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Powerful Wealth Preservation Strategies with Ed Slott, CPA
James Lange, CPA/Attorney
Special Guest: Ed Slott, CPA
|Click to hear MP3 of this show|
- Introduction to Ed Slott, CPA, America’s IRA Expert
- Money-Saving Ideas for People Who are Still Working
- Putting Money Into a Non-Deductible IRA
- Ed’s Two Favorite Ways of Creating Wealth
- Using Life Insurance As a Wealth-Creator
- Potential Disadvantages of Roth IRA Conversions
Nicole: We are talking smart money today, and this is going to be a show jam packed with information, and we’re really excited about that. I’m Nicole DeMartino, your host, thank you so much for joining us. Today, we not only have one, but two nationally renowned IRA experts, the two top people in the country right here with us today. First, of course, we’ll start with Jim Lange. Jim is a CPA and author of the best-selling book “Retire Secure!” Jim is a nationally regarded expert on the topic of IRAs and Roth IRA conversions. Jim, you have been busy traveling all around the country spreading the word, right?
Jim: I have been.
Nicole: That’s right. And we also have here Ed Slott with us today. Ed has been named America’s IRA expert by Mutual Funds magazine. Ed, you’ve been traveling as well, and we are taking a look at your book today, “Stay Rich for Life,” and I’m sure we’ll be chatting about that book a little bit later, but thank you so much for joining us today.
Ed: I’m happy to be here with Jim. Thank you.
Jim: And I’m going to add another word to the introduction. To be fair, Ed is THE IRA expert in the country. If there’s one guy who has written more books and sold more books and given more talks and trained more advisors, Ed is the guy. So, I appreciate the kind words, Nicole, but, really…
Ed: Well, thank you, Jim.
Jim: …and I mean that sincerely.
Ed: But, my biggest credential is, I’ve been to Pittsburgh several times.
Jim: And you’re very familiar with Pittsburgh baseball teams. You were speaking quite articulately about Bill Mazeroski…
Ed: Oh yeah, yeah. That’s my day. I hate to admit it, but yeah. That was my day, boy.
Jim: Anyway, Ed, this show’s going to be running on April 7th, and what I was hoping to do is to talk about things people can do immediately that have an immediate deadline. So, I’m thinking about people who are still working, and the issue is, what can they do to further their retirement and to get the best out of the tax laws in terms of immediate action that they can take between today when the show is running and April 15th. And I thought if we could start with that, that that would be a good starting point for our listeners.
Ed: As any tax preparer knows, there isn’t much you can do after the year ends. When you’re doing taxes, you’re recording history. History that already happened, and the book, for most tax provisions, the book is closed on December 31st. But one thing, and it’s a perennial, every year IRAs are one of the exceptions to that rule, where you actually have until April 15th to contribute to an IRA or a Roth IRA for the prior year. And I would encourage everyone, and this may be controversial but, to contribute to a Roth IRA and give up the tax deduction. People hate giving up a tax deduction, but I gotta tell you, theoretically, people say, “Well, if you invested the money that you made from the tax deduction that you got, obviously, if you get a tax deduction, you get a bigger refund, and if you invested that, then there might be some correlation there.” But, as someone who has prepared tax returns for more than twenty-five years, I never saw, or even heard a client talk about investing a refund. In fact, while I was doing the taxes, they were talking about where they were gonna spend their refund. So, to me, if you’re gonna waste the tax deduction anyway, you may as well forego the tax deduction and put money in a Roth IRA. Anybody who worked during 2009 can put $5,000 in a Roth IRA, and if you’re fifty or over, you can put an extra $1,000, so that’s $6,000, and you can do it for a spouse even if they’re not working. In fact, there are income limits, but those are easily skirted, and that’s new this year. In fact, I did that myself. I was never able to do that before, but this year, I actually put $12,000 in a Roth IRA. Yes, it’s legal, before you say I can only do $6,000. Actually, I put $24,000 in. Figure that one out. I put $6,000 in, because up until April 15th, you can put $6,000 in a traditional non-deductible IRA, and I did one or my wife, as well, and then we also put $6,000 in for 2010, because it’s better, rather than waiting until the last minute to put the money in early in the year so it’s growing tax-free, especially in a Roth IRA. But, mine were not originally in a Roth IRA because I didn’t qualify, because there were sill income limits on who can contribute to a Roth. But, I put it in a traditional, non-deductible IRA, and then the next day, we converted all of them, because those rules have changed this year, opening up the floodgates for Roth conversions, put all of it in a Roth IRA at no cost to me. All we did was move money to taxable accounts to tax-free accounts at no cost. So, everyone should at least do that.
