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The Roth Conversion Option – An Aggressive Strategy
James Lange, CPA/Attorney
Special Guest: John Bledsoe, CFP, CLU, ChFC, MSFS, AEP, CLTC, Financial Consultant/Author
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|
- Introduction of Special Guest: John Bledsoe, CFP, CLU, ChFC, MSFS, AEP, CLTC
- The Roth Conversion Option – Convert Now, Recharacterize Later
- Separating IRAS is Key to Roth Conversion Strategy
- Converting a Non-Deductable IRA to a Roth IRA
- Rolling Over an Inherited Roth IRA
Hana Haatainen-Caye: Welcome to The Lange Money Hour Where Smart Money Talks. We are talking smart money. Thank you so much for joining us tonight. I’m Hana Haatainen Caye joining Jim Lange nationally recognized IRA, 401(k), and Roth IRA conversion expert. Jim is the author of the best seller Retire Secure! with testimonials from Larry King, Charles Schwab, Jane Bryant Quinn, Ed Slott, and 60 other financial professionals. Tonight we’re excited to have a special guest, John Bledsoe, who has more than 20 years experience in the financial services business. John is a highly sought after speaker for attorneys, financial advisors, CPAs and general audiences. He serves as a consultant to several of the largest securities and insurance companies in the nation and has written over 1000 financial articles for newspapers and magazines, and has authored four books, Rock Solid Estate Planning, Texas Living Trust, Roth to Riches, and his newest book The Gospel of Roth. John, we want to welcome you tonight.
John Bledsoe: Thank you.
Jim Lange: And I actually want to throw in a little addition to the introduction. John is one of a long time, I’m talking all the way back to 1998, Roth IRA conversion experts. He wrote a great book and a great article, in fact I even still have his article on my website. I thought it was so good I called John in 1998 I said John this is a terrific article can I put it on my website and send it to my clients and he agreed. And then just recently when he was working on the book he consulted with me and I thought man this is just fabulous information that I want to bring to our listeners.
Hana Haatainen-Caye: I also wanted to add that with his new book it has been said that everyone who has an IRA or retirement plan should read this book. You will learn how to create up to 40% more in spendable after tax dollars by maximizing the new Roth IRA rules to your advantage. The Roth conversion option is the only way to go. So what we’re going to talk about tonight let’s start off with I wanted to ask you, oh I’m sorry…
Jim Lange: Well I’ll tell you what I want to do, I want to give people the really good stuff first. What do you think about that John you think we should?
John Bledsoe: I think that’s a great idea.
Jim Lange: Alright first of all as a little caveat you know before the show we always have a little disclaimer, you know these opinions are not the opinions of the station or even of mine. And usually I just let that go. Well you have I think a fascinating idea that is the theme of your book or at least it’s the way you start and it is an idea that I’m familiar with because I actually wrote an article on it and I think it’s a brilliant idea but it’s very aggressive so I am going to tell people you really have to do this at your peril so I’ll say disclaimer, disclaimer, disclaimer, but I do want to get right into what I think is just a really unique every potentially enormously profitable idea for our listeners. John, do you want to set up the scenario of let’s say somebody has for discussions sake a half a million dollars in their traditional IRA or their traditional retirement plan, and the basis of your idea in terms of splitting it up for the potential re-characterization.
John Bledsoe: Absolutely. First of all it’s obvious that you passed the litmus test Jim of being a lawyer by doing the disclaimer and that is absolutely appropriate because first of all so many people have read about the conversion opportunities beginning in 2010. Of course the tax office changed and beginning in 2010 no longer are there any restrictions to people being able to convert from a regular IRA to a Roth IRA. Regular IRAs as most people know are tax deferred. You get a tax deduction when you put the money in, or if money comes from a qualified plan you get a tax deduction for it. When you pull the money out of the IRA or the retirement plan of course taxes are then due on the larger amount as it’s pulled out. Conversely, the new Roth IRA that’s now almost 13 years old is tax free, the money that is in a Roth IRA grows tax free, when you pull the money out there’s no income tax. But, the conversion of a regular IRA to a Roth IRA triggers that tax and you have to pay taxes, a public conversion later as you’ll learn. So many people, so many articles and advisors have talked about you should run all these very complicated numbers and then decide whether or not you should convert to a Roth IRA or whether or not a Roth IRA is right for you and I think that’s dead wrong Jim. I think the approach should be what I call the Roth conversion option. Essentially, I believe that everyone should convert from a regular IRA to a Roth IRA and take the option because you have the ability to undo it without any cost or penalty to you after a period of what appears to be enormous length of time. You actually have if you converted in 2010 you have until October the 15th or shortly thereafter to 2011. Some of you converted on the first day of the new year, which first working day is going to be January the 4th of 2010 right around the corner, you would actually have from then until October the 17th because the 15th falls on a weekend of 2011, that’s 651 days. So for example with your $500,000 IRA if you converted that to a Roth IRA you would be able to watch that and watch the conditions as well of the tax changes and other things that Congress has in store for us, many surprises I think are going to be a little negative perhaps with taxation making the Roth conversion all the more powerful. So I believe it’s a very important opportunity and I believe numbers should be run but I think the conversion option needs to be taken in advance of those numbers because you don’t know what the account value is going to be on the day you go firm on it until much, much later, a year and ten and a half months.
