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Ed Slott on the End of the Stretch IRA
James Lange, CPA/Attorney
Guest: Ed Slott, CPA
Please note: Some of the events referenced in our audio archives have already passed. Please check www.retiresecure.com for an updated event schedule.
|Click to hear MP3 of this show|
- Guest Introduction: Ed Slott, CPA
- Stretch IRAs
- When May Stretch IRAs Disappear?
- How Likely is a Tax Law Overhaul?
- Beginning Retirement Planning at a Younger Age and the Book to Help You Do It
- What Are The Best Assets to invest in Currently?
- If You Don’t Make a Tax Plan, the Government Will Make One For You
- How Same-Sex Couples are Affected
David Bear: Hello, and welcome to this edition of “The Lange Money Hour, Where Smart Money Talks.” I’m David Bear, here in the KQV studio with James Lange, CPA/Attorney and author of two best-selling books, Retire Secure! and The Roth Revolution: Pay Taxes Once and Never Again. Today’s show will focus on a potential change in IRS tax laws that could be devastating to many listeners. Looking for revenue, Congress is again considering limits on retirement accounts to prevent inherited tax benefits from compounding over several generations. Is this the end of the stretch IRA? To provide some perspective on the issue, we are pleased to welcome America’s top IRA expert, Ed Slott, back to the Lange Money Hour. Named “the best source for IRA advice” by the Wall Street Journal, Ed hosts two popular websites, www.irahelp.com and The Slott Report. He’s authored many best-selling books, including two classics: The Retirement Savings Time Bomb…and How to Defuse It and Retirement Decisions Guide: 86 Ways to Save & Stretch Your Wealth. He also has a new book called Fund Your Future. He writes personal finance columns for several publications and presents continuing professional education IRA seminars across the country. His Retirement Rescue! TV special runs on many PBS stations around the country, including WQED. Listeners, stay tuned for an interesting and informative hour, and with that, I’ll say hello, Jim and welcome back, Ed.
Jim Lange: Welcome, Ed!
Ed Slott: Great to be here! Great to be back on the show again, back in the Pittsburgh area.
Jim Lange: Well, David’s introduction is accurate and probably doesn’t go far enough, and just so the audience gets a perspective, Ed is the most popular IRA and retirement plan writer and speaker in America today. For many people, it is by far the favorite show that I do when Ed is on. Ed sells more books, commands a higher speaking fee, is always entertaining, enjoys national recognition from millions of viewers for PBS, and is always on the cutting edge with his newsletter, which I’ve been subscribing to for years, talking about the most recent thing going on for listeners and for viewers and for readers. Ed, one of the areas that you wrote about, and it seems we had a heck of a scare, is the area of the potential death of the stretch IRA. Now, when I think of the stretch IRA, I kind of almost think of you as the father of education for the American public on the stretch IRA. Could you give our listeners an idea of what the stretch IRA is, and the jeopardy that we thought we might’ve seen in the potential change for the stretch IRA?
Ed Slott: Well, I guess the good news is, they can’t take it out of the tax code because it doesn’t exist in the tax code. It’s just a name everybody’s made up, the stretch IRA. Some companies call it ‘multi-generational IRA,’ and it’s really just the ability (which is in the tax code) for a beneficiary, say, a 40-year old, or even a 1-year old, to inherit an IRA, but instead of getting taxed on it all at once, they can take distributions over their life expectancy, only having to take a minimum amount each year. So, that’s where the term ‘stretch’ comes from. They could stretch it, or extend distributions over their lives to make it last a long time. So, for example, a 1-year old who inherits could stretch it, or extend the tax deferral, over 80 years. So, that really could snowball into some big money and provide a legacy for beneficiaries for the rest of their lives, if they only take the minimum. Now, when that was set up, that was actually set up by IRS. In the code, there was the ability to have a life expectancy method, which we all call the stretch IRA because it’s easier to understand that way. But the IRS, when they wrote the rules, believe it or not, expanded the use of the stretch IRA to the point where any beneficiary could get it, as long as they’re named on the IRA beneficiary form and they’re a human being, which means they have a pulse and a birthday, because you have to be a human being. Only a human being has a life expectancy. A charity doesn’t have a life expectancy, or an estate, or certain trusts. So, if you have a life expectancy, you get the stretch IRA, which turns the IRA not only into a retirement vehicle, but into an estate planning vehicle, as well, and it’s even more powerful if it’s a Roth IRA because Roth IRAs don’t have required minimum distributions during the Roth IRA owner’s life. So, even at 70 ½, where a traditional IRA owner will have to start taking distributions and bringing the fund balance down, a Roth IRA owner can let it keep growing and growing in his estate. It will be included in the estate, but then, when the beneficiary takes over, he’s likely to take over a much higher balance. He does have to take required distributions, even a Roth beneficiary does. But they could still stretch it over their lives and it’s more likely that every one of those payments for the rest of their lives will be income tax-free. So, that’s a pretty good deal. But here’s what you’re talking about, and it’s not even that new. It just comes up new every year.