Jim: Well, I couldn’t agree with you more Ed, and I’m putting in $5,000 or, if you’re fifty or older, $6,000 into Roth IRAs, as long as your income is less than $166,000, if it is more, I would agree again, put in even on a non-deductible basis, and I actually have run those numbers, and it pretty much agrees with what you said in that you’re still better off with the Roth rather than with the traditional IRA. The only exception to that might be if you are in a very high tax bracket now, and you’re very likely to be in a very low tax bracket, say, in the next two years, so maybe in that situation, I might prefer a traditional IRA. But, you’re also right in that you’re actually putting away more money, because if you put in, say, $6,000 into a Roth, you’re actually putting in $6,000 of value into your retirement plan. If you put $6,000 into a traditional IRA, and you get a $2,000 refund, you’re really only contributing $4,000 in terms of true purchasing power.
Ed: And especially if you spend that refund, as I find most people do.
Jim: Yeah, and I think that your advice on the non-deductible IRA for our high-income clients is very good advice, and I don’t find a lot of people doing that.
Ed: To me, that’s just a no-brainer. Really, what are you doing? You’re moving money from one pocket to another, and the place you’re moving it to is tax-free. One of the big advantages, in case anybody listening is worried about, well, now it’s in a Roth. What if I need it? One of the great benefits of a Roth IRA contribution, the money you contribute, the $5,000, the $6,000 if you’re fifty or over, can be withdrawn any time for any reason, tax and penalty free. So, there’s no risk at all. I mean, I hope that nobody does withdraw the money, because you want to hit that money last, because that money’s growing the fastest because it’s growing tax free. That money will never be eroded by taxes, and it will never be required to be withdrawn in your lifetime. So, it’s just a no-brainer to me. If you have the cash in a taxable account, and you qualify, you had earnings, then put something in a Roth IRA, or do the non-deductible to a Roth conversion this year.
Jim: Yeah, in fact, I did the numbers on that. If you are younger and you put in $5,000, let’s compare putting money into a non-deductible IRA as opposed to just investing the money, the difference over a 40-year period is actually $50,000. So, if you think about it, you can be $50,000 better off even though it doesn’t cost you an extra nickel now to put money into a non-deductible IRA, as opposed to letting it sit in the normal after-tax environment.
Ed: And here’s another tip for young people. Now, young people generally don’t have the money to put into a Roth, because whatever money they made, they probably spent, but I’m really talking to parents and grandparents. It really would benefit your children or grandchildren if you would put money in an IRA for them at an early age, as soon as they have earnings, because the greatest money making asset any individual can possess is time. As you heard Jim talk about 40 years, the compounding exponential numbers are staggering. I’ll give you an example. When my older daughter got her first job at age 15, she made $350 over the summer working in a library, so I put $350 in a Roth IRA for her. That’s the kind of thing I’m talking about. Now, the $350 she made, she spent. That’s what kids do. So, I had a talk with her and she kind of explained it back to me. She said, “So is this the way it works? I make $350, I spend that money, then you put it back in and it grows tax-free forever? Is that the way it works in this country? What a country! Is that the way it works?” And I said, “Well, that’s the way it works when you’re under my roof.” And I don’t mind that she spent the money because I know about the compounding, and even if it’s a few hundred dollars a year from some odd jobs, compared to, say, a friend of hers that ten years later, at age 25 when they’re out of college and get their first job, even a few hundred dollars a year for those 10 years, when those same two people are 70 years old, those few hundred dollars, or even a few thousand, for the first ten years while the other child was contributing nothing, can turn into hundreds of thousands more. The numbers are staggering at that point. So, it really pays if you’re younger to get that money in as soon as possible.
Jim: And, again, I could not agree with you more. In fact, I’ve actually read some literature on that. One the other hand, I do think some people go too far. For example, they pay their infants for modeling…
Ed: Well, it has to be legitimate.
Jim: …calling it earned income, and then they make a Roth IRA contribution.
Ed: Yeah, it has to be legitimate work. And it’s a gray area, but what my definition of what’s legitimate work if you’re paying a child, in my case my daughter worked for a library, you know, that’s fine, but let’s say you’re paying a child, to me, the definition of legitimate work, or genuine work, is paying your child for something that, if they didn’t do it, you’d have to pay somebody else to do it. I’m not talking about cleaning your room, but maybe painting the house, or, you know, something else that you might pay somebody else to do.
Jim: Well, I think that’s great. The other thing, I think that that adds a, let’s call it a personal component, as well, which is encouraging work, and also, in effect, subsidizing the savings, which I think a lot of parents are happy to do.
Ed: Well, I don’t mind subsidizing the savings in the early years, so I don’t mind putting that in because I know she’s gonna spend her money, but the other reason I did that, not only because I know about the compounding and how it will really pay later on for her, is that when she does get on her own and have her own job at 25, I believe it’s more likely she’ll continue the savings process because I already set up the foundation for her.
Nicole: And that’s a good place, actually, I need to take a quick break. We’ll be right back talking more smart money with Jim Lange and Ed Slott.
Nicole: This is the Lange Money Hour, where smart money talks. I’m Nicole DeMartino here with James Lange, CPA/Attorney and best-selling author of “Retire Secure!,” and our esteemed guest today, Ed Slott, America’s IRA expert and, actually a little later, we’re going to be talking about Ed’s book “Stay Rich for Life,” and that book you can certainly get. You can jump on his website, www.irahelp.com.