Jim Lange: Alright now I want our listeners to really understand what he is saying. And by the way, this is an area where John and I respectfully disagree. What he is saying is since you can–the technical word is re-characterize–I like to just call it un-convert, he’s saying that since you have the ability to un-convert your Roth IRA conversion that if you make a Roth IRA conversion let’s say in 2010, and John’s point is let’s do it as soon as possible, that you can decide later on depending on the tax laws and probably more importantly depending on how the investment does, that you can re-characterize or undo the Roth IRA conversion. So what John, and he’s a little bit of a lone wolf here, but it’s a very interesting idea, is saying is to convert all your IRAs and retirement plans and then to determine at either later in the year or possibly even up to October 15th of 2011 to decide which ones you’re going to keep and which ones you’re not. John I don’t think that we have talked about separating your IRAs into a number of IRAs.
John Bledsoe: Right would you like for me to speak to that now?
Jim Lange: Well yeah because that’s critical to the whole strategy. If you don’t do that then we’re nowhere.
John Bledsoe: So let’s say you have your example of $500,000 and it could be any amount of money, but understand it’s proportionally $500,000 and you had five different mutual fund investments, each exactly equaling $100,000. Then what you would do on January the 4th of 2010 is you would convert your one IRA worth $500,000 by mutual fund into five different Roth IRA conversion accounts. For simplicity you might call them Roth IRA 1, 2, 3, 4, and 5 respectively. And what that does assuming that mutual funds and other asset classes move differently up and down depending upon their specific submarkets and asset classes etc. then that would give you an opportunity with them being separated out like that Jim, of course you’re an expert on this as well, then if Roth IRA 1 goes up by 30% and Roth IRA 2 goes down by 30%you don’t have to mix the two together. You can un-convert, you certainly wouldn’t want to pay on a $100 000 IRA that was converted that dropped down to $70 000, you’d want to perhaps do it again a later year, you wouldn’t want to have to pay taxes on $100 000 when it’s already dropped to $70 000. However, you have the advantage to the extent that any of these accounts go up during this long period of one year ten and a half months, if they go up you then have the extra analysis and advantage of understanding that you might be able to convert an asset that you already know has gone up from $100 000 or $130 000 to a tax free environment forever and only pay the taxes as if it were worth $100 000. It’s like watching a football game on a DVR and watching it after the fact and getting your buddy to bet on the game against you when you already know the outcome. You have all of the options by doing this.
Jim Lange: I love that analogy. I’ve never heard that before but that’s pretty good.
John Bledsoe: We’re not watching many of those games by the way I’m calling by way of other disclaimer I’m calling from Dallas, Texas and we consider our football season to be in bad shape here at this point so we’re not re-watching any of those games right now.
Jim Lange: Well I don’t want to say anything bad about the Cowboys being from Pittsburgh myself but I do think you guys capitalized on something that is false advertising and that is there is no truth to Dallas being America’s team. It is statistically proven that all through the country there are Steeler bars, and the way I would define America’s team is who has the most supporters not just in the city that the team is in but all throughout the country, and I think that Pittsburgh really has you there.
John Bledsoe: I think you may be right.
Jim Lange: In fact there are Steeler bars all over the country but I won’t hold it against you.
John Bledsoe: And there are Steeler cows all over Texas as well.
