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

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Strategies for Those Who are Close to or at Retirement
Jim Lange, CPA/Attorney
Episode 8

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

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TOPICS COVERED:

  1. Strategies for Those Who are Close to or at Retirement
  2. Why Employers Should offer a Roth 401(k)
  3. Advantages of Not rolling Money into an IRA
  4. The Advantages of the One-Person 401(k)
  5. Annuitizing your Retirement
  6. Special Tax Treatment for After-Tax Dollars

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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 for joining us tonight we are talking smart money, I’m Beth Bershok along with Jim Lange, CPA, attorney, author of two best-selling editions of the book Retire Secure! Pay Taxes Later. And before we get started the first thing I have to do Jim is congratulate you because the book got a really great review in Estate Planning Magazine for June 2009. The book came out in February; it’s a Wiley book and just this month if you can pick up a copy of Estate Planning Magazine and go to page 42 the review is on that page and they say at the very end highly recommended. I’m also going to point out one little section where it says this book is a great read full of illustrative and entertaining stories but also full of practical advice. And then it notes also the charts and the formulas that you have listed all through the book. At the end of the show, you want to stick around for the end of the show because we’re going to give away some copies of this book. Highly recommended by Estate Planning Magazine so make sure you stick around and find out how to get a copy. Alright Jim so we’re going to talk about one of your major niches, which is people that are close to or already retired. You get to that point, you’ve been working, you’ve been saving, you’ve been planning for retirement, you finally get there and then what do you do? That’s where things kind of get complicated. We have some great advice tonight, some great strategies and if you have a question 412-333-9385 is the studio line, Jim will be happy to take your questions, 412-333-9385. Now Jim we said we were going to talk about whether you are close to or already retired, just retired, let’s start with close to retirement. So let’s say you’re a few years away from retirement, what should you be doing and if you haven’t retired yet for instance should you be contributing regularly to a Roth 401(k) or regular 401(k)? You need to start planning before you retire.

Jim Lange: Yes you do and some of the advice I would give somebody who is close to retirement is actually the same in terms of contributing to a retirement plan. I think a lot of times right now with the market down people are saying well gee now isn’t a good time for me to make contributions to a retirement plan. I would disagree and say it’s probably even more important to. With a younger person I’m almost always going to recommend Roth IRA contributions if they are working and also contributions to a Roth 401(k) if that is available to them.


1. The Differences Between a Traditional 401(k) & a Roth 401(k)

Beth Bershok: Okay, can you explain the difference between a traditional 401(k) and a Roth 401(k)?

Jim Lange: Sure, a traditional 401(k) is where you have the you chip in some money that is typically withheld from your check, the employer will then accumulate that money for you. It’s usually in some type of investment and you don’t have to pay tax on that money or in other words or another way to look at it is, you get a tax deduction. The money grows income tax deferred and then eventually when you take it out you have to pay tax. With a Roth 401(k) you don’t get a tax deduction just like a regular Roth IRA, but when you eventually take the money out or perhaps even your heirs take it out, you’re not only not taxed on the money you originally put in but you’re not taxed on the growth.

Beth Bershok: Jim this has never happened on this show before, this has never happened on The Lange Money Hour: Where Smart Money Talks, but KQV is all news all the time and we just got this warning and I have to pass it on. We just got from the national service a tornado warning, this is a tornado warning for southeastern Allegheny county in southwestern PA, Westmoreland County in southwest PA. So there is an actual warning a tornado warning for south eastern Allegheny county and Westmoreland County and that’s in effect until 7:30. So for another 25 minutes the tornado warning is in effect. That’s just what happens on live radio.

Jim Lange: I suppose so!

Beth Bershok: It’s just crazy, but pleased by advised tornado warning southeastern Allegheny county, Westmoreland county and that’s in effect until 7:30.

Jim Lange: And I guess the only thing listeners can do if they happen to be at home and there’s some static on the line they can go to KQV.com.

Beth Bershok: Yes, actually I advise that we have listeners all over the country and Jim every time we do a show the next morning I have emails from literally all over the country, California, Ohio, Michigan, Texas, they’re all listening online you can do it here.

Jim Lange: You notice Beth that not strategically say Detroit where we did get a call the other day.

Beth Bershok: I went with Michigan, but yeah. So here you can do it too, listen at KQV.com. Okay back to now we were talking about if you’re close to retirement if you haven’t retired and you’re talking about a regular 401(k) or a Roth 401(k), the one point we should make is that not every employer offers a Roth 401(k).

Jim Lange: Right that’s a big deal and I am always encouraging employers to offer their employees a choice of a Roth 401(k) or traditional 401(k) or the employee can actually mix or match; that is do some in a traditional and some in a Roth. So for example in my small company of about 10 people the people who are eligible for a Roth 401(k) have their choice. I put in a certain amount which by the way is a traditional retirement plan, that is they don’t have to pay tax on it, or they can deduct it, the money grows tax deferred and they’ll have to pay tax when they take it out. But for their portion, the employee portion, my employees have the choice they can either do the traditional 401(k) or the Roth 401(k). Now in general I am a big fan of the Roth 401(k) because it grows tax free and particularly for younger people. However since the focus of today’s show is people who are approaching or at retirement, I have to potentially adjust that advice. It’s going to be based on tax bracket and here’s why the advice might change for somebody who is close to retirement. It is very possible that if you are at your peak earning years close to retirement you’re in a high tax bracket now in which case the traditional 401(k) the tax deduction will be very effective and will be worth a lot of money to you, in which case you’re probably better off with the traditional 401(k). Then if you’re interested in the Roth IRA world maybe do a Roth IRA conversion after you retire. So I am still a big fan of Roth IRA conversions for a lot of retirees, but for people who are still working who are in a high bracket now and will likely be in a low bracket in a very short period, for those people I would tend to do a traditional 401(k) and then do a Roth IRA conversion later. If you’re going to be in the same or a higher bracket later on which is going to apply to a lot of younger people or you have a very long time arise, then we’re almost always better off with the Roth 401(k).