Jim: Ed, you mentioned that you put money into a non-deductible IRA and you immediately converted that into a Roth IRA.
Jim: I’d like to pick up on that theme, because there are a lot of people out there right now who have non-deductible IRAs, and in the old days, when they were able to put in $2,000 but they weren’t allowed to deduct it, and they have some of that money. And the other thing that I would say is conceptually the same, is they have after-tax dollars inside their retirement plan. So, for example, their salaries were high enough that the company plan, between their contribution and the company plan, it would be more money than the IRS would let them deduct. They did it anyway, which was prudent, but they ended up getting, in effect, no tax deduction for the money going in, but the money grew tax deferred. I wonder if you have any advice for people who have some after-tax dollars inside their non-deductible IRA, or after-tax dollars in a qualified plan, either it’s in an IRA, because perhaps, at some point, it was rolled into an IRA, or it might still even be in the company 401(k) plan.
Ed: Well first, as you said, after-tax money non-deductible contributions you didn’t get a deduction for, so when you pull that money out, you don’t pay tax on it. But, the earnings you still pay tax on. But, going back to my scenario, I never had non-deductibles before, so it was a little less complicated for me. A day didn’t even go by to have earnings, so other people, though, have non-deductibles from years back which they’re supposed to keep track of, and if you don’t know about it, maybe your accountant or tax preparer does, because there’s a form attached to your tax return called “8606 Form—Non-deductible IRAs.” If you’ve ever made non-deductible contributions to your IRA, you should have that form attached to your tax return. You may not even know it’s there. Sometimes, you get a tax return back from a preparer and there’s a lot of paper in there, and that’s one of them. But, that’s pretty important if you want to convert, because that tells you how much of the amount that you’re going to convert you don’t have to pay tax on. Now, one thing you can’t do, and this confuses people, you can’t just take the after-tax money, the non-deductible contributions, convert that and pay no tax. You actually have to use a percentage, commonly known as a pro-rata rule. I’ll give you an example. If you’ve made $30,000 of non-deductible contributions over the years, and the balance in all your IRAs say $300,000, I made a real easy example, that’s one-tenth, 30 over 100, if you convert the 30, then 10%, that same percentage is tax-free. $3,000 is tax-free, not all $30,000. $27,000 you’ll pay tax on. But, if you convert the whole $300,000, which includes that $30,000, then you’ll get the $30,000 out tax-free into a Roth IRA. But, the point is, you didn’t get a tax benefit for after-tax money going in when you made a non-deductible contribution, and that goes as well for after-tax money in your company plan. So, you shouldn’t pay tax when that money comes out either.
Jim: Great, great.
Ed: It’s a little complicated. That’s something you should really go over with your tax advisor. But, you should have, at least, that form included in your tax return.
Jim: Yeah, actually, somebody came in this morning and the husband and the wife each had $50,000 in their IRAs, they each had substantial 401(k)s, and they said they remembered putting contributions in on an after-tax non-deductible basis, and I looked at their tax return and they didn’t have an 8606.
Ed: Well, that’s a very common problem for a lot of people. You’re gonna have to reconstruct that somehow. That’s a cumulative form. So, the good news is, once you pull out the wreckage and reconstruct it, you put in the totals right up to date. The only way I know to reconstruct that if you don’t have any records, look back at years on your IRA statements where you made contributions, and then compare it to your tax return for that year. If you didn’t take a reduction, then that’s a non-deductible contribution, and add it up. Now, the good news is you don’t have to go back to the year of the flood. The first year you could have had a non-deductible contribution was 1987. The reason I say that, if you ask people, Jim, you may find this too, when you ask people that don’t know, how much have you made in non-deductible? Oh, $300,000. That’s mathematically impossible. You know, there are limits. It’s a limited amount.
Jim: On the other hand, sometimes, people have a reasonable amount of money in after-tax dollars inside their retirement plan at work, so some highly compensated executives, or, actually, for a lot of people, it’s not all that uncommon for me, in Pittsburgh where people have a lot of 401(k) plans is a company called Westinghouse, and it is not uncommon for me to see Westinghouse employees with maybe $1,000,000 in their 401(k), of which, maybe $50,000 is after-tax.
Ed: Yeah. The problem with that is, it’s a gray area in the tax law. But, there is a way to isolate, there seems to be a way, like I said, it’s a gray area, generally, you still have to use that pro-rata rule, but there’s a way to isolate the $50,000 and get it out, but you have to go through a few moves, and I would be very careful. You’d actually have to take a distribution of everything, and take the pre-tax money, the taxable money, put it into a regular IRA, then you’re left with the after-tax, and you should be able to convert that tax-free. The problem is, if you do it that way, they’re required to withhold 20%, so unless you have the 20% somewhere else to make up that rollover, you could be in trouble.