Jim Lange: Well that’s good. By the way, we have used this strategy in the past and it has worked out very well and the key to if you are going to do this strategy the key to, you see the problem is let’s just say for discussions sake that you really want to end up converting $100,000 and you do John’s idea which is convert everything, and let’s say you just did it in one account. So now you have a $5,000 Roth IRA conversion that let’s say consists of five different mutual funds and two of them went up and two of them went down and one of them broke even and what you might really want to do is keep one or two of them. If they’re all mushed together in one account then you’re really going to have nowhere near the flexibility that you’re going to have if you use John’s idea of separating the accounts and presumably accounts with what’s called negative correlation meaning that when one goes up the other one tends to go down, when one goes down the other one tends to go up. That way you get the greatest divergence of results and the idea is the losers, the ones that don’t do well, they get reconverted or re-characterized to regular IRAs and the ones that do well you keep. And so let’s say you do even just keep it real simple, two $100,000 accounts and one does well you’re really happy because a year and ten months later you’re up 30% so you only paid taxes on $100,000 and your Roth is $130,000. And then let’s say it goes down, so now you’d be very unhappy if you have to pay tax on $100,000 and the Roth is only worth $70,000. So with John’s strategy you’re getting the best of both, that is you are separating the IRAs and then deciding later on you know just like John said after you watch the video or the DVD and then you bet your friends it’s 20/20 hindsight.
John Bledsoe: Go ahead.
Jim Lange: So I think that is a really good idea. Now to be fair though we have to talk about it really is aggressive, and I know that that’s how you start your book and I like your tone because I of course write and sound more like a classless attorney and you’re saying everyone should do it right now, and that’s the part that’s a little bit hard for me to take. But I think that we should talk about a few of the risks of doing this because I don’t think anyone of us are trying to sell our ideas so to speak we’re just trying to provide good information for our readers. So I have one or two ideas of why it might not work out so well but I thought maybe I’m asking you to say some of the weaknesses of this plan but I thought I’d throw that out to you and then I’ll chirp in with one or two of the things that I might be thinking. Or do you think it’s just so strong that there’s no response to that?
John Bledsoe: I think actually it’s very strong even though it’s counterintuitive, and that is that we have even a best case scenario for the strategy. We understand that people have to make smart financial decisions and when you fill up your car with gasoline you have the risk if you put the wrong type of fuel in, if you put diesel into your gasoline car it can wreak great damage. You have to take great care of your investments and your retirement accounts, but I believe that the strategy is much more dangerous to do the traditional strategy. By the way I’m no longer the voice crying in the wilderness, I even see large magazines and newspapers as recently as this weekend in the New York Times talking about the advantage of having the do-over or the re-characterization, or being able to un-convert as you so well put it. So even if a person knows for sure in that $500,000 example you only want to convert $100,000 and you only think you want to convert $100,000 and you have $500,000 available in retirement accounts, by doing my strategy what you’ve actually done is you’re able to pick the one that has hit the peak, the one that has done the best during that period therefore saving the maximum amount of taxes and getting the maximum amount tax free. I think it’s high risk to do it the other way Jim.
Jim Lange: Well that’s an interesting perspective and you are right there are some more of the popular IRA and Roth IRA experts on board. I think that Bob Keebler is actually talking about a similar type strategy.
John Bledsoe: Absolutely.
Jim Lange: To what you’re saying. Now to be fair the obvious potential problem and hopefully you’re assuming nobody would be, I was about to use the word stupid but that’s probably not the right word, let’s say careless, is to do the conversion then forget about it and miss the deadline for re-characterizing then all of a sudden you have a tax liability for $500 000 worth of income compared to $100 000 worth of income, which is what you were planning on paying originally.
John Bledsoe: Absolutely just like if you miss the filing dates of your federal tax returns there are large penalties associated with that you have to watch it as you go along but you really only have to watch it for one important date, and I suggest that everybody put it on the calendar actually a check point to watch which would be naturally December the 1st of 2010, of this next year. And so clearly you have to watch those dates but we have to be careful with a lot of things including beneficiary designations and these IRAs can be very very devastating if people are not careful. And so care is definitely in order, and I don’t take those cautions lightly I just think that in the examples that we’ll use, in all the examples that I’ve read it’s much better to look back and say I’m so glad I have these options as opposed to not doing and saying oh my goodness I don’t have the option because I didn’t do what that fella told me to do.
Jim Lange: Well you know John I love flexibility in retirement and estate planning and the whole basis of Lange’s Cascading Beneficiary Plan™ is not to fix in stone what’s going to happen but rather defer until after the first death that is the husband and wife are married and let’s say have a couple kids and let’s say your obvious choices of who you’re going to leave it to is number one your spouse, number two your B trust, number three your kids, and number four your grandkids. I advocate a strategy of deciding later. In effect what you’re saying is do the Roths now and then decide later which ones you’re really going to keep.
John Bledsoe: Absolutely very similar to your strategy, which by the way you’re way ahead of the game on that.
