaranteed income source for the rest of your life?

John: Yes.

Jim Lange: Alright, that’s a traditional pension and the other good news about that is that pension is guaranteed by the Pennsylvania Constitution, so that’s about as solid a pension as you’re going to get. That combined with Social Security, depending on when you take it, can be a wonderful base.  That pension and your Social Security, you can kind of look at that money as money that is going to pay the bills, it’s going to keep a roof over your head, it’s going to keep gas in the car and it’s going to keep food on the table. Alright now if there is some other money some let’s say inherited money, I call that after tax dollars. Yes you could invest that money. One thing that you might consider is taking the money that you had saved as a teacher and back then you had money in a 403(b) you might have called it your annuity, the tax table was 403(b). Let’s say you have some IRA or 403(b) money, you might consider making a Roth IRA conversion of at least a small amount and using part of your inherited money to pay the taxes on the Roth IRA conversion.
John: I thought you had to be working to do a Roth?

Jim Lange: You have to be working to make a Roth IRA contribution, but what I have in mind for you is a Roth IRA conversion where you’re taking your existing IRA and your existing retirement plan, or at least a portion of it. You’re paying taxes up front, and the money grows income tax free for the rest of your life, and that’s a very important point.  In fact, for a lot of people, a lot of retirees-- and I probably have as many retirees or even more than people who are actually working in my practice-- those people don’t have earned income and can’t make a Roth IRA contribution.  They can’t contribute to a Roth 401(k) or a traditional IRA, but they can make a Roth IRA conversion, and so can you.

Beth Bershok: John, does that help you?

John: I guess it does. Actually, we’re against the clock here.

Beth Bershok: We are just about out of time. Thank you so much for listening and calling in tonight. You know, Jim, we really have just been able to scratch the surface tonight on this topic. What I strongly recommend is that if you’re listening tonight--and we obviously have people with a lot of questions--is that you come to one of the workshops. We have one this Saturday at the Holiday Inn Moss Side Boulevard in Monroeville. Still some space but we are close to capacity. 1-800-748-1571. That number answers 24 hours a day, so you can call it tonight. There’s a session at 9:30-11:30 and 1:00-3:00. And then the next free workshop is going to be on November 21, a Saturday. It’s at the Four Points by Sheridan in Mars. So really you get to see Jim in person, and you can get all of this information in person. 1-800-748-1571. You can also find more details at retirescure.com. And when we come back on November 4, it’s going to be all about year-end tax planning, so please join us for that. 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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