Beth Bershok: But if you’re a few years away you’re 60 or 61 or 62, in most cases you’re saying a traditional a regular 401(k) may be the best bet.

Jim Lange: That might be it’s going to depend on two things. One is what is your tax bracket now versus what will it be later and two what is your time horizon. The higher the tax bracket now and the lower later, the more you want the Roth 401(k). I’m sorry the higher the tax bracket now the lower later the more you want the traditional 401(k) now. Likewise, if you’re going to have the same or a higher tax bracket later, then you’re going to want to go to a Roth 401(k). The other factor of course is a lot of people are assuming the tax rates are going to go up and if that’s true, than a Roth 401(k) becomes more favorable.


2. Why Employers Should Offer a Roth 401(k)

Beth Bershok: Is there any reason Jim an employer would not offer a Roth 401(k)?

Jim Lange: I think it’s out of inertia. So for example I think all the big companies or at least most of them are now offering their employees a Roth 401(k) or in the non-profit world for example University of Pittsburgh and Carnegie Mellon University, two of the large non-profits they both offer their employees the choice of a traditional 403(b) or a Roth 403(b). And I think we’re seeing the bigger companies switching over to offer their employees a choice, it’s maybe a tiny bit more book keeping but I don’t think it’s certainly substantial. And I think it’s going to take a while but I think eventually the smaller firms are going to catch on to realize it’s a great benefit that they can give their employees and it doesn’t cost them anything. So if you are a small employer or if you are let’s say a benefits person at a company, you really ought to start thinking about offering your employees the option of a Roth 401(k) or traditional 401(k).

Beth Bershok: Okay 412-333-9385 is the studio line. If you have a question during The Lange Money Hour: Where Smart Money Talks. Alright let’s move to you’ve just decided to retire and now the big question is what am I supposed to do now? I mean you’ve been planning and you get there and then what do you do? Now let me put this scenario to you Jim because this is what I normally hear, this is what everybody says. You’ve been socking money away in your 401(k) for years and years, you have a nice balance in your 401(k) and the first thing everybody says you get to retirement and they say oh my gosh make sure you take that 401(K) and you roll it into an IRA.

Jim Lange: Well the first thing I would do is step back and think for a moment before you do anything. I forget the exact statistic but people spend more time planning their vacations than planning their retirements.

Beth Bershok: That may be true in my case.

Jim Lange: But the first thing is you really want to become educated or go to the appropriate advisor that you trust 100% because there’s going to be a lot of people that are going to give you different advice and it’s not necessarily always in your interest. So the normal rule what a lot of financial advisors, a lot of stock brokers, and a lot of people in the money field will tell you is the day that you retire take all your money from your 401(k) and roll it into an IRA and usually the IRA happens to be managed by them or maybe they’re going to sell you a product inside the IRA. And I’m not even saying that a lot of times that they couldn’t do a better job investing than your 401(k). Certainly you’re going to have a universe of choices in an IRA as opposed to a limited number of choices in a 401(k) but there’s some good reasons why you might not want to do that immediately and I think that it is really important for people who are retiring to consider all those reasons before they do anything.


3. Advantages of Not Rolling Money into a an IRA

Beth Bershok: Well what would some of the advantages be of not rolling that money into an IRA?

Jim Lange: Well for one thing it is possible that you’re going to have a better or potentially cheaper investment choice in the 401(k). I’ll just give you an example, there’s a lot of Westinghouse employees and I know that we have a number listening tonight and they have in their 401(k) plan one of their options is a fixed income account. Now sometimes the fixed income account is actually higher than average interest rate on a guaranteed investment, it’s called a GIC, a guaranteed income investment. Sometimes you want a guarantee or if you’re a university or a nonprofit person, you might have some money in TIAA which is an excellent bond fund and it might be better to keep some of that money in a guaranteed bond fund rather than taking the money and rolling it into an IRA. Now it might be appropriate to take a portion of your retirement plan and roll it into your IRA, but the reason is it’s possible that one or more of your investment choices in the 401(k) might be entirely appropriate for you and it might not be appropriate to roll the entire amount out.