Jim: Yeah, we’ve actually been doing that. By the way, I think you’re right on point in terms of isolating it, but the way we’ve been accomplishing that, and we can’t do this for everybody, but let’s say, for discussion’s sake, a guy has a million dollars, going back to that Westinghouse guy, he has a million dollars in his, either his 401(k), let’s even assume by this point, it’s been rolled into an IRA of which $50,000 is after-tax, if he starts his own new one person 401(k) plan, for which he would need to have earned income, and then let’s say that plan, we roll the $950,000 of the traditional 401(k) into that, leaving the $50,000 after-tax IRA in the IRA.
Ed: Again, you’re isolating the after-tax. But, the problem is, with some recent rulings IRS came out with, say if it’s done as a direct rollover, you still might be stuck with the pro-rata rule, but they haven’t said definitely, it seems that it does work if you take a withdrawal. But, I won’t even get into the thick of this here. This is something that you might want to bring up to your advisor and see if they know about this. You know, this is kind of like inside baseball, a little too technical, but it’s good to bring it up that there may be a way to take out the tax-free money, convert it to a Roth tax-free.
Jim: Well, it seems to me that reading your books and reading your articles and newsletters through the years, that you seem to have a fear of higher taxes and you, in effect, discount the money in traditional IRAs, and are looking for ways of getting tax-free growth.
Ed: Oh yeah, I’m a big believer in tax-free. I really do see the government lowering the boom on people, and taxes going through the roof. Earlier, you started talking about people putting money in IRAs and 401(k)s and if they were in a high bracket, they get a big deduction, and then when they take it out, they’ll hope to be in a lower tax bracket. That was the whole case for tax deferral. But now, I call that whole case the big lie because you’re probably not going to be in a lower tax bracket in retirement. Most of my clients that were good savers have large IRAs and the required distributions, the money they have to take out exceed what they used to make at a job. So, the taxes they pay are higher in retirement. A lot of the people can’t believe it. They say, “How could I owe more money, how could I make more money when I’m retired than when I was working?”
Jim: We have the exact same problem, and in a number of your books, and probably, at least for my mind, the one that I have, in fact, I have it with me right now, and there’s paperclips all over it and it’s marked up and scratched up, etc., “Retirement Savings Time Bomb,” you advocate a strategy of leveraging tax-free growth of life insurance.
Ed: Right, yeah, I’m a big fan of that. I’m a big fan of Roth IRAs and life insurance because they have something in common. They help you move taxable money to tax-free territory, and an environment of rising tax rates, which is what I see, you have to start that plan now, because if you don’t plan, if you do nothing, you end up with what I call the government plan. Either you make a plan, or you get a plan. Either the plan is done by you or to you. So, either you do something now or you get the government plan later, and the government plan later can be confiscatory. The rates I can see easily going 40-50-60%, and that’s just federal rates, and the states are all broke, they’re piling on every which way, so I think it behooves people to look at ways to move money to leverage money, and that’s where life insurance comes in, to tax-free territory. To do it, you have to spend money now, like anything. But, if you think about it, anything good in life, you pay for upfront. It’s always the bad things that you pay for later and much more. So, Roth IRAs and life insurance you pay for upfront, but the leverage and the tax-free nature of it make it worthwhile, in my opinion.
Nicole: That’s a great point, Ed, and actually we’re going to have to stop right here for a second. We need to take a quick break. You’re listening to the Lange Money Hour, with the top two IRA experts in the country, Jim Lange and Ed Slott. We’ll be right back.
Nicole: We’re back at the Lange Money Hour where smart money talks, and we’re discussing the IRA topic with Jim Lange, Pittsburgh-based CPA and best-selling author of “Retire Secure!,” and Ed Slott, our friend and colleague and author of “Stay Rich for Life.”
Jim: Ed, before the break, you were talking about your two favorite ways of creating tax-free wealth, which is Roth IRAs or Roth IRA conversions, and then life insurance, and I know that you have always been a long-time proponent of life insurance, and I guess what I was going to ask you is, let’s say the intersection, before 2010 when there was an income limitation allowing you to convert your traditional IRA to a Roth IRA, the opportunities for high-income taxpayers for Roth IRA accumulation when it was limited. Now, without that income limitation, we can have a lot more money and a lot more people who are eligible or Roth IRA conversions. On the other hand, you have traditionally always been an advocate of life insurance, and you have some very compelling arguments for it, I was curious how you see the intersection of the two, and if you like one over the other, or if you actually like to combine both strategies of Roth IRA conversion and life insurance.