Jim Lange: Yeah actually I was promoting that back in 1998 back when you wrote the 10 myths of Roth IRA conversions, which I still think that that really applies today.
John Bledsoe: I think so, the difference is I agreed with you immediately.
Jim Lange: Okay fair enough. Well let me ask you this, this is one of those things that sounds too good to be true, do we have to worry about the IRS saying hey look the reason we originally let people re-characterize was because let’s say it’s before year end you think your income is going to be $90,000 and you make a Roth IRA conversion, then you get a K-1 or you get a W-2 or you get a 1099 and your income as it turns out, or you get some capital gain distributions that you didn’t know was coming and then all of a sudden your income’s $110,000. So your income now will not allow you to make a Roth IRA conversion, and I think that the reason why the IRS allowed you to re-characterize was well it’s now the following year when you found out it doesn’t work so they let you undo it. I don’t think that they were every thinking hey let’s give these tax experts a fantastic loop-hole to gain just hundreds of thousands of dollars of value by having the ability to convert and then re-characterize.
John Bledsoe: I agree with you wholeheartedly. Most of these things happen and they have unintended results. And remember again we’re talking about congress and the IRS so you’re taking a great leap forward when you say they were thinking at all. But when you recognize that they had an interest in people converting from regular IRAs to Roth IRAs and it’s been in the law for several years with the ability for people to do it without any restrictions beginning January 1, 2010, and the reason for that, Jim, I think it’s important for the listener to understand. The reason that the government likes the idea of people converting even though they’ll have many, many more dollars in most cases in the future because of the Roth IRA conversion, they love the idea of people converting in 2010, why? Because they get the money sooner. As a matter of fact the government reminds me, and I don’t know how you were brought up but when I was growing up one of my favorite stores, our fancy store that my mom took me too was called K-Mart. I remember they had a blue light special and it would just make you so excited whatever they were selling even if you didn’t want it the fact that they would sell it for a limited amount of time while the rotating blue light was on. Well the government is actually doing that in 2010, they’re actually trying to market for the second time Roth IRA conversions this time for everybody, and that’s not a temporary rule and that’s going to go on forever as the law is written now. But what that does is make people able to convert, they can convert some in 2010, 2011, 2012, so they don’t have to worry about being restricted out again under the current law. But the government said we’ll even give you a special privilege, we’ll let you defer to the taxes in 2011 until 2012 if you’d like at no interest cost, you can do have the conversion added to your income in 2011 and 2012 each year respectively if that’s your choice. But the unintended result is obviously they didn’t mean for the window to be that broad for this application. Who knows whether they’ll change it or not in future years but we’re 100% safe in my estimation, and I’d like to hear your take on it from a standpoint of them changing the law this year saying no you can’t un-convert. That’s the law as it is now, that’s the thing that people can do in good faith in January, they can convert and know that they have until October the 17th of 2011 to un-convert. They may not have that wide a window or Roth conversion window ever again. This may be a great opportunity for them to do that, they may actually restrict it until April or a different regulations for future years all the more so why I think they should do it.
Jim Lange: Well that to me is probably even though I would agree with you that it’s a low probability, although you might think it’s zero probability, but that to me is one of the most compelling reasons not to do it. So let’s say for discussions sake that one of these firms run the numbers, and by the way that’s what we do for quite a few people, so when you say oh these fancy firms that run the numbers I’m thinking yeah well that’s us. But let’s say that we run the numbers and we determine that the ideal amount to convert is $100,000, and by the way just to give listeners an idea of the benefits of making a $100,000 conversion. Let’s say for discussions sake you’re 65 years old, you make a $100,000 conversion, you pay the taxes from outside the IRA. 20 years later you, not your heirs, not your kids, not your grandkids, but you are $40,000 better off by my numbers. Then let’s say you die and you leave the money to your kids. Your kids will be better off by $700,000 and the other possibility is you leave the money to your grandkids and they’ll be better off by $8.6 million, and now we’re actually talking about with John’s strategy of enhancing that so that the benefits could even be higher. I’m not going to go through all the assumptions but let me just go back to say that my fear with your strategy that frankly with all due respect I would characterize as very aggressive, although I wrote an article talking about it myself so I can’t really knock it, is what happens if the right number is $100,000, you convert, you do what you say separate it into five different accounts, you convert all of them, and then the IRS says hey you know we were too generous with the ability to allow people to re-characterize we’re either going to change the deadline or that they just say hey guess what you can’t re-characterize.