Beth Bershok: Okay, I have another question for you about rolling that into an IRA, but I have a really serious weather announcement too. The KQV has stuck around to check this weather out this is all news all the time so we want to make sure we’re bringing it to you even during the Lange Money Hour. Reports into the KQV news center that Ellsworth Avenue has actually passed Morewood. There is also severe flooding along Carson and numerous reports of trees and wires down throughout the entire area. As we told you earlier we did have a tornado warning for south eastern Allegheny County and western central Westmoreland county that’s in effect for another 15 minutes. And now this just in Ellsworth Avenue has collapsed passed Morewood. Flooding along Carson just avoid Carson altogether. Numerous reports of trees and wires down through the area. So if you are travelling tonight, make sure you are extra careful if you have to get in the car and go somewhere. If you don’t have to I would stay where you are as there is flooding in a lot of areas. Okay back to we were talking about rolling your 401(k) into an IRA, this is at retirement. This would normally Jim that would be the time that you would do it, you wouldn’t really at any other time say hey I’m going to roll my 401(k) into an IRA, this would be happening to you at retirement.

Jim Lange: Well typically a lot of times the reason why it comes to a head at retirement is that’s the first time you’re allowed to do it. A lot of times the rules of the 401(k) or the 403(b) plan will not allow you to have access or roll that money into an IRA until you actually retire. So that’s when the decision is first a possibility. It is very possible, even likely that that’s when you’re going to be approached. There isn’t anything magical that there’s no critical emergency that you have to transfer all your money out even if that’s the appropriate thing to do, that you have to do it within two days or two weeks of retirement.

Beth Bershok: That’s what I was wondering, say if you’ve been retired for 5 years would this still be an option if you wanted to do it you could do it anytime after retirement?

Jim Lange: That’s correct.

Beth Bershok: Okay now, in prior years if I’m not mistaken there were tax advantages to roll your money from a 401(k) to an IRA.

Jim Lange: Well let’s just take the Westinghouse people. In the event let’s even just say two years ago I think was even last year. In the event that a Westinghouse employee died and left their money in their 401(k) to an employee I’m sorry to their children, their children would have to pay income taxes on the entire amount the year after the Westinghouse employee died. If the employee the day before he died rolled the money from a 401(k) into an IRA and then he died then the child could stretch or defer the taxation for many, many years. So I’ve actually switched my advice to Westinghouse people I used to tell them for tax reasons we want to get the money out of the 401(k) into an IRA, forget about investment reasons, but now that tax law has basically been changed so that there is no real difference in terms of the force or the time that the beneficiary must take the money out of the 401(k) and there’s actually some tax advantages of keeping the money in the 401(k) that hardly anybody talks about.

Beth Bershok: Why does hardly anybody talk about it, let me ask that first.

Jim Lange: Well I don’t want to say anything bad about any of the financial advisors, obviously most financial advisors are going to be paid to manage assets or to sell products and it’s typically going to be in their interest to have the money come out of the 401(k) into the IRA. In all fairness I think most of them actually genuinely believe that they can do a better job and that there are a lot of good reasons to get the money from the 401(k) to the IRA such as a much better diversified choice of options; and it’s very possible that they can actually do better either with managed money or some of them are interested in doing different annuity type products.

Beth Bershok: So what are some of the advantages that most people aren’t telling you about?

Jim Lange: Well again I mentioned the investment advantage. There’s two other advantages to a 401(k) that most people don’t think about. The first is creditor protection. Creditors when they are going after their people that owe them money, and by the way you might not owe somebody money right now but if you drive a car it’s possible that you will become, that you could lose a lawsuit and you can owe somebody a lot of money and you don’t want to be wiped out or in today’s litigious society, a lot of people can sue you and you can literally lose your shirt. So any time you can have money protected from creditors it’s better. Money in a 401(k) is a better creditor protection it’s called an ERISA type plan that has better creditor protection than an IRA. So an IRA does have some creditor protection, in fact a fair amount, but it’s not the same and it’s not as good as a 401(k) plan. So that fact in and of itself would have a slight plus to the 401(k). The other advantage and this is very recent is that in the event that you die with money in a 401(k) plan and you leave it to a non-spousal heir, the non-spousal heir when I say non-spousal heir I’m really talking about your kids or your grand kids in most cases. They can actually do a Roth 401(k) and inherited 401(k) Roth IRA conversion.

Beth Bershok: Which is not available if you have an IRA?

Jim Lange: Which is not available for an inherited IRA so there’s actually a tax advantage of the 401(k) versus the IRA, which is much different than it was even 2 years ago.

Beth Bershok: So that’s another reason to do it. You mentioned something a few minutes ago that gave me an idea. What if you have an advisor that says immediately when you retire roll your 401(k) into an IRA and you think it’s not the right thing to do; you don’t want to do it you want a second opinion how do you get a second opinion financially? Is it like a doctor? It’s easy find out how to get a second opinion medically, what do you do if you want a second opinion financially?

Jim Lange: Well I would say the same thing to see more than one person and to try to educate yourself. I personally think that what would be very good is if you became somewhat conversant in some of these issues and then when you talk with your advisor have certain questions to ask to see if they know their stuff or not.

Beth Bershok: And if they don’t?

Jim Lange: Well if they don’t then you might think for a second. So for example do they have my book? No that’s not fair.

Beth Bershok: Hey wait your book just got highly recommended in Estate Planning June 2009 they should have it.

Jim Lange: But I think it would be fair to just ask an advisor well which books or which literature do you follow regarding IRAs? And if they come back and they tell you Natalie Choate, Ed Slot, Bob Keebler, Jim Lange, you might even say do you have that book handy could I see it. And if they can’t produce any of those books or they don’t seem conversant in the area that might raise a flag that maybe that there’s a certain lack of knowledge in that particular area. There’s a lot of very good investment people that don’t know the ins and outs of the tax law and what retirees and pre-retirees should be doing.