Congress never intended this. Congress intended a retirement account to be for one life, for your life, for your retirement. They never intended IRAs to grow to these large balances that some people have, and in case you’re wondering, if you’re listening now and you’re wondering, how do people get $400,000, $500,000, two-three million in an IRA? Well, they didn’t do it with contributions of $2,000, $3,000, or even $5,500 or $6,500 a year. They did it…the big chunks probably came in when they rolled their company plan, their 401(k) or their 403(b), that which represented a lifetime of savings at their job, into an IRA, which put chunks in there. And Congress, when they wrote the rules for IRAs, never really intended, or never even thought of the possibility, that this money would outlive the IRA owner, and that’s why the IRS had to write rules to what happens if there’s money left over. And the reason they never intended, they never thought about the possibility, Congress, is if you go back in the history of IRAs, they started out of the 1974 ERISA law, and at that time, people were losing their pensions. Companies would file bankruptcy, and people that thought they had pensions coming to them found out they worked for thirty years for a company and ended up with nothing. So, some activists, one of them being Ralph Nader, actually, at the time came out and said, “You know, somehow, people should be able to take their pension money with them. Maybe they should have some sort of individual retirement account.” And that’s what it eventually got named, an individual retirement account. So, when they set it up, they set it up because they were worried people would have nothing. They never thought people would ever have too much. They were worried about people running out of money, not having retirement money, and having other problems, maybe running out of money, ending up on public assistance, and all kinds of related problems. So, they never figured that into the mix. Then, when the balances started jumping up with 401(k)s coming out and big rollovers coming in, all of a sudden, Congress said, “Look at these big balances!” And back in the 80s, they added actually a tax on having too much money in an IRA. Then, they went the other way, and then there was another 15% excise tax. Do you remember that, Jim?
Jim Lange: I remember that one. I hated that.
Ed Slott: Yeah, it was a penalty for saving too much! First, they create a law because you didn’t have anything, then they realized, they woke up one morning and “Look at this! These people have too much money! Let’s tax that!” So, that’s exactly what they did. That lasted for a while, maybe around ten years, and they got rid of that excess tax. So, that doesn’t exist anymore. So now, when they look for revenue, that brings us up to today. Congress, and this has been going on for years, I think this provision’s been popping up for ten years, which tells me it’s probably going to happen at some point, because they have the rules written, and as you’ve seen, if all the proposals, they have all the rules written, and the proposal is, “To heck with this stretch IRA. Why do we care about beneficiaries? The point of the IRA was always to take care of the person who earned it, the retiree. It was never meant as an estate planning vehicle.” So, they basically said, “Look, if you don’t use it in your lifetime,” and this is not law, this is what they’re proposing, and it never became law, but it comes up all the time as a revenue enhancer, and it would bring a lot of revenue in, they said, “Forget going out 60, 70 years, or even 10 years, if you don’t use it during your lifetime, your IRA, it has to be cashed out in five years, period.” Now, that is not law. What I just said is not law. The stretch IRA is still here. I just gave you some background of where it came from and what they were thinking. And now, what they’re thinking is, “You know what? IRA, the ‘R’ in IRA stands for ‘retirement’: your retirement, not your kid’s or grandkid’s retirement.” And that’s why they keep looking at this as a source of income, and I think you will see it being flopped in somewhere because it’s already written, ready to go. It was on the President’s proposal list. It was on a bunch of other proposals that came out that never went anywhere. But, like I said, the provision’s already written and ready to be inserted at a moment’s notice as a revenue raiser.
Jim Lange: And this scares the heck out of me because, as an estate attorney who’s drafted probably about 1,700 estate plans with a stretch IRA being an important component, and I have the Cascading Beneficiary Plan, that lets…
Ed Slott: Right, I know you do.
Jim Lange: …that lets parents disclaim to children and children disclaim to grandchildren and grandchildren disclaim to great-grandchildren. I’ve always wanted to stretch the heck out of this thing.
Ed Slott: Right. But it was never intended for that. When it came out, that was not the intent. It was actually created, believe it or not, as a benefit from IRS.
Jim Lange: All right. So, let’s say that your…
Ed Slott: It looks like you did a lot of estate plans in the last few weeks, because I have your last Lange Report and it says 1,500. So, you did 200 in the last week or so!
Jim Lange: Yeah, we were a bit busy!
Ed Slott: Yeah!
Jim Lange: I think we just actually got an update, or maybe I said 1,500 that included the stretch and 1,700 total.
Ed Slott: All right, all right, don’t worry!
Jim Lange: Anyway, whatever it is.
Ed Slott: I just want you to know I read the Lange Report!
David Bear: All right!