John Bledsoe: I think that that would be unprecedented. It certainly could happen but I think the likelihood if we want to go into that can be much great with other bad things happening as well. So I think that because of the fact that these types of rules with regard to retirement accounts, that reminds me years and years ago people were afraid to put money into retirement plans because they thought the government would change the rules in the future when they pulled the money out and they thought it was some grand conspiracy. In reality everyone as you pointed out in your example, they did better by doing the tax deductions, putting the money away, letting the money grow tax deferred and then ultimately converting to a Roth IRA if they were able to. Those numbers were astronomical. So people do have to take some leap of faith but this is not a very big one here because the fact of the matter could be significantly worse. The downside could be by you not having taken advantage of this ability, as it’s written in the IRS publications and all the instructions for IRAs that you have until October the 15th, actually the 17th again because it’s a weekend of 2011 to un-convert anything or re-characterize anything that you converted in 2010 you have that option. And the reality is that what you may discover in 2010, and many people have discovered it now, income taxes are set to go up in 2011. Income taxes are going to go up from federal level of 35% to 39.6% but it doesn’t have to stop there. Announced rates for 2011 may end up being 45%.
Jim Lange: Well there’s a whole lot of areas that I wanted to comment on that but I think it is time for a break.
John Bledsoe: Very good.
Hana Haatainen-Caye: You’re listening to The Lange Money Hour Where Smart Money Talks. We’ll be right back with guest John Bledsoe.
Hana Haatainen-Caye: This is Hana Haatainen-Caye, we’re talking smart money with Jim Lange and John Bledsoe.
Jim Lange: John, I wanted to get back to the point of potentially negative tax law that could have a negative impact on your strategy. Probably the best argument that it won’t happen is that they can always change the tax law in the future but you would think that somebody who is already in the system, that is somebody who’s already made the Roth IRA conversion when there is a given set of laws would actually be grandfathered, and that’s probably an argument for your strategy of doing all of it early. So if they do make a change in the law presumably it would be done after January 2010 and if your conversion is already done then you would be grandfathered.
John Bledsoe: Right I agree with that.
Jim Lange: So I think that that is good. Now there’s also some other strategies. I was actually talking with Barry Picker the other day who is another Roth IRA expert and he’s been on this show and he says well what he kind of likes is doing a portion of it early in the year but he also says that he wants to reserve some in case it goes down during the year itself. So let’s say you do a Roth IRA conversion in 2010 and one of the accounts goes down, he’s actually suggesting well maybe you want to re-characterize some of that in 2010 that is not wait for 2011and then wait the requisite period or have other IRAs, traditional IRAs that you haven’t converted to convert then. And that to me is an interesting strategy also.
John Bledsoe: Correct and I must say the idea of this of January 4th of 2010 or when anyone hears about this strategy they ought to consider converting right away simply depending on a money calculation. Meaning the idea of that would be accounts would be worth more in the future then they were right now. But in reality accounts can go up and down. The problem with Barry’s assessment of this, and we ran literally hundreds of thousands of numbers through our models with how investment performance has tracked in the past, the low date in the year is more often then not someone who invests in stocks or even bonds is often not the first day of the year. It can be somewhere else within the year would mark the low point of that investment. The reality is nobody knows when that is, they would be very very wealthy if they did and I certainly would take advice from them, though I don’t think they would need advice from anyone else, if they could pick the low of the year that would be the date to buy everything. The reality is though that we don’t know when the low point is and we don’t know which accounts are going to go up or down. So my strategy even if somebody has CDs is that the accounts by preserving the January date on the conversion of 2010 and waiting they have more options. In reality though you might look back with an alternate strategy if you had some powder that was dry and you could convert if it went even lower than the year if it was important for you to convert some in 2010 then that alternatively might work out better actually though four out of five times with the partial conversion strategy. But it’s better to convert them all on January the 5th with the anticipation that you will ultimately convert $100,000 or $200,000 out of a $500,000 account.
Jim Lange: Well again to me it’s a really compelling interesting idea that intuitively I like but I’m just a little bit too conservative maybe just brought up that way, and I do sometimes like having some traditional IRA around that we can potentially convert again. But by the way in either case whether you’re attracted to John’s strategy, whether you say hey that’s too aggressive, I do think and maybe I’ll ask you this too John, that people really should be looking hard at whether they should be making a Roth Ira conversion. And before we even get to 2010 it’s still 2009 and let’s say that for discussion’s sake that you are a senior, that is you’re over 70, you have not taken your minimum required distribution for 2009 yet and you don’t intend to because the government said you don’t have to take a minimum required distribution in 2009. This is likely to be the lowest income year that you have ever had, and to me I wouldn’t be if I was in that situation that is I am 70 or older, I was in a low income because I don’t have a minimum required distribution, I would be thinking about doing a conversion in 2009 and if I’m over $100,000 then even without the MRD then I’m very interested in 2010. So John would you say it’s fair that whether you are using your aggressive strategy or even let’s say more conservative strategies that a lot of people, maybe not everybody, but a lot of people certainly the majority of IRA and retirement plan owners should at least be thinking about a Roth IRA conversion plan?