Beth Bershok: Well we are taking you through this tricky transition if you’re close to or already retired what on earth do you do now? And we actually have some lesser known issues that we’re going to be covering here in just a minute so hang on it. It is The Lange Money Hour: Where Smart Money Talks.

Beth Bershok: Thank you for joining us tonight I’m Beth Bershok along with Jim Lange and we are taking you through close to or already retirement a kind of tricky transition what do you do now? We’re going to get back to it in a second but I did want to give you the number again to sign up for the free workshop that we have coming up this Saturday. It’s 800-748-1571 and this is called Two New Tax Laws Create Shocking Opportunities for Wealth Preservation. Jim does a lot about his Lange’s Cascading Beneficiary Plan, we take you through the Roth IRA conversions 2009 and 2010. And we have two sessions this Saturday one from 9:30 to 11:30, one from 1 to 3. So the toll free number please tell us which session you want to go to, it’s 1800-748-1571. This is at Crown Plaza South right across from South Hills Village this Saturday. It is definitely worth your time so call 800-748-1571 you can also get the information on our website retiresecure.com. But again that workshop is coming up this Saturday June 20th Crown Plaza South across from South Hills Village. Okay Jim we are navigating the tricky waters of close to or already retired and we were talking about what to do with the money in your 401(k), should you roll it over into an IRA or should you not? And we were talking about the advantages and disadvantages. I have a quick question before we get to the next segment and that is can you just do a portion can you roll over a portion of your 401(k)?

Jim Lange: Yes you can.


4. The Advantages of the One-Person 401(k)

Beth Bershok: So you can pick any portion and roll that into an IRA if you thought that was appropriate?

Jim Lange: Right so for example some of the Westinghouse people might prefer to keep some of the fixed income portion of their portfolio in the guaranteed income contract and then take the rest of it and roll it into an IRA.

Beth Bershok: Now some of your advice comes from new tax laws and this is something that’s relatively new for you as well, this is a relatively new strategy setting up a one person 401(k) after you retire.

Jim Lange: Yeah this is actually a Jim Lange original, I didn’t read this anywhere I made this up.

Beth Bershok: Actually I have to be honest I remember the day it was the week you came up with this you were just like bursting with excitement, oh my gosh I just thought of something we can do this one person 401(k) and for a second I had no idea what you were talking about until you started to explain it. But you have to do this after you retire.

Jim Lange: Usually it is possible that you can do it before hand and actually this also applies to self employed folks. A lot of times accountants will tell them to do an SEP plan a self employed pension plan when a one person 401(k) plan might be better. But this is a fabulous strategy for retirees that have some income. So let’s say for discussions sake that you are working at your main job you know 10, 20, 30, 40 years and you have a lot of money in your 401(k) plan. But at retirement instead of not doing one thing you do something that earns some money, maybe you even do a little consulting for the company that you’re retired from; maybe you work at the golf course, maybe you do a little work for your children or your children’s business, or maybe if you own real estate or a family partnership you actually funnel some income from that partnership to yourself as a management fee. In some way let’s assume for discussions sake that you can have some kind of income even if it’s $2,000, $5000, $10,000 it doesn’t have to be the equivalent of a full salary. Then what you can do now this gets a little tricky so bear with me listeners, thank you but the rewards are great.

Beth Bershok: And if you have a question on this 412-333-9385 so let’s go through it.

Jim Lange: What you can do is you can set up this one person 401(k) plan. Now let’s even say that the profits are $5,000 and the contribution that you’re allowed to make to a 401(k) plan just the same as you are allowed to make to your 401(k) plan when you are working. The difference here it’s a one person 401(k) plan completely under your control so if you want to manage the money or if you want to hire a money manager it’ll be 100% under your control. But here’s the interesting thing, I’m not all that interested in the money that you’re going to contribute to it because that’s probably going to be minimal if your earnings are not great. What’s a very interesting strategy is to take money from your 401(k) or perhaps it’s already been rolled into an IRA and then take that money and do a trustee to trustee transfer more commonly called a rollover but take that money and put it in your one person 401(k).

Beth Bershok: And that’s okay you can do that part.

Jim Lange: Yes you can, now that goes against what everybody that’s a different direction than most everybody has encouraged people. Everybody said, hey get money from your 401(k) to your IRA. Now I’m saying in certain situations it might be very interesting to take money from your 401(k) plan at work or even your IRA if you’re already retired and the money’s already in your IRA. If you can set up one of these one person 401(k) plans then you transfer the money to the 401(k) plan.

Beth Bershok: Is there a limit on that or you can transfer the whole thing?

Jim Lange: There’s no limit and under the portability rules which more or less say that you can transfer most any retirement type asset to another like a 401(k) to a 403(b) and a 403(b) to an IRA to a 457 Plan, etc. But what’s one of the great things about this one person 401(k) plan it can be completely under your control and here are the two biggie issues with it which I mentioned before but now I can create this for the person who is just a one person operation. You can this one person 401(k) plan is still a ERISA plan which means that you still get the superior credit protection that I mentioned earlier. So you get better creditor protection and by the way the famous case on that is OJ Simpson because OJ Simpson has some big time judgments against him by his creditors.