Jim Lange: Well, I do appreciate that! So, let’s say that…and I have a lot of clients, and Pittsburgh’s a working town, and a lot of Pittsburghers, you know, they’re good family people, they raise their kids, they pay for their braces, they pay for their college, they pay the mortgage, they pay the car payments and it’s hard to accumulate money, but they’re good, conscientious people. They work for companies that stay around for a long time. So, a lot of people have $500,000, $600,000, a million, two million dollars in an IRA or a retirement plan, not much else, and for years, they have assumed that, at their death, their kids would be able to stretch this thing out, and their grandkids even, and it would be a very nice supplement. They’re worried about their kids. They’re worried about their grandkids, and yes, this, I call it the death of the stretch IRA, is not law yet, but what should some of these people be thinking about now?
Ed Slott: Here’s the flipside of it: the government, as usual, will shoot themselves in the foot, because now, if people that have advisors like you, are hearing that, you know, “The plan I had isn’t going to happen,” there’s a lot of people out there that should be planning that aren’t, as we all know as professional advisors, that this will get them to do the planning they probably should’ve done. In other words, this will be a catalyst to taking action that will end up with the government getting less money and people getting more money, and people could’ve always done that, but they just haven’t gotten around to the planning.
So, here’s what I would say to somebody: if they’ve accumulated a lot of money, and there’s money that they’re not going to spend right away, or maybe even in their lifetime, I would turn the tables and get a better benefit out of the tax code if the stretch is not going to be there. And there are a couple of things, also, with the stretch that should be considered. As you know, a lot of kids, or beneficiaries, I should say, kids, grandkids, may not use the stretch and may just cash it all out very quickly anyway and cause themselves a big tax because they just can’t wait to get their hands on the money, unless they have a trust set up, or something.
But there are a lot of people that are not going to use the stretch even if it’s there. So, one way to do that, if you have a big balance, especially at today’s low rates, I would take a chunk of that balance down. Pay the income taxes. Even today, we’re in some of the lowest tax rates we’ve ever seen, so turn that into life insurance, an even better, tax-free benefit, than the stretch IRA. Now, you can leave tax-free life insurance and a lot more of it, to the same beneficiary. You could do it through a trust, or without direct, and they get all this money and a lot more…actually, it could be five or ten times more than they would’ve gotten, and it’ll all be tax-free. So, in the end, the government will have set in motion these actions. It’ll be a catalyst for people to do planning if they do that because that’s going to get around that they killed the stretch IRA, and smart people will do just like I said and end up having millions more than they ever had going to their beneficiaries tax-free for paying some tax upfront, and the government, after all this, who is the big loser, will think they’re the big winner because they’re getting all the money from IRAs upfront now, people who, like I just said, cash it out. It is the same thing with Roth IRA conversions. The government thinks they’re a big winner because they get the money upfront, but on the back end, they lose big, and taxpayers, you know, retirees and their families, workers will be the big winners.
Jim Lange: So, basically, what you’re saying, there was the old strategy that we used to call ‘pension rescue,’ which was basically just what you said…
Ed Slott: Yeah!
Jim Lange: …which was taking money out of an IRA, paying tax on it, taking the proceeds, buying life insurance with the proceeds, often in an irrevocable life insurance trust…
Ed Slott: Umm-hmm.
Jim Lange: …and the numbers that, you know, when you compared the, let’s say, the status quo of just maintaining the IRA, dying with the IRA, paying income and estate tax on the IRA versus how much money the heirs would get after taxes with the life insurance. The life insurance often made more sense. But now, if that law does happen and there is no stretch, then there are some very, very clear benefits to exactly what you’re saying, which is cashing in a portion of the IRA, and then converting that into life insurance.
Ed Slott: Well, I used the numbers that you just used. You said somebody has $500,000 and they planned to maybe spend a lot of it, but not all of it, during their lives, and the big plan was to leave some of it over to beneficiaries. Say they want to leave $100,000 over to beneficiaries. I would take $100,000 down now, you know, depending on what you need. So, you might have to take $150,000 to net $100,000 after taxes. Put $100,000 in a life insurance policy. Then, instead of the kids getting $100,000, they might get a million, and it’ll all be tax-free. So, who’s the big winner now?
Jim Lange: Well, I think that’s a very good strategy that I’ve been looking at, and the other one is, frankly…
Ed Slott: And people probably wouldn’t have done that if they weren’t urged to action if this thing goes through eventually, which I think it will, to end the stretch IRA, and the kids will inherit a better asset: no required minimum distributions and no taxes.
Jim Lange: And how do Roth IRA conversions play into this? Does this become more attractive now?
Ed Slott: Oh, it will be less popular. That’s another area where the government’s going to lose because the people that I have, our clients that are doing Roth conversions, the only reason I’m having older clients doing Roth conversions is for the estate planning. I would never have them do it if it had to be cashed out in five years (let’s say somebody’s 70 years old) because the cost of paying the tax upfront isn’t worth the benefit given their life expectancy plus five years.
Jim Lange: Umm-hmm.