Ed: Well, it’s a good question. I get this question even from advisors, and every person is different. It comes down to a function of need. First, there’s no question the leverage with life insurance is much greater. For a dollar you put in, you could have a return of ten or twenty dollars all tax-free, and life insurance can also be set up to be estate tax-free, as well. So, the leverage is there. But, you don’t want to go broke doing either. Let’s just say that upfront. You know, you have to have money to do these things, and with a Roth conversion, you know, one of the big questions I get, and I do a lot of consumer programs, Jim, and the big question I get, or it’s not even a question, but I sense this is what they think, they think with a Roth conversion, you either have to convert all or none. It’s not an all or none, you can do partial conversions. When I say that, people say, “Oh, really?” Yeah, it’s not an all or nothing, so don’t think that if I have $300,000 in my IRA, I have to convert all of it, and I don’t have the money so I won’t do any of it. You can do a partial conversion. But, if you think you might need the money later on in your lifetime, then you’re better off leaning towards a Roth IRA because that money is more accessible. It’s true if you have a good insurance guy, he could set up a policy where you actually could get into that policy during your life, but that’s a little more complicated and not as easy as it sounds. So, if you’re sure you’ll never need that money, I would go with the life insurance. If you think you might need some of it, do some life insurance and maybe some in a Roth, but don’t go broke doing either.
Jim: Well, I would agree with everything you said, first on the ability to convert a portion of your IRA to a Roth IRA. I often make the recommendation after running numbers, and the recommendation often is based on tax brackets. So, for example, if you are, let’s say for discussion’s sake, for a 15% taxpayer, if we don’t change the taxability of Social Security, we might want to make a conversion to the top of the 15% bracket. So, if your income was, let’s say, $40,000, you might want to do a $27,000 conversion to get to the top of the 15% bracket, or if you’re in the 25% bracket, we sometimes go to the top of the 25 or 28, but you’re absolutely right that we would not do all of it.
Ed: Well, you make a good point too. On the 15% bracket, and this is something you have to go over with, if you’re preparing yourself, it might be a little tougher, but if you have a CPA preparing your return, it might help you. Jim mentioned the 15% tax bracket. That’s a low tax bracket, and nobody should waste a 15% tax bracket. In my view, you should use up every cent of that, in other words, if your income is under that limit, use the rest of the 15% to get money into a Roth IRA at fifteen cents on the dollar. And you’d be surprised, you know, most people don’t realize, they say “Fifteen percent, oh, that’s only for poor people,” you know you can have a $100,000 income and still be in a 15% bracket? Here’s why. The 15% bracket for 2010 goes up to $68,000 of taxable income. A taxable income, I stress that because that’s income after all your deductions, exemptions, your itemized deductions, so you can have $100,000 of income and you might have heavy work-related deductions, real estate taxes, mortgage interest, and all of a sudden, your taxable income, as you used in your example, might be $40,000, which means you can throw in another $28,000 o Roth conversion income at 15 cents on the dollar. That’s the bargain of the century. Everybody should look to, at a minimum, use up that bargain and at least get the stuff that’s on sale.
Jim: And the other opportunity that I often see people miss is sometimes older people who have significant medical expenses or, perhaps, they’re in a retirement home and the cost is deductible, is sometimes they miss doing a Roth IRA conversion that will create some income that will offset some of their very high medical expenses, and they miss the opportunity of, in effect, getting a free Roth IRA conversion.
Ed: Yeah, and there’s another example of that I’m seeing in people with returns just this year, many people that had small businesses may have had bad years because of the economy and actually have business losses, or something called net operating losses when you have business losses even from prior years that carry over, so you could have an actual, and there are clients, they’re not poor, but they have negative income because they have a bad year of income, so yeah, definitely throw in conversions. I mean, if you can get money into a Roth IRA for free, I mean, who wouldn’t do that? But, as you said, most people don’t think about it because they don’t look at other items on their return.
Jim: Well, I think that’s a great point. I really like the idea of doing Roth IRA conversions and, perhaps for some of our high income and high net worth clients, we are running numbers and making very significant Roth IRA conversions, but I would say that, probably, for the majority of middle income taxpayers, that the advice that we are typically giving after running the numbers, is literally a series of conversions based on tax brackets, which has two advantages, one, it’s not a huge amount of money that they’re paying up front, so that’s the psychological advantage, and two, the other advantages their just actually paying at a lower tax rate.
Ed: Well, another big advantage of the Roth is that it comes with a do-over. It’s limited in time, but it has a money back guarantee. If you convert now in 2010, you have until October 15, 2011, over a year away, to change your mind for any reason at all. So, it’s really no risk.
Jim: Well, let’s talk about that for a moment. So, let’s say, for discussion’s sake, that we make a $100,000 Roth IRA conversion in 2010, and it’s now October, 2011, and that $100,000 conversion actually went down to $50,000. How would you advise somebody in that situation?
Ed: Well, if it really went down, you could actually undo it. It’s called a Roth recharacterization. And you’re no longer on the hook for value that no longer exists, and if you really still want to have a Roth, all you have to do is wait more than thirty days and you can reconvert the money.
Jim: Alright. Is there a strategy that, well, I know there is a strategy, I was curious what your opinion of it was, where people are doing multiple conversions of IRAs, and they, let’s say, for discussion’s sake, you had $1,000,000 in an IRA in 2010, and what some people are doing is they’re breaking it up into ten different, let’s say, equal accounts, and now they have ten IRAs of $100,000. And even though they really only want to convert $100,000, but they’re converting all 10, and then they’re waiting until October, 2011 to see which ones did the best, and then they’re recharacterizing the other ones. I was curious if you had any opinion on that strategy.