Beth Bershok: But he was still living in a mansion in Florida.

Jim Lange: Right, part of it was the real estate exemption but part of it he still has money and that money is because he had a 401(k) plan and if it’s good enough for him and it protected his money and he had some serious heat, I think that it would be very good for a lot of clients. So you would get a better protection of your existing money than in an IRA and the other thing is, if you die and leave it to your children or your grandchildren they can then do a Roth IRA conversion of the inherited one person 401(k) plan.

Beth Bershok: So really your strategy with setting up this one person 401(k) is not to just keep contributing to this plan, it’s long term strategy.

Jim Lange: Yeah it is. It might be a little bonus to continue making a contribution to the plan but the real reason why I’m interested in it is superior creditor protection and the ability for heirs to make a Roth IRA conversion of the inherited 401(k).

Beth Bershok: But the key is something that you mentioned earlier you just can’t set one of these up after you retire, you must have some kind of earned income.

Jim Lange: You must have some earned income.

Beth Bershok: And you may want to search out, do you think it’s advantageous enough that you might want to search out some kind of earned income just to be able to do this?

Jim Lange: Now you’re getting me in trouble because somebody’s going to say, hey Lange said you should go back to work dad. I don’t want to necessarily try to play psychologist and talk about the benefits of work and the benefits of retirement.

Beth Bershok: Well it gets dad out of the house and it gets this plan in place.

Jim Lange: I would say it’s always probably good to have a little earned income and particularly if it’s something you enjoy doing. But if you’re doing that anyway rather than not making any contribution to a retirement plan, it is an interesting strategy to get better creditor protection, to have all your investment choices under your control, and then have the ability for your kids to make a Roth IRA conversion of the inherited 401(k).


5. Annuitizing Your Retirement

Beth Bershok: Okay let’s move into some of what you consider to be lesser known issues that you think our listeners should be aware of and this is if you’re nearing or at retirement or after you’ve retired. Let’s start with taking advantage of outdated annuity tables that may allow retirees a better than market rate if you annuitize a portion of your retirement.

Jim Lange: Yeah there’s a lot of types of retirement plans where they will sometimes give you a choice of taking a lump sum or it’s called annuitizing which is taking so much money per month every month for the rest of your life.

Beth Bershok: This is when you get to retirement you make this decision.

Jim Lange: Yeah that’s correct. Well sometimes the annuity tables are not updated frequently and sometimes what will happen and this is particularly true in the public sector you know so there are some teachers who can sometimes take advantage of some of these ideas. The annuity amounts that you’re getting are based on older interest rates which are much higher than today’s rates. So if these rates were established let’s say 5-10 years ago or even longer ago it’s possible that the guaranteed rate is going to be more attractive than a fixed income investment today. So sometimes it makes a lot of sense to take a very hard look to see what are the investment options and what are the annuitizing options of the employer that is offered to the employee before you make a move and before you make a IRA rollover or IRA trustee to trustee transfer. By the way we’ve been using the rollover pretty loosely and that’s because that’s the most common word. Technically I prefer a trustee to trustee transfer and the difference between a trustee to trustee transfer and a rollover is a trustee to trustee transfer, you literally never hold the money it goes directly from your employer to a wherever the money is being invested.

Beth Bershok: It never passes through your account.

Jim Lange: Right you never get a check, there’s no withholding on it if it’s done correctly and technically that would be a trustee to trustee transfer, where theoretically a rollover is when you actually get a check, you take that check and you go to your bank or wherever you’re going to invest it and you give them that check.

Beth Bershok: That’s what you’re calling a rollover?

Jim Lange: That’s a rollover.

Beth Bershok: That’s technically what a rollover is.

Jim Lange: That’s right and I don’t like rollovers because you get into issues of withholding and a lot of other problems that are frankly not needed.

Beth Bershok: Aren’t’ most of these a trustee to trustee transfer though?

Jim Lange: Most of them are but I’m just saying that I’m being a little bit technical. But I really prefer a trustee to trustee transfer then a rollover. I will tell you this, even if it’s more common if you’re one of the people that did a rollover that should have done a trustee to trustee transfer, you have some major problems because if you don’t tell anybody anything there’s going to be a 20% withholding tax on the money.

Beth Bershok: 20% of your portfolio?

Jim Lange: Right and remember the point of this is you’re not going to be paying tax on it because let’s say you have a million dollars in a 401(k) and the idea is you’re going to do a trustee to trustee transfer into let’s say your own set of investments, whether it’s Schwab or Vanguard or a money manager or whomever, the point is still to get a million dollars from one account to another and have no taxation at all. If you have a 20% withholding now there’s only $800,000 being transferred even though there’s no taxable income and you have some real problems.

Beth Bershok: You have some real problems you just lost 20% of your portfolio that’s huge.

Jim Lange: It is huge! That’s why I don’t want to poo poo this difference between a trustee to trustee transfer and an IRA rollover.

Beth Bershok: And how does that happen? Do you give those instructions or would you end up with a rollover if you didn’t give the instructions to do a trustee to trustee transfer, is that how that would happen?

Jim Lange: Well I think most companies who are harboring your money in the 401(k) are not going to do anything until you tell them what to do. If you just say hey I’d like my money or I’d like to do a rollover and without thinking they write you a check they’re going to withhold 20%.