Ed Slott: So, it would diminish the amount of Roth conversions being done and make that less popular. Like I said, it would be the best thing, I think, that would ever happen to the life insurance industry.
David Bear: If these rules are changed, how will spouses be affected?
Ed Slott: Well, spouses could always do a rollover, remember. So, they can keep it going for the rest of their lives, unless it’s a young spouse and they choose to be a beneficiary, and I’m sure they have…I think I’ve even seen some transitional rules for spouses where they could keep it going for their lives. So, spouses are generally not affected. They sort of, figuratively speaking, step into the shoes of the deceased spouse and keep it going for their lives.
Jim Lange: All right. Well, that is terrific information. Now, let me ask you this: why don’t you put your, I guess, genie cap on. Do you have any idea when this will happen, and do you think that there’s a difference in the political parties in who wins?
Ed Slott: Well, you know, it’s out there, and I know you’ve seen it come up in every tax, but these have never become law. And I’ve actually spoken to the person at Treasury that puts this out all the time, and even the things that they really want are not becoming law, like one of the provisions that’s also out there is the provision to eliminate required minimum distributions for older taxpayers who have less than $75,000 total in all their IRAs, and you don’t see that happening either, and everybody wants that to happen. So, it all comes down to when they actually have a bill that it’s going to end up in law, because this thing’s, like I said, ready to just be inserted.
Jim Lange: Yeah. Sy Goldberg, you know, was telling me that, hey, this thing’s going to happen, and he said, “Well, I’m trying to make it twenty years, not five years.” But…
Ed Slott: It’ll be five years because if they open the door for twenty years, you know, what are they doing, really?
Jim Lange: Okay.
Ed Slott: That means you have to keep track of it for twenty years, but you would’ve had to keep track of it all different years for all different beneficiaries. In effect, the five-year rule would throw people into action, like I said, and probably create a better plan when they have to keep track of less things, you know, less holding periods.
Jim Lange: Well, I actually think that’s a great perspective, and I think that’s one of the reasons why the country looks to you and your newsletter for the best up-to-date information and the best strategies. David, do we have time to go on to the next topic?
David Bear: We do. Actually, I had a question that I wanted to ask, which is, you know, given this consideration, what do you think the chances are of a general overhaul of the tax codes that they keep talking about?
Ed Slott: You know, I really don’t see it. All they do is place Band-Aids around the edges, and, you know, they’re so busy fighting with each other that I don’t really see any major changes. I mean, you know, each side has their own pet projects, or pet proposals, and the administration, you know, the President has proposals and none of them went through either. So…
David Bear: Yeah!
Ed Slott: …I don’t think anything major’s happening. We’re not going to see a 1986 tax act probably for the rest of our lives.
David Bear: Well, in that case, let’s…
Ed Slott: And by ’86, I mean a major overhaul.
David Bear: Right. Well, why don’t we take a quick break here, and when we return, Jim and Ed will continue the conversation.
David Bear: And welcome back to the Lange Money Hour. I’m David Bear, here with Jim Lange and Ed Slott.
Jim Lange: So, one of the things, before we get back into the meat of the show, is I just did want to mention two fabulous resources for our listeners, both books by Ed Slott. One, probably not getting anywhere near the readership it deserves, because this generation doesn’t read about retirement plans and funding their future, but Ed has a great book that, perhaps, could be used as a gift, called Fund Your Future: A Tax-Smart Savings Plan in Your 20s and 30s. You know, I think that, as a parent, I would love my kids to read this book, internalize the book, and then actually do what it says. Ed, do you find there are many children that are interested, or do you think that this is more the kind of thing that the child isn’t going to buy (when I say child, I mean adult child), but that Mom or Dad or even Grandpa will buy for their children?
Ed Slott: Well, this is, as you said, I wrote this specifically for adult children in their twenties and thirties because those years are the biggest transition years. You get out of college, hopefully one day. If you have kids, you know what I mean!
Jim Lange: I do!
Ed Slott: “Maybe I’ll go and take that Master’s!” “Maybe I’ll take a Master’s…you know, I’m switching! Maybe I’ll go…what about a Doctorate…what about this?” You know, go to work already! You know? But eventually, they will get out of college, I assure you, you know, either time or running out of money, or something, and they have transition. They get their first job, hopefully. They might get married, or maybe they’re having children, buying a house, there’s so much that happens in those years, and the thing is, the last thing on their mind is saving for retirement because that’s for old people. So, that’s why I wrote this book because the single biggest moneymaking asset any individual can possess is time, and young people have more of it than anyone else, and mostly, they squander it, especially when it comes to preparing for retirement. That should be capitalized on, and that’s why I wrote that book. It’s a very simple book. It’s only…I don’t even know how many pages, but, you know, I took into account that they can’t pay attention to anything for more than five minutes without looking at fourteen other devices, if you know what I mean.
Jim Lange: I do.