Ed: Yeah, I did that myself, actually. I have six different Roth IRAs with different investments, so if some don’t pan out, I can cherry pick and recharacterize the losers and keep the winners. It’s like getting the bet on a horse after the race is over. I only keep the winners.
Jim: That’s a great analogy. I have not heard that. But, you know, that strategy, and there’s a number of…
Ed: I gotta tell you though, you know, practically, it’s a ton of paperwork. Every day in the mail, I get, you know, you’re gonna get a lot of paperwork, a lot of letters from the places you have investments with, you’re gonna get buried in paperwork, but you only have to keep the accounts separate until the time to undo it expires, October 15, 2011. Then you put it all together.
Jim: Alright. Well, the thing that was really interesting to me is that, even though it seems like almost too good to be true, that you haven’t found any flaws, at least conceptual flaws or statutory flaws or significant fears, other than the additional paperwork, which is certainly going to be more work for both the client and, if a client has a money manager, more work for the money manager also.
Ed: Yeah, you know, it is a lot of paperwork. I spend two to three hours signing papers, and, you know, I know what I’m doing, and at one point during the meeting with my advisor, remember, I don’t sell any stocks, bonds, funds, insurance, like I talked about life insurance, I didn’t say I like it because I sell it, I like it because of the tax leverage. So, I have my own financial advisor and it took almost three hours and in the middle of that meeting, I just said, “Tell me where to sign. Let’s just get this over with.” It is a lot of work, but, you know, I’m just trying to get the best bang for my buck and give myself the most flexibility and leverage.
Jim: Well, the other thing that I like about that strategy, and I certainly don’t want to be presumptuous about your money, but I suspect that there’s a very good chance, going back to what you had said earlier in terms of spending, that is, first, you’re gonna spend your after-tax dollars, then your IRA dollars, and then your Roth dollars last. It is very possible, even likely, that those Roth IRA dollars will never be spent by you.
Ed: Well, I’m hoping that, that’s really, I’m not really doing it for myself, I’m doing it so my kids will have a tax-free legacy. But, it’s a safety net for myself, as well, and the thing I like about it, is that, remember, with Roths, there are no required distributions, so now that money’s just gonna sit there. It will never be taxed and it never has to be withdrawn.
Jim: Let me ask you this then. Let’s say, for discussion’s sake, and your daughter’s still pretty young, I imagine?
Ed: Yeah, she’s 21 now.
Jim: Okay, well, let’s go into the future a number of years, and, God willing, you’ll be blessed with one or more grandchildren, and could you tell me how you’d likely set up your estate? Let’s assume, for discussion’s sake, that, you know, you love and trust your wife, and you have a very good feeling about your daughter, and then, let’s say you are blessed with grandchildren, what might be…
Ed: I would probably move the IRAs to my kids or grandkids, depending on the situation, I’d rather have my wife get the life insurance, because that is just tax-free cash, no restrictions, no required, nothing. I mean, that’s just pure cash.
Jim: Well, I like that system. Would you necessarily name your children or grandchildren as the primary beneficiary?
Ed: No. I would probably, at this point, things change, but I would probably, at this point, actually, definitely at this point name my spouse, my wife and then kids percentage-wise. So that, if it turns out she gets all that insurance and doesn’t need the money, she could disclaim, and that’s why it’s so important to check beneficiary forms to make sure you have a contingent beneficiary, because the plan I’m talking about won’t work for people if they haven’t named contingent beneficiaries.
Nicole: And you know what, Ed? I’m going to jump in right now, I need to interrupt. We’re gonna take one more short break.
Ed: Okay, jump.
Nicole: I’m jumping, and in one minute, Ed and Jim will be back to finish this tidbit here. This is the Lange Money Hour, where smart money talks.
Nicole: Okay, we’re back with the Lange Money Hour, where smart money talks, and we’re in the middle of a great dialogue between Jim Lange and Ed Slott, the country’s top IRA expert.
Jim: Ed, earlier, you know, we’re talking about these wonderful strategies, you know, doing these Roth IRA conversions, numbers that I’ve run, say if you make a $100,000 conversion, that you’re gonna be better off by $40,000, your children will be better off by $700,000, and grandchildren is $8.6 million. Then, we talked a little bit about after-tax conversions without having to pay the taxes, and then we also talked a little bit about this strategy of making multiple Roth IRA conversions, and then recharacterizing the ones that didn’t do so well, and just keeping the ones that did, and like you said, I’ve never heard that before. It’s like betting on a horse race after the race is already over. Are there some pitfalls, or are there some things that can go wrong with this?
Ed: It sounds too good to be true, tax-free forever, right?
Ed: And it might not be for everyone. So, you’re asking what could go wrong?
Jim: What can go wrong, and who does this not apply to?