Beth Bershok: That could be a huge costly decision.

Jim Lange: Yeah and its happened to a lot of people and it’s miserable. So what I would like people to do is to have all their ducks in a row, figure out a strategy before they do anything.

Beth Bershok: And then say this is where I want my money to go, you transfer it.

Jim Lange: That’s correct.

Beth Bershok: Well I want to get back for a second we were talking about the annuity tables how do those tables get outdated so that the interest rate is years behind?

Jim Lange: Well if you think about it if you were buying an annuity and when I use the word annuity I’m not referring to the tax deferred annuities that a lot of people like now. Because of the guarantees but let’s say an immediate annuity where you give the insurance company a chunk of money and they give you a check every month for the rest of your life, or in the event of your retirement there are certain employers that will give you a choice of a lump sum or you get you know let’s say a million dollars or half a million dollars or whatever it is and they just say here you can do whatever you want. Or you can opt to receive X number of dollars per month for the rest of your life or X number of dollars per month for your life and the life of your spouse. Well if you were to go to an insurance company and buy that annuity the relevant factors are how long the insurance company thinks you’re going to live and what the interest rate is today. Now right now the interest rate is relatively low. A number of years ago it was much higher so let’s say that that company and this is even more true in the public sector, is basing the amount that they will pay you on if you annuitize based on the interest rate. If they don’t bother updating that interest rate which many of them don’t do, the old rate is much more attractive than today’s rate so therefore it might be more attractive for you to annuitize a portion of your retirement plan than roll the whole thing over into an IRA.

Beth Bershok: And you can always pick a portion is what you’re saying.

Jim Lange: And that’s my big thing because I’m never going to want to annuitize everything but I’m often wanting to annuitize a portion of the retirement plan and sometimes you get a better deal doing it through your employer than you can in the private sector.

Beth Bershok: There’s a lot of things to figure out.

Jim Lange: There’s a lot of things to figure out and frankly most people don’t really get this information.

Beth Bershok: Well which is why you should call our office 412-521-2732. I have another question about this annuitizing situation. What if you get to retirement and you make a decision and you say yes I am going to annuitize this portion of my retirement plan, I’m going to annuitize 50%. Can you ever go back and redo that?

Jim Lange: No.

Beth Bershok: No so you’re done. If you decide to annuitize a portion of your retirement that’s it that portion will always be coming to you in an annuity you cannot reverse this decision.

Jim Lange: Yeah that’s true and that’s why you really want to think twice before you annuitize. So it’s a scary decision so let’s say because remember the annuity is guaranteed for the rest of your life, typically. So let’s say you decide to annuitize and the day after you annuitize you go to the doctor and the doctor says gee I’m sorry you have this terrible cancer you’re only going to live a year, then obviously annuitizing would be terrible because after you die if it’s a one life annuity poof you lose it all. So you’d love to go back and say hey I changed my mind I would like to roll the money or do a trustee to trustee transfer and the employer or the annuity company or the insurance company is going to say no. So you really do want to think twice before you annuitize because that is something that you can’t take back.

Beth Bershok: And are there certain types of clients Jim in your own practice you think it’s generally a good idea for them at least to have a portion?

Jim Lange: I often do and there’s certain types of people who do better with annuitizing. So for example somebody who is not as interested in leaving money to their children and they’re interested in a guaranteed income for the rest of their lives, that’s a good person to annuitize and they might annuitize even more than somebody who has children and is very interested in leaving money behind. The other thing is what’s your health like?

Beth Bershok: Yeah right.

Jim Lange: What is your genetic history.

Beth Bershok: What if you’re 65 and both of your parents lived to be 100?

Jim Lange: Well assuming you’re in good shape then I think annuitizing would be great and for anybody that does annuitize I would really strongly, strongly recommend that they take the advice of Voltaire the famous writer who has some advice for people who annuitize. He does.

Beth Bershok: Who knew?

Jim Lange: Who knew? And I am now going to quote Voltaire directly, who thought a financial guy would be quoting Voltaire on the radio.

Beth Bershok: This doesn’t happen every day.

Jim Lange: But here it is word for word directly from Voltaire on people who choose to annuitize. In Voltaire’s words, “I advise you to go on living solely to enrage those who are paying your annuities.”

Beth Bershok: Hey listen this is a true story Jim, my grandfather lived to be 95 and he was in fabulous health up until he passed away. He had an annuity and he also had a pension and he used to say, I’m the guy that’s driving these people because they have to keep paying me. Every single year and the reason he did all that was because his parents lived so long, his dad lived to be 94 and he said I know that I’m going to have the same situation so he collected it all of 30 years.

Jim Lange: And that was a great move on his part and it’s possible that his employer offered some type of pension or annuity choice.

Beth Bershok: Yes he got a pension.

Jim Lange: Alright and the other possibility is you can go to an insurance company and purchase an annuity and that again will work out well for people with long life expectancies.

Beth Bershok: Okay we are going to take a quick break. Before we do that we are going to come back Jim we have a couple of other lesser known issues that we want to address here before the hour is out.