Ed Slott: And it has larger print and pictures, so if they can’t, you know, focus on one thing at a time, they can look around in the book. Anyway, it could probably be read in an hour or two, but there’s a very powerful message, and it’s all around the concept I just said, that time is money, a compound interest. I think Einstein called it the ‘eighth wonder of the world,’ and if you combine that with tax-free growth in a Roth IRA, it is powerful. You know, I’ve done illustrations for people with Roth IRAs. I’ve done illustrations where I’ve said, “Even if you didn’t put one dime into a 401(k) for your whole life, you know, all you did, oh, you spent all of that money, but you did save $5,000 a year (you know, this is once you’re working) and you did that for…” I’m doing it now, actually, while we’re talking on the phone. “You did that for forty years and you did nothing else. Every dime, and every other source of money you made, you spent, because there are issues when you’re going through all those transitions, and you do tend to spend every dime that comes in. But if you just took off the top $5,000 a year (and actually, the number is $5,500 this year for under fifty), but say just $5,000. If I compounded that at 6%, and you’ve done that for forty years, let’s say you started at age 25. You got your first job and all of that, and you did that to 65. You would have over $800,000. If you put that in a Roth IRA, and you did nothing else, at 65, you’d have $800,000, more than $800,000, tax-free.” Now, that’s a retirement account. If you did nothing else, that’s the power of compound interest, and most people look at, “Well, how could that be for just $5,000? And I did it at a pretty low rate, considering I carried it over 40 years.” You know, and here’s the big difference: let’s say somebody else…I’m just changing it now to 30 years. Let’s say somebody started not at 25, but they started at 35. Do you know the amount is cut almost in half to about $400,000? Now, what is $5,000 times those ten years? They only put in $50,000 less, but yet, the return at 65 is about $400,000 less.
Jim Lange: So, the lesson is to start early.
Ed Slott: Right! That’s the power of compound interest. But wait, there’s more! (I learned that from public television.) If somebody actually started…this is a little out there, which you know, but sometimes, people have to know. What if somebody started magically at age 15? I don’t know what 15-year old could put away $5,000 a year, but let’s say they did. They had a job somewhere, just to make the point. So now, we have 50 years to 65. Remember when it was 40 years? It was about $800,000. Those extra ten years, because they’re on the early end, from 15 to 25? That person would end up with $1,500,000, tax-free, at 65. Now, that’s double the $800,000. So, for putting in just $50,000 in the early years, you know, $5,000 a year for ten years, that return was over $800,000.
Jim Lange: Which brings up the possibility that parents can put money in. So, let’s say, you have a fifteen-year old who has a summer job, or maybe you can put him on your payroll, or somehow…
Ed Slott: Right! That’s what I’m getting at. That’s where that money comes from.
Jim Lange: Okay.
Ed Slott: But remember, I figured all this at what I consider a very low rate for a fifty-year span, 6%. Would you agree that’s probably a very reasonable rate or overly conservative?
Jim Lange: Well, yeah. I mean, everybody, right now, wants to use low rates because they’re a little bit nervous because of the volatility in the market…
Ed Slott: Right.
Jim Lange: …but over the last seventy years, the market has returned, you know, close to 10%.
Ed Slott: Right. I did 6%.
Jim Lange: Yeah. So, I think that that is being conservative.
Ed Slott: Yeah. So, what I just told you…and that’s the concept in Fund Your Future. So, you show this to somebody who’s not fifteen, but, say, twenty-five. The power of starting early, paying yourself first, the old concepts, you know, old school, take that money off the top, put it in a Roth IRA, and if you can get in a Roth IRA at work, do that too. Now, the numbers I just gave you is if you did nothing else, no other savings, spent every dime. Can you imagine what these numbers would be if you had a Roth 401(k) at work, too, on top of a Roth IRA?
Jim Lange: Well, you’re talking about a secure retirement for the listener’s children and grandchildren, which I think is a major concern to a lot of people.
Ed Slott: That’s why I wrote Fund Your Future. You put that in a stocking stuffer, or whatever, it’s a nice little book, but the power and the concepts in that book, and they’ve been tested over time, I didn’t invent these things, it’s math. Maybe you can get through to somebody to start early, and if they do, they will have a lifetime of savings that we never enjoyed, and all tax-free in a Roth IRA.
David Bear: So, it’s safe to say that giving them financial acumen is better than giving them financial assets?
Ed Slott: You bet it is, if they use it. But they’re more likely to use it if it was a gift from a parent. And I have all those things that I just did. I happen to be in front of a computer screen now, so I just did the calculations on a program, but I have all of that in the book, and it is staggering. I know we all know about compound interest. I’m sure, Jim, you talk about it to clients and their kids, but until you see the numbers like I just gave you, it’s staggering!