Ed: Alright. First thing I want to say, and I have to address this because I do tons of seminars and programs and presentations for consumers all over the country, and when this topic comes up, like clockwork, I get some version of the same exact question in every program. And the question is this, regarding Roth IRAs, pretty much like we’re flowing now, we’re talking about all the benefits, and then somebody stands up and asks something like this: Can I trust the government to keep its word that after I pay the tax, my Roth IRA will be tax-free forever? Will they keep their promise? Now that’s a question I can’t answer, but here’s how I answer it, because people are thinking that I’m in the soup myself. I converted, I’m thinking that, I’m hoping they keep their word, but nobody knows. You’re asking about something in the future. But here’s my feeling on this. Number one, if any politician repealed this provision, or made people pay tax, it would be unconscionable, and I think it would be political suicide being that they set up all these provisions, and they have so many people in the soup, and then they change their mind, they’d be looked at as reneging on their promise of tax-free. And I think it would be political suicide, because most of the people who voted for this and created the Roth are still there. That’s one thing. The other thing is that our government, as everybody knows, is broke, and the Roth IRA brings in money, so economically, even though it’s only short-term, our legislators only think short-term, because if I was the accountant for the government, I’d say what are you doing with this Roth? You’re giving away the store. But, they don’t look long-term, they only look short-term, and short-term Roth IRAs bring in money. It’s probably the golden goose that they’ve been looking for since the beginning of our nation, something that brings money into the government, and people like it. So, we’ve never had anything like this before. So, for those reasons, I think the Ross will be around for quite a while, and I’m betting myself on it, but there’s no sure thing. So, that is a valid worry. Now, there’s certain people, as I said a little earlier, who should not covert. It’s not for everybody. If you can’t afford it, if you don’t have the money, you don’t do it. I’ll give you an example. My mother’s gonna be 84 years old this year. She saw my show, “Stay Rich for Life,” you talked about it on public television, and she said, “I saw your show. Should I do a Roth conversion?” And I said, “No, ma, don’t listen to that. What are you watching that stuff for? You’re on a fixed income. That’s not for you. Why would you pay money now, where, in your lifetime, you can’t even get a benefit from?” So, if you’re, say, in your seventies or older and you’re converting, you’re not doing it for yourself. You’re doing it for the next generation. It’s not age, it’s need. And you’re doing it for the next generation, because at that age, you don’t have the life expectancy to make the outlay upfront in taxes worth the benefit in your lifetime. So, you’re doing it for the next generation. So, if you need the money, don’t do it, especially at that age. But, on the other hand, you could be 99 years old and have plenty of money. That’s why I said it’s not age, it’s need. If you don’t need the money, and you have the money to pay the tax, then it’s a great move if for estate planning for the next generation, still not for your lifetime but for the next generation, it’s a great move to pay the tax and do the conversion and set your kids and your grandkids up for something called a stretch IRA, where that Roth IRA can go on, the kids can enjoy it and take distributions of it over their lifetimes, tax-free for the rest of their lives. So, that’s a group that should do it. If you have the money, obviously, it’s a no-brainer for an estate plan, but if you don’t have the money, don’t do it. Or, another group that shouldn’t do a Roth conversion, when people ask me, “How soon can I get to my money?” it’s not for you. The power in the Roth is long-term, tax-free compounding. The longer you keep it, the more it’s gonna grow. But if you’re looking at trying to get at it in five or ten years, it’s probably not worth paying the tax. So, if you think you’re gonna need the money, it’s probably not for you. But maybe you want to look at partial conversions where you convert a little each year. And if you truly believe you’ll be in a much lower tax bracket in the future, then it’s not for you. So, it’s not for everybody, but everybody should evaluate this to see if it’s right for you. I’m a big believer in getting money into tax-free territory now, before they lower the boom on all of us with higher taxes, because look what’s going on in our country, the debt, the Wall Street problems, and now our government’s problems have become our problems, so they ask us to pony up so these Wall Street guys can live big, and that’s gonna mean higher taxes later.
Jim: Well, I would agree with you, and from a lawyer’s standpoint, let’s say, sometimes I get the objection, “Hey, gee, they promised us that we would never pay tax on Social Security, and now we’re paying tax on Social Security.
Ed: Yeah, I get that too, by the way. You know what I tell people? I say, “Yeah, the guy who promised that, F.D.R., has been dead for sixty years. But the guys who promised the Roth? They’re still here.
Jim: Well, and not only that, even F.D.R., it was never part of the Internal Revenue Code that that money would be tax-free forever. So, the legal word for it is dicta, meaning it’s not legally enforceable language, and I would argue that the Roth IRA, the language in the code says this money will grow tax-free as long as it is invested. So, to me, to change that from a lawyer’s standpoint, that would be an after-the-fact, or the legal parlance is ex post facto law, which is a violation of the Constitution, and you would have, as you said, a very well financed revolution.
Ed: Yeah. So, I think it’s a good bet, and I took that bet myself.