Beth Bershok: Thank you for joining us tonight, I’m Beth Bershok along with Jim Lange and we are taking you through the tricky waters of retirement. If you are near retirement or at retirement then you have a lot of decisions to make. I want to give you really quickly first though the RSVP number for our workshop that’s coming up this Saturday because you get some great information at this workshop, you also get Jim’s book, Retire Secure! Pay Taxes Later. Ed Slot wrote the introduction into that book, Larry King wrote the foreword and it just got rated in Estate Planning Magazine this month highly recommended. You get the book if you come to the seminar. It’s 800-748-1571. It’s this Saturday Crown Plaza South across from South Hills Village. We have two sessions 9:30-11:30 in the morning, 1-3 in the afternoon, Jim goes through his wonderful estate plan called Lange’s Cascading Beneficiary Plan. You also get the latest information on Roth IRAs and Roth IRA conversions and a couple of new tax law changes. So I really recommend this, this Saturday two sessions and you can RSVP tonight. This line answers 24 hours a day 800-748-1571. Okay back to Jim you’re getting close to retirement or you are retired and what do you do? There are a lot of issues that you claim are lesser known issues that we want to make sure people are aware of tonight, our listeners are aware of. We just covered outdated annuity tables and how you can take advantage of that, but you also talk about something called special tax treatment of after tax dollars in your retirement plan. Explain what you mean by that first.


6. Special Tax treatment of After-Tax Dollars

Jim Lange: Yeah first by the way this is one of my favorite issues and you know I go all around the country giving talks about IRAs and retirement plans and Roth IRAs and Roth IRA conversions.

Beth Bershok: And actually you just got back from San Francisco.

Jim Lange: Just got back from San Francisco and addressed 100 financial advisors there and I brought up this issue again because I always bring this up because it’s very important. Many, many employees particularly people who are earning let’s say middle or higher incomes have after tax dollars inside their retirement plan. Most of the dollars inside a retirement plan are pretax or before tax meaning that when you take them out you’re going to have to pay income tax on them. This money is money that employees contributed to their retirement plan but because their income was so high and the amount of the contribution was so high, it didn’t qualify for a tax deduction. So they put the money in, the growth on that money, the growth on the after tax is still taxable but the original contributions itself is after tax dollars inside an IRA, which conceptually is the same as a non-deductable IRA. So that’s a kind of interesting thing because a lot of our listeners will have made contributions to non-deductable IRAs throughout their career, which by the way many working people who were making more than $166,000 today should be making contributions to non-deductable IRAs but this show isn’t for you this show is for the people nearing or close to retirement.

Beth Bershok: Don’t panic we’ll do another show on that topic another day, we’ll cover that.

Jim Lange: Actually all these concepts are really important. But anyway a lot of these people will have after tax dollars in their retirement plan , sometimes it just gets lost completely.

Beth Bershok: Now how do you keep track of that, that was my next question. When you’re getting statements does it show up like that, do you know what happens?

Jim Lange: Well first of all I like to think it’s your advisor who should be watching out for you. I would like to think for example that my little old lady or little old man clients who know nothing about this stuff will still have everything done right because we’re out watching their back.

Beth Bershok: You are watching their back, but you know what happens? I can only speak from the way I handle my statements. I look at them, I see that I have money in them, I don’t do a really thorough review or even these issues don’t cross my mind and I’m guessing most people look at their statements the same way.

Jim Lange: I think that that’s very common and a lot of times people don’t understand their options. Now sometimes rather than the money just being the after tax portion just being lost and people never realizing it and never getting the benefit of it, sometimes what will happen is somebody at the benefit office will explain, hey guess what you have $50,000 in after tax dollars inside this retirement plan you can just take this $50,000 right now and not have to pay tax on it and you can blow it or spend it or save it or do whatever you want with it, and guess what no tax. And people say hey that’s great so they do that with their $50,000 and then let’s say the other moneys or the pretax dollars that might get rolled over or a trustee to trustee into an IRA or left there or whatever. But there’s special treatment that that after tax dollars that you can take advantage of that can seriously help enrich you and enrich ultimately your children and grandchildren.

Beth Bershok: Okay so let’s say you do have this after tax issue and let’s just call it $50,000, what can you do with it that would be so great for your heirs?

Jim Lange: There’s a number of variations, one possibility is to actually do a Roth IRA conversion while you are still working if that is possible and by the way, it’s incumbent upon either you or your advisor to actually look at the rules of the retirement plan to see what you’re allowed to do. But let’s even assume that you’re further down the road, the money’s already in an IRA or perhaps it’s still in the employee company 401(k) plan. What you might be able to do and I’m not going to be able to go through all the details because we don’t have enough time, but you can through an interesting and I have to watch out I don’t know if the word maneuver is right or tax planning action is right.

Beth Bershok: Let’s go with a tax planning strategy.

Jim Lange: A tax planning strategy might be that if you’re let’s say you’re interested in what I was talking about earlier setting up your own one person 401(k) plan, you can set up the one person 401(k) plan, take the money in your 401(k) or take the money in your employer’s 401(k), do a trustee to trustee transfer to your new one person 401(k) plan but that 401(k) plan is very likely to have a rule that says we will not accept after tax dollars of an IRA.

Beth Bershok: Is that a common thing, is that why you say that?

Jim Lange: It is common, not only is it common I actually look for it; I want it.

Beth Bershok: Really?

Jim Lange: Yeah and the reason I want it is because now that’s the money that you’re not allowed to roll into the one person 401(k) plan, so let’s say that that money is in a plain old IRA and you’re not allowed to roll that into your 401(k).