Jim Lange: It is, and I think it’s an important resource, and I think that a lot of parents should use it, whether it’s a stocking stuffer or, of course, these days, kids are reading it digitally, and very frankly, the version that I have is digital. And the other book that I have right in front of me on my iPad, which is probably not so much for the kids. In fact, I would say it’s not, but it’s actually for the parents, and Ed, this is what I consider your classic book. I know you’ve written a lot of books, and I know that you’ve sold a lot of books, but in terms of my favorite book of yours still has to be, and I know that you’ve done numerous editions of it, is The Retirement Savings Time Bomb…and How to Defuse it: A Five-Step Action Plan.
Ed Slott: Yeah, that still has everything in there. It’s a little technical, a little dense, I’d have to say, it may be tough to get through it. It’s a lot of pages, but that’s got everything in there, and if you follow those steps, you will have a secure retirement, and I’m a bigger believer…actually, even though everything about me is IRAs, in today’s environment, IRAs (and I’m going to say this publicly) are a bad asset.
Jim Lange: Uh-oh! Now, this is revolutionary to hear Ed Slott say that IRAs are a bad asset!
Ed Slott: Yeah! I can’t believe it! You know, because I don’t see the future, but I see the trend that taxes, if you ask anybody, and anybody is an authoritative resource, there’s the tax code and anybody. They’re both authoritative. So, if you ask anybody, they will say taxes are going up, and you see it little by little, and why take a chance? So, if taxes are going up, it means your IRA, as it goes up, even if you do well in the market, is actually going down because more of it is being owed back to the government. So, the big plan for the future is to trim that down and turn it into tax-free income with a Roth IRA, or, like I said before, life insurance. You have got to get to tax-free sources to improve your retirement savings and to keep more of the money you make.
Jim Lange: Well, that’s two of the steps of your five step program is to insure it and Roth it.
Ed Slott: Yeah, and it’s still true. It’s going to be even truer as taxes start rising because as taxes start rising, your retirement savings, if it’s in an IRA, remember, the reason I call it a bad asset, it’s loaded, or, what I call ‘infested’, with taxes. The only way to get them out is pay the piper now while rates are low and get it out of there.
Jim Lange: Well, anyway, I do highly recommend the resource The Retirement Savings Time Bomb…and How to Defuse it: A Five Step Action Plan, with one very, very, very little minor exception, it is completely up-to-date, and the part that it’s not is pretty much irrelevant. So, I would say that that is one of the most up-to-date, authoritative sources for IRA and retirement plan information.
Ed Slott: And that’s a great book. It’s a great book for every advisor to have, and it’s a great, basic, fundamental book for advisors and for people that want to protect their retirement savings from, I call it, the single biggest factor: taxes. Taxes are the single biggest factor that will separate people from their retirement dreams, and if they don’t have a tax plan, they don’t have a plan, because you can make all the money you want in the market. I don’t care if you make 30% a year. If you give half of it back to the government, what have you done? You built a savings account for Uncle Sam, and I don’t even know if you know, but he’s not your real uncle.
Jim Lange: And then, right before we do the break, I’m going to quote Ed to Ed: “If you don’t make a tax plan, the government will make one for you.”
Ed Slott: That’s right! Well, what I usually say is, either you make your plan, or you get the government plan. Which plan do you want: your plan, or the government plan?
David Bear: Well, that’s an obvious question, so anyway, let’s take that one final break, and when we return, Jim and Ed will continue the conversation.
David Bear: And welcome back to the Lange Money Hour, with Jim Lange and Ed Slott.
Jim Lange: And we were just talking about two of my favorite of Ed’s books, Fund Your Future: A Tax-Smart Savings Plan in Your 20s and 30s, and we were talking about what a great gift this would be for your children or grandchildren, and the power of compound interest in retirement plans and Roth IRAs, and then, the book for you, yourself, would be The Retirement Savings Time Bomb…and How to Defuse it: A Five-Step Action Plan, which is my favorite book of Ed’s, and Ed, by the way, being really the top IRA expert in the country, in terms of most objective criteria, books sold, speaking engagements, etc., etc. But Ed, right before we took a break, we said something about you have a choice of making your own plan, or taking the government plan. Could you be a little bit more specific, please?
Ed Slott: Yeah. When I do seminars for the public consumers, sometimes I title them. People say, “What’s the title of your talk?” And I say, “It’s called ‘Your Plan or the Government Plan?’” And I throw that question out to the audience, and what do you think most people say? “Do you want your plan or the government plan?” And, obviously, people say, “I don’t want the government plan. I don’t even know what it is, but I don’t want that plan!” And the government plan is the plan that’s in effect if you do nothing, and actually, people say they don’t want the government plan, but that’s what most people get because they don’t do proactive planning. They don’t take the bull by the horns and do the planning they can do to create a stretch IRA, to create a tax-free retirement account, to create tax-free income, which they can all do.