John Bledsoe: Yes I agree with you. If your income is going to be less than $100,000 and modified adjusted gross income, which is essentially your adjusted gross income with a couple of additions and subtractions you then converting in 2009 is even better particularly perhaps even bridging some of those because if you’re over 70 you don’t have for the first time in history any of these mandatory distributions in 2009, and again to follow the conspiracy theory I have no fear that the IRS is going to make you make a distribution in arrears in 2009 we’ll pretty much accept that as set in law. So great you had to make no distribution for 2009, your income may thus be lower than it would have gone then. I think the strategy for making large conversions in several different asset classes in 2009 is very very winning and I would say definitely do that if your income is lower than $100,000.
Jim Lange: And there you can either use let’s say my more conservative strategy of determining what is the appropriate amount to convert and convert that, or your more aggressive strategy you could do the same thing again, you can take all your accounts, split them into five or ten different IRAs, convert all of them to Roth IRAs and basically just use the same strategy that you’re recommending. By the way you know I don’t think that we have mentioned that that is the premise of your book and we should probably give listeners a chance to get the book, which by the way I think you just did a great job on it, I’ve always liked your writing. You are the most un-Philadelphia like attorney-writer I know.
John Bledsoe: I’ll take that as half praise.
Jim: That’s actually the way it’s meant. But why don’t you tell listeners how they can get the book and where they should go to get it, which by the way I haven’t seen the official book but I think you have sent me email files.
John Bledsoe: I haven’t seen the official book either. I’ve seen the gallery and the book is actually shipping out tomorrow afternoon, it will be available in fine book stores everywhere including Amazon.com and Barnes and Noble and coming soon to a retailer near you. It’s also available if anyone listening would like to get a copy early the book by the way is priced at $29.95, it’s 256 pages and it has a lot of charts and graphs and illustrations about Roth IRAs and regular IRAs in a simple English explanation of all the rules and what to consider. It’s available on a website that I have called GospelofRoth.com and you’re able to buy the book there and get it a week or two sooner than Amazon or Barnes and Noble have it.
Jim Lange: Now would another advantage of that being you might send out an occasional newsletter of an update?
John Bledsoe: Absolutely we are doing newsletters and blogs and keeping up with the occasional changes in both the tax law and the environment and all of that will be added and is added monthly, we do a monthly newsletter via email.
Jim Lange: And that might be better for the listeners to do that rather than to go to Amazon where you’re not going to know their contact information.
John Bledsoe: Absolutely. If they want to sign up for the list they can do that or my email is John@JohnBledsoe.com. Now you’re giving your book away at your seminars is that right?
Jim Lange: Yeah it is, I am.
John Bledsoe: That is amazing, obviously if Larry King gives it an endorsement he’s a lot better known than these IRA experts, but it’s a great book and I had to buy my first copy off of Amazon Jim so I should have come to your workshop.
Jim Lange: Well you could have but I think the idea here is I’m interested in working with people that come to the workshop and it is in my interest and their interest that they be educated and that’s an extra incentive and a lot of times what people will do is they will thumb through the table of contents and read what is most relevant for them, and then when they come in to see me they have one leg up. On the other hand frankly most people don’t and they just come in and we take it from scratch. You know we have spent really most of this show talking about this idea and we have about 20 other questions that we wanted to get to.
Hana Haatainen-Caye: Jim, let me jump in here. John let me ask you a couple questions. First of all can a non-deductable IRA be converted to a Roth IRA?
John Bledsoe: Yes, they can as a matter of fact non-deductable IRAs are a special type of IRA. If you’re not able to deduct an IRA, in fact everyone whether or not if you have a retirement plan at work or even if your income is very very high, everyone can contribute either $5,000 or $6,000 to a so called non-deductable IRA. And beginning next year you’ll be able to, and by the way that line is if you’re 50 or more Hannah you can contribute $6,000 or if you’re below age 50 you can do $5,000 to a deductible, and there’s nothing saying that next year you can’t immediately convert that to a Roth IRA. So what happens then if you had $5,000 in a non-deductable IRA and that was converted to a Roth IRA that $5,000 would be your basis it would be what you didn’t get a tax deduction or your after tax dollar contribution, then that $5,000 grows as if you had been able to contribute to a Roth IRA all along. So there’s a tremendous advantage if you have a large amount of your IRA accounts that are non-deductible IRAs. The sooner you do that the math is even greater, the math that Jim gave was astronomical just converting $100,000 to a Roth IRA. It’s even greater if you have non-deductible IRAs if you convert them sooner instead of later.