Beth Bershok: Okay and you don’t want to take it and go to Jamaica.

Jim Lange: You don’t want to take it and go to Jamaica, so what you can do is you can have now you have isolated the after tax dollars of the IRA or retirement plan inside a single account, you can and it’s been a long time since I’ve talked about this, do a Roth IRA conversion.

Beth Bershok: No I think it’s been 10 minutes since you talked about that.

Jim Lange: Of that money, but here’s the beauty of it you don’t have to pay the tax.

Beth Bershok: And you don’t have to pay the tax because you’ve already paid the tax because it’s after tax dollars and because you can’t roll it into a 401(k), you can do the conversion.

Jim Lange: That’s correct where if all the money in the IRA was still around they’re not going to let you do a Roth IRA conversion because of something called the proration rules which we’re not going to get into. But the ability to do a Roth IRA conversion is terrific under a lot of circumstances, but to get a Roth IRA conversion without having to pay the tax that’s nirvana.

Beth Bershok: Well because that’s the whole thing about converting to the Roth is you have to pay the taxes upfront, but you don’t have to if you can take the after tax dollars in your IRA, that’s a huge strategy.

Jim Lange: And it’s big and so many advisors miss it. Now when I give this talk throughout the country I get more questions on this issue and it’s not necessarily the day that I give the talk, but it’s actually weeks later, months later, even years later and I like getting those questions from the advisor because that means the advisor’s looking out for the client, doing this maneuver tax planning strategy whatever you want to call it, helping the client, and probably isn’t making any additional money doing it.

Beth Bershok: But I want to point out what you’re actually saying is you take these after tax dollars, if you want roll it into the 401(k) you can do this Roth conversion. The huge advantage you have there is that now the money is going to keep growing without paying additional taxes by rolling it into the Roth and therefore down the road, you pass it onto your children, your grandchildren, they don’t have to pay taxes on it you’ve just created a huge legacy in a transfer.

Jim Lange: That’s correct and not only the proceeds are income tax free, but the growth and capital gains and dividends etc. that’s all income tax free.
Beth Bershok: That is an incredible strategy we’re covering that this Saturday are we not?

Jim Lange: We are.

Beth Bershok: Okay so if you want to see that strategy in actual chart form and it’s really easy to follow the workshop is this Saturday at Crown Plaza right across from South Hills Village. Let me give the phone number again really quickly here so you don’t miss this if you want to attend. 800-748-1571. We’re down to a couple of minutes and I don’t want to miss this, special treatment of NUA which stand for net unreleased appreciation, sometimes known as company stock. What is the big advantage there?

Jim Lange: The big advantage there is a lot of people in their retirement plans even though it’s less favored today than it was a number of years ago have company stock as a portion of their retirement plan. And this is money that the company contributed to their retirement plan but not in the form of a variety of investments but actually in the stock of the company. This company stock or the NUA portion of the retirement plan is allowed special treatment by the IRS. And to oversimplify I will just say that the company stock can end up getting capital gain treatment instead of ordinary income tax treatment. So in many times and usually you have to do this planned out as part of a bigger strategy you can get capital gains treatment which is much more tax favorable than ordinary tax treatment of a withdrawal of money from a retirement plan.

Beth Bershok: We have actually covered some extremely advantageous strategies tonight this is if you’re close to or already retired. I would recommend by this time next week we’re going to have this audio up on our website retiresecure.com. I really recommend going back and listening to portions of it or listening to the whole show, you can get some great information again and hearing it again, I think would be helpful. So that’s at retiresecure.com. You’ll see a little button that says listen now. Click on it, go to the show and the audio will be posted. Now we’re down to the last couple of minutes, we do want to give away some books. We promised this earlier at the beginning of the show. The book is Retire Secure! Pay Taxes Later, and not only did we have Larry King write the foreword, Ed Slot wrote the introduction, Charles Schwab gives it a great recommendation, Jane Bryan Quinn gives it a great recommendation. We have over 60 financial professionals who gave us glowing testimonials. We just got this fabulous review we found out about it last week, Estate Planning Magazine June 2009 did a really lengthy review, if you can get a copy of this it’s on page 42. Highly recommended is the way they wrapped it up. And we’re going to give away a few copies of this book highly recommended by Estate Planning Magazine. Jim are we going to do five again?

Jim Lange: Yeah we’re going to do five again for our Pennsylvania residents.

Beth Bershok: Yes I should point that out this is for Pennsylvania residents.

Jim Lange: We have the compliance people to work with. For Pennsylvania residents and that will be five listening to the Wednesday night show and also five for the Sunday morning show, we don’t want to forget those people.

Beth Bershok: We don’t want to forget those people

Jim Lange: Because they had to listen to all these irrelevant weather reports.

Beth Bershok: Yes they did for them it will be but here’s the number it’s the office number 412-521-2732. That of course is the number any time you want to reach us, 412-521-2732. If you dial my extension which is 219 I will get this to you and you can also email me at admin@paytaxeslater.com. I want to point out we have a weather update KQV is going to have a weather update coming up here in just a moment. Thank you so much for joining us we’ll be back in two weeks which is July 1st. Go to the website to find out what the topic retiresecure.com. It is 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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