The tax code can be beat by things right in the tax code by provisions that can turn taxable money to tax-free money, can turn a dollar of taxable money to ten dollars of tax-free money. But people don’t take advantage of it. So, if you do nothing, you get the government plan, which means you sit around and wait, basically, until you’re, say, seventy-and-a-half, and then the government will tell you how much tax it needs from you at that time, because if you’re going to wait for the government plan, the government can keep changing the tax rate, and the government might say, at some point, Congress will say, “You know what? We need money. This year, taxes on your retirement account are 50%.” And don’t think it can’t happen because if you look at the history of tax rates, we’ve had years in the fifties, sixties, seventies, up through the eighties where it was 70%, 80%, 90%. I don’t know if we’ll see that happen, but Mark Twain had a great quote. He said, “History doesn’t repeat itself, but it rhymes.” And we might see big tax increases. So, if you’re going to sit around waiting for the government, that means the tax rate you’ll be paying will be determined, not by you, because it’s not your plan, it’ll be determined by the government. Sometime in the future when you need the money most, when you’re retired, when you’re not working, when you’re the most vulnerable, that’s when they’ll tell you how much tax they need, rather than you taking action now creating your plan at known values. We know what the tax rates are today. You know exactly what it’s going to cost today. So, I would do the plan now, based on your terms, make it your plan, not wait around for the government plan, which is loaded with uncertainty.
Jim Lange: Well, Ed, to switch gears a little bit, one of the things that I’ve always enjoyed about your newsletter is that you are on top of the cutting edge tax changes and what some people should be proactively doing. There was, as you know, the Supreme Court case that basically turned DOMA, which is the Defense of Marriage Act, on its head, and I’ll do a real quick summary, which basically said that the Supreme Court, and then, in a subsequent ruling by the IRS, said that same-sex couples will be treated the same as opposite-sex couples in the United States for federal tax purposes. Could you elaborate about this a little bit, because I think that this is…I mean, this is an area that’s very important, I think, for same-sex couples. It’s so important we’re going to do a radio show on it. I’m actually going to be doing a workshop on it on December 7th, but I know that this has implications for people in states like New York, where same-sex marriage is recognized, and perhaps, and more importantly for a lot of our listeners, like Pennsylvania, where same-sex marriage is not recognized. Can you tell us a little bit about the impact of DOMA?
Ed Slott: Well, I think a lot of Pennsylvania’s same-sex couples will be visiting New York.
Jim Lange: Well, it’s funny that you say that, because that’s actually one of my proactive recommendations.
Ed Slott: Come for a weekend, get married, and under the federal law, if you’re married and they have, basically, something they call a ‘state of celebration’ rule, where if you’re married in a state that recognizes same-sex marriage (which New York does), then, for federal tax purposes, you’re married, which means you can file joint returns. You can do an IRA. We were just talking about it earlier. The spouse can do an IRA rollover, which they couldn’t do before. There are benefits between spouses in the estate area, portability, estate and gift tax transfers between spouses, and, like I said, filing a joint return, even making a spousal IRA contribution. So, there are a lot of benefits. Now, you have to look at each situation. Everything’s a double-edged sword. There are some same-sex couples that might say, “You know, we’re both doing pretty well. We have a nice income. We just calculated that if we get married, tax-wise, we’ll pay more, because welcome to the world of marriage and the marriage tax penalty.” So, it can go both ways.
Jim Lange: Well, I think you’re right, and I think it is case by case, and then, I just actually read an article in the New York Times that said there’s a lot of same-sex couples who want the right to be married, but don’t want to marry themselves. They’re comfortable with the way they are.
Ed Slott: Right! But, you know, not everything’s about taxes. You know, if you want to get married to enjoy some of the survivor benefits, like even an ERISA for company plans, to inherit somebody’s 401(k), have those kind of rights, and if you do get married, as a same-sex couple, you’re like all of us. You’re in the soup. You’re married, which means you can only file married/joint or married/separate. You can no longer file single. So, you can’t toggle and do what’s best for you. If you do get married, that marriage will be recognized for all of federal tax law and federal benefits, retirement, all of that, income tax benefits, estate tax benefits, gift tax benefits will be recognized the same as any married couple. The only hitch is in a state like yours, they’ll file a joint federal tax return, if they elect to do so, but they may have to file separate single state tax returns.
Jim Lange: Right, but in Pennsylvania, that’s certainly no big deal because the Pennsylvania income tax is fairly simple.
Ed Slott: Yeah, the hard part’s paying it!
Jim Lange: Right! One of the areas that you haven’t mentioned, that, to me, is very important, but right now, as I understand it, we don’t have total clarification on how this will be treated, particularly for states like Pennsylvania that do not recognize same-sex marriage, is the issue of Social Security and spousal benefits. To me, this is one of the most important ways to protect a spouse.
Ed Slott: Right!
Jim Lange: So, for example, even for opposite traditional same-sex couples, I (and I’ve had a whole bunch of people on, including Jane Bryant Quinn, Jonathan Clements, Larry Kotlikoff and a bunch of Social Security experts who agree) am a big fan of holding off on Social Security until later, bumping up the benefit that you’re going to get every month.