Jim: Alright, and one other area where there is tremendous confusion, and I was curious as to what your opinion of it is, is that in 2009, we had a $3.5 million exclusion, that is, money that you can exclude from your estate before you had to pay estate tax, and in 2011, it’s going to drop to a million, but this year, at least according to the current law, there is no estate tax. Now, I always assumed they were going to do something at the end of 2009 to, in effect, smooth over that enormous inequity of the accident of you dying, either say in 2009 or 2010 or 2011, has enormous tax consequences for people who have, let’s say, more than a million dollars, and I know that there is some talk that they’re going to make the tax later in the year, and make it retroactively, and I don’t know if you have any opinion on that?
Ed: Well, nobody knows, but I’d be careful using that word “accident” this year.
Jim: Okay, that’s fair enough.
Ed: Because there’s no estate tax this year. You know, if you’ve got money and you’re around, I’d watch my back this year. I certainly wouldn’t go over the kid’s house for dinner. Who knows what they’d be putting in the food? So, you could call that an accident, or maybe a happy accident, but really, it’s a ridiculous thing. This is another thing that really gets me about this Congress. They’re so busy, I don’t even know what they do anymore. Whatever they do, it doesn’t appear to be productive on either side, and now we have this situation for people, we don’t know what the estate tax law, yes, technically, there’s no estate tax. If you drop dead now, there’ll be no estate tax, but I believe they’re gonna fix it retroactively. I would hope so, and I guess we’ll wait and see, because, really, you know, we’re a few months into the year already, and lots of people have died. Some big estates have been created. I happened to see recently that the founder of Taco Bell died this year. Does that mean that whole franchise is tax-free now? I don’t know.
Jim: Yeah, I mean, it’s a terrible situation, which is one of the reasons I like flexibility in estate planning, but not only do we not know what the estate taxes are gonna be in the future, we don’t even know what they are right now.
Ed: Yeah, I tell people it’s probably gonna go back to a three-and-a-half million exemption, but who the heck knows? For years, I told people what’s happening right now, that would never happen, I remember saying that in seminars, oh, that’s never gonna happen, they’ll never leave 2010 with no estate tax, those nuts. That’s what they did.
Jim: And I said the same thing. Well, let me ask you this. Going back to life insurance, because earlier in the “Retirement Saving Time Bomb” book…
Ed: It’s a tough book to pronounce. It’s the “Retirement Savings Time Bomb and How to Defuse it,” and you can find it on my website, www.irahelp.com.
Jim: Which is, by the way, I would say that is the classic.
Ed: Yeah, me too. It’s a favorite of my kids.
Jim: I like “Stay Rich for Life,” but in terms of, you know, real meat…
Ed: Depth, yeah.
Jim: …and it has stood up to the test of time. But anyway, one of the ideas was that the life insurance would also pay for estate taxes, and now, it seems, at least for the, let’s call it the middle range estates, maybe $500,000 to $3 or $4 million, we hope we’re gonna get some relief. Are you still an advocate of life insurance?
Ed: Oh yeah, the life insurance, whether or not there’s a tax, obviously, if there’s gonna be post-death expenses and taxes, that’s the money you wanna use to pay for it, tax-free money. But, even if there was no tax, if you can take a dollar of taxable money and turn it into ten dollars tax-free, I’d do that all day long. It’s the leverage. It’s the greatest single exemption in the tax code. And it’s unlimited. So, it’s a great wealth-building tool if you see the long-term big picture. Yes, you have to pay some money upfront, but it can be arranged to all be estate and income tax free.
Jim: So it sounds like you are recommending a combination of a series of Roth IRA conversions.
Jim: And depending on the person, obviously for everything…
Ed: Yeah, and depending on the availability of cash. Again, I never want anybody to go broke doing anything, but if there’s money sitting around and other assets and bank accounts, or in the stock market that’s really not doing much, it’s better leveraged with Roth IRAs and life insurance.
Nicole: Well, you know what gentlemen, we are out of time, unfortunately, and I wish weren’t. This was a lot of fun.
Jim: It goes quickly.
Nicole: It does go quickly. Ed, it’s really been our pleasure. Thank you for joining us.
Ed: I’m thrilled to be here. I’m a big Jim Lange Fan.
Nicole: Well, when are you coming back to Pittsburgh?
Ed: I actually am coming back soon. I don’t really know when.
Nicole: Okay, let us know.
Ed: No, I’m gonna look it up right now.
Nicole: You look that up. I’m going to give our listeners one more time, if you want more of Ed, jump onto his website…
Ed: I’ll be in Pittsburgh May 20th.
Nicole: Oh, that’s right around the corner. We’ll have to see you. Stop over at our office.
Nicole: Again, if you want more of Ed, great tools, great book, great website, www.irahelp.com. That’s all for us today. We’ll be back in two weeks. Thanks so much for joining us. Thanks again, Ed.
Ed: Thank you.
Nicole: This is Nicole and Jim saying thank you for listening to the Lange Money Hour, where smart money talks.
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.