Jim Lange: Right – I would add two things to that. The non-deductable IRAs are for people that make too much money to convert to make a contribution to a Roth IRA. The other thing that I would say that I think what is it $166,000 if you’re married something like that.
John Bledsoe: Yes.
Jim Lange: So the other thing that I would say that’s very interesting about a non-deductable IRA and I’m not going to have time to go through this in detail. A non-deductable IRA where you put money into a retirement plan, you don’t get a tax deduction, the money grows income tax deferred, and then when you take it out the distributions are prorata, that is some of it is a return of your capital that you’ve already paid tax on and some of it is a gain which that person will have to pay. That is conceptually similar to after tax dollars inside your company retirement plan. So let’s say for discussion’s sake that the company retirement plan will let you put in based on your income $30,000 or $40,000 but the IRS would only allow you to deduct well now $22,000 but before much less. So a lot of people particularly high income earners have non-deductable portions or after tax dollars inside their retirement plan. There is a very cool method where we can isolate that and avoid the prorata rules, and I know I’m jumping, and actually end up making a Roth IRA conversion of a portion of that money without having to pay the tax. And I hate to do this to listeners, and by the way by pure coincidence that is something that I cover in my workshop, but it is a very cool thing and the benefits are tremendous because you don’t even have to pay the tax, even John the best of your strategy you’re still going to have to pay some tax to the IRS. With one of the strategies that I have for the non-deductible IRAs and money in the after tax dollars retirement plans people could potentially make a Roth IRA conversion without having to pay the tax. Again one caveat is you have to jump through a number of hoops to do that but it can be very worth while.
John Bledsoe: Sometimes jumping through these hoops makes you a lot of money.
Hana Haatainen-Caye: And another question for you John. Can a beneficiary roll over an inherited Roth IRA to his or her own name?
John Bledsoe: A beneficiary can only roll over a Roth IRA if they’re the spouse. So like regular IRAs if an account holder dies his or her spouse can then take the money and convert that or rename that account into his or her own name, and the advantage of that is that Roth IRAs unlike regular IRAs have no mandatory lifetime distributions therefore seven and a half is no big deal to a person who has Roth IRAs only because they don’t ever have to take the money out during their lifetime. However if their children or grandchildren or other beneficiaries then and only then after the account holder has died and the account has been inherited by these children or grandchildren or other people non-spouses, then they must begin to withdraw the Roth IRA but they don’t have to take it out immediately they take it out over their life expectancy. So it’s a long enjoyment of these tax free distributions that are tax free even after you inherit the IRA as a Roth IRA and you can take them very, very slowly relative to taking it out all at once.
Jim Lange: And I am a great fan of that, in the traditional IRA world it is called the stretch IRA or now the stretch Roth IRA. I actually in my estate planning through a series of disclaimers you can determine after somebody dies whether the money should go to a spouse, potentially a B trust I probably wouldn’t be a fan of for Roth IRAs.
John Bledsoe: A big option here Jim, a lot of people ask well what if I die after I’ve done the Bledsoe strategy or the Roth conversion option and what if I die during that period can my heirs unconvert it? The answer again it yes, if the person has IRAs the executor, the heirs cannot make a conversion after the fact after somebody died even if they intended to do it. However if they use our strategy, my strategy on the Roth conversion option they’re able to un-convert after a person’s death all the way up to that October 17th of 2011 date for 2010 conversions, they’re able to do that without, they’d be able to pick and choose just as if the person was alive. And again if the person inherits a regular IRA versus a Roth IRA it’s significantly more money. If the beneficiary is over age 50 it could actually be 20% even more money because of the tax laws of inheriting a Roth IRA versus a regular IRA.
Hana Haatainen-Caye: Okay Jim we’re going to have to take a short break. We’ll be right back with our guest John Bledsoe on The Lange Money Hour Where Smart Money Talks.
Hana Haatainen-Caye: This is Hana Haatainen Caye, we’re talking smart money with Jim Lange and John Bledsoe.