Ed Slott: Oh, me too! I mean, if you do the numbers, it comes out to an 8% return for all those years.
Jim Lange: Right, and one of the reasons that it is a great thing to do, not only will you get that benefit, but if you then die, your spouse can then claim the higher of their Social Security, or what you were collecting.
Ed Slott: Right.
Jim Lange: So, by you holding off and collecting more when you’re seventy…and let’s just say, for discussion’s sake, you hold off, collect the highest amount at seventy, then you die and your spouse survives you by ten or twenty years, your spouse will get that higher income for that period.
Ed Slott: That’s a huge benefit. There are some big benefits. Like we were talking about Roth IRAs before, if you were not allowed to be legally married, that means you’re partners, two unmarried people, an unmarried couple before this law, and your partner inherits your Roth IRA. They can’t do a Roth IRA spousal rollover. They would actually have to take, just like any non-spouse beneficiary, required distributions, even if they didn’t need the money. Now, they’re considered married if they do get married in a state that allows it. The spouse, the surviving spouse, now, can do a rollover, a spousal rollover of that Roth IRA and continue not to have to take distributions for the rest of their lives, building that account up tax-free.
Jim Lange: Ed, maybe you and I should go into the ‘get married quick in New York for Pennsylvania resident’ business, you know, kind of like the Las Vegas of crossing the state lines and getting a quick marriage.
David Bear: A travel business, right there!
Jim Lange: But I think that that is a really important point. And by the way, we’re actually doing three workshops for same-sex couples on December 7th, and we’ll go into this in detail. But the other thing that I did want to mention is, and even though the law isn’t clear right now, that we are certainly hoping that one of the benefits will also be the Social Security benefit for spousal benefits for same-sex couples that would not be available if the same-sex couple does not marry.
Ed Slott: Yeah, well, I guess some of that has to be ironed out like anything new, but the big overall message is that if you’re married in a state that allows same-sex marriage, it’s allowed for all federal law.
Jim Lange: Right, which, by the way, isn’t really consistent with the way we’ve been thinking about things, because usually you think, “Well, the state law controls that.”
Ed Slott: Right, right. It’s different now, though.
Jim Lange: Right.
Ed Slott: And as you said earlier, the IRS really quickly came out with a ruling on that.
Jim Lange: Right, which I actually thought was terrific because, no matter how you feel about it, you’re certainly simplifying, and you’re making things much clearer for the taxpayer.
Ed Slott: Yeah, yeah. I mean, it’s not totally clear, but I think we’re like 80%-90% of the way there.
Jim Lange: Well, I think it’s going to be a great benefit, and that’s what we’re going to be talking about for, basically…
Ed Slott: I think you’ll have a great seminar and a great turnout. You know, sometimes when I talk about this, I just did a program on this for advisors, and they were looking at me like, “that doesn’t affect a lot of people.” You know, they had that look, they didn’t say that. And I said to them, “Think about this: this will affect more people than the federal estate tax,” which is true because most people don’t have $10,000,000.
Jim Lange: Right. I actually never thought about that myself.
Ed Slott: Like, we talk about estate planning all the time, the five and ten million exemption. How many people have more than that? And we talk about that all the time. That’s what I said to these advisors. We’re always talking about that. But this affects more people than that does.
Jim Lange: And it also affects people in the middle income and middle wealth category.
Ed Slott: Right.
Jim Lange: You know something? We are rapidly running out of time.
Ed Slott: No!
David Bear: Yeah, time goes quickly!
Jim Lange: And what I thought I would do is if you have any last thoughts for our listeners, on either something that we’ve touched on or we haven’t touched on, because I know that you always have pearls of wisdom for us.
Ed Slott: Well, here’s the big message: tax-free is always better. There’s a big difference between tax deferred and tax-free. Tax-deferred means you won’t pay tax on it yet, but you will at some future time at maybe a higher balance, at a higher rate. Tax-free is always better. Your plan should be consistently, or do it in chunks, to move your tax-deferred account to tax-free territory, either over time, but do it consistently. You’ll end up with more money because tax-free money grows the fastest because it’s never eroded by taxes.
David Bear: Well, and with that, let’s say thanks for listening to this edition of the “Lange Money Hour, Where Smart Money Talks”, and thanks to Ed Slott for his IRA industry insights. He can be reached directly at his website, www.irahelp.com. Thanks also to the Lange Financial Group program coordinator, Amanda Cassady-Schweinsberg. You can hear an encore broadcast of this show at 9:05 this Sunday morning, here on KQV, and you can always access the archive of past radio shows, including written transcripts, at the Lange Financial Group website, www.paytaxeslater.com. And please join us for the next new edition of the Lange Money Hour in two weeks, on Wednesday, December 4th, when our guest will be LGBT rights expert, Evan Wolfson. In the meantime, have a safe and happy Thanksgiving.
James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA 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, 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.