John Bledsoe: Jim I want to give a quick feedback for you. I have visited YouTube normally to watch musicians and other artists and you have several brief explanations about IRAs on YouTube. If anyone wanted to get an advance on buying your DVD a flavor for how well you explain these subjects using the chalk board and the graphics it’s great they can type in in the search engine either Roth IRA you’ll be at the top or Roth conversion or Jim Lange. I think that visually it’s very very helpful just like people who attend your workshop to see you in action and how you explain this so well to people.
Jim Lange: Well I appreciate it, and I believe I sent you a copy of that workshop.
John Bledsoe: You did indeed and I have not yet watched it but I have seen the snippets on YouTube and I intend to watch the whole thing as soon as I get some popcorn.
Jim Lange: Okay very good.
Hana Haatainen-Caye: John let me give you a scenario. Let’s say someone has a large regular IRA and the income tax on the Roth conversion will cost them almost $300,000, how long will they have to live in order to break even on this $300,000 expense?
John Bledsoe: Great question, and of course what’s being asked here is if there’s $300,000 that I’m going to pay to income tax now then I’m $300,000 poorer because I’ve converted my regular Ira to a Roth IRA and now I’ve got $300,000 in additional tax, that’s a loss how long will it take to make it up? The answer is it’s made up immediately and it’s not a loss. The $300,000 categorically that you owe on your IRA let’s say a 30% average rate at a million dollar IRA conversion, that $300,000 is just a debt like if you have a debt on your home mortgage or a debt in your business that you personally guaranteed. You’ve got a debt against every dollar in your retirement account and your IRA to the US government. The government is a really bad partner because they want the money when it’s the highest. After somebody is seventy and a half and they’ll make you start taking the money out after age seventy and a half. So for most people the answer is there is no cross over they’re ahead they actually have more money as counterintuitive as that may appear by converting and paying the taxes sooner instead of later.
Jim Lange: I would agree with John and that’s a huge misnomer. One of the results of thinking oh it’s going to take a long time to break even is that older IRA and retirement plan owners are hesitant to make a Roth IRA conversion but I would agree with John, I’d put it in a slightly different way. I would say if you have $1 million in your IRA and you have $300,000 yes I would agree that you have $1.3 million total but if you wanted to buy goods or services you would have to cash in your IRA, pay taxes of $300,000, so you really only have $1 million of purchasing power. And likewise if you make a Roth IRA conversion you write a check to the IRs for $300,000 you now have a $1 million dollar Roth IRA and if you go to cash that in the next day you still have $1 million of purchasing power which is why I agree with John in that yes your break even period unless you change tax brackets, and we’re not going to have time to get into that, is literally going to be day one. And I think it’s really important for seniors to understand that we’re looking for the most purchasing power not just the most dollars. And if you take into consideration the fact that the money is going to grow income tax free, and if you also take into consideration even if it didn’t grow a dime that the income tax rates are almost inevitably going to go up, that this is really going to be a good deal.
John Bledsoe: I agree.
Jim Lange: Alrighty. You know we don’t have much time left but there was one thing I do want to get to and then we have two minutes and we’re going against the rules but John I want to throw out a question to you. What is the order that you like to spend money? So let’s say that a retiree has some after tax dollars, they have some IRA dollars, and they have some Roth IRA dollars which presumably is what most of our clients who are interested in these strategies will end up with. What do you like to spend, and let’s assume they’re retired, their social security and pension can’t pay their expenses, which pot do you like to go into first?
John Bledsoe: Well the last let me take that in reverse order real quick. The last money one should ever spend if they have Roth IRAs converted or Roth IRAs contributed is the Roth IRA. That’s tax free forever money that you don’t have to take out, that’s the last money you would ever touch and then you have to run the analysis as to whether or not if you got CDs or other money that’s saved that doesn’t trigger a tax maybe that money first and then the IRA money because of the enjoyment of that deferral where there’s still the potential to convert that to a Roth IRA second. And then lastly and finally burn that most precious asset the tax free forever during your lifetime Roth IRA.
Jim Lange: By the way I would agree with that. I want to thank you so much John but unfortunately we are just about of time.
John Bledsoe: Thank you for having me I really enjoyed it and keep up the good work Jim.
Hana Haatainen-Caye: Thanks so much John and I want to think our listeners for joining us. This is Hana Haatainen-Caye with The Lange Money Hour Where Smart Money Talks. Please join us on January 13th when Jim will talk about Roth IRA conversions with Steve Coleman, CPA, certified estate planner, and coauthor of many Roth IRA articles.
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.