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How to Achieve Tax-Free Growth
James Lange, CPA/Attorney
Special Guest: John Bledsoe, CFP, CLU, ChFC, MSFS, AEP, CLTC
Please note: Some of the events referenced in our audio archives have already passed. Please check www.retiresecure.com for an updated event schedule.
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- Introduction of Guest, John Bledsoe, CFP, CLU, ChFC, MSFS, AEP, CLTC
- Advice on Combination Strategies
- A Look at Some of the 10 IRA Commandments
- Roth IRA Mistakes
Nicole: Hello, and welcome to the Lange Money hour, where smart money talks. I’m Nicole DeMartino, marketing director for the Lange Financial Group located in Squirrel Hill, and, as always, I’m here with Jim Lange, nationally recognized Roth IRA expert. Jim’s a CPA and he has thirty years of experience, and he’s also a best-selling author, as all of you know, of “Retire Secure! Pay Taxes Later.” And as I announced on our last show, Jim is finishing his third book entitled “The Roth Revolution,” and this book is entirely dedicated to the Roth IRA, Jim’s favorite subject. I’ve actually been reading it, and I think it’s excellent. He does an exquisite job covering every facet that you would need to know if you’re considering a Roth IRA conversion, so definitely stay posted for that. Jim, I also want to congratulate you. Recently, you’ve been named one of Pittsburgh’s 2010 Five Star Wealth Managers.
Jim: Oh, actually, when you pointed that, I thought that that was John Bledsoe.
Nicole: No, no!
Jim: I did!
Nicole: No, no, no, recently, our office was awarded that, and I did some research, and I found out that the award recognizes best in client satisfaction, so if any of our clients are listening out there, thank you so much for nominating us and supporting our win, so congrats! Congrats to you. Tonight, we’re excited, because tonight’s show is live, and I’m going to give you that number right now. The studio line is 412-333-9385, and tonight, we have a special guest, friend of the firm, John Bledsoe, on the phone with us tonight. John, are you on?
John: I am.
Nicole: Alright, well, welcome back. I know you were on the show before.
John: Right. Thanks very much for having me.
Nicole: Oh certainly, and before we get started, I want to give you the introduction you deserve for everybody out there. John has twenty years of experience working as an estate planner and a financial planner for some of the country’s wealthiest people. As a matter of fact, he’s considered an expert for the super wealthy. And actually, what I’m looking at here and I know you can’t see it, John has several designations after his name, a ton of them. I know we used to call it alphabet soup a long time ago because there’s so many, but for those of you who don’t know, if you’re in the financial services industry, you can take additional training and specialize in different things, and once you get that certification, you earn that designation. John actually has six of them. He’s a Certified Financial Planner, a Certified Estate Planner, Chartered Life Underwriter, Chartered Financial Consultant, and he’s earned his Masters in Financial Services, as well. He’s the best-selling author of “The Gospel of Roth,” which you can all get on Amazon.com, and we’re going to talk about that a little bit later, but he’s also a consultant for several large companies out there, insurance and securities-related. So we have an expert, an author, a teacher, all around friend of the firm’s, so does that cover it?
John: I think that maybe covers it a little too much.
Nicole: Oh no, no, no.
Jim: Well, to be fair, also what Nicole failed to mention is that you’re actually one of the long-time retirement and estate and IRA and Roth IRA conversion experts. I mean, I remember that you were writing stuff back in the late 90s. In fact, some of the stuff, including, you had an article called “Ten Myths,” was so good that, back then, I asked you if I had your permission to put it on my website. You said yes, and it’s still there. So, I really consider you a veteran Roth guy, and the other thing that I like about you is that you’re not only a Roth guy. You know, you’re not just like a one subject guy that, like me, you use Roth IRA conversions as just one of, but not your only tool that you can help clients.
Jim: So, actually, with that in mind, what I thought we would talk about are, rather than just talk purely about Roth IRA conversions, which we did last time, and we’re certainly going to be talking about that quite a bit, but what I thought we would start with is some of the combination strategies that you sometimes like to advise your clients. Things that you might say, “Well, for example, let’s do a Roth IRA conversion and, at the same time, I want you to XYZ.” I actually have a chapter in the book that I’m writing right now called “Complimentary Strategies,” and I have a case study where I’m recommending about six different strategies to do on top of the Roth IRA conversion. But, I thought I would ask you some of the things that you like, because you are an overall planner, and by the way, a lot of those designations, they’re not just, you know, random alphabet soup. You know, for example, CFP represents, I don’t know, a couple thousand hours of work to earn that designation, but anyway, John, with that background, could you tell me about some of the combination things that you like to do in conjunction with Roth IRA conversions?
John: Well, absolutely Jim, and I think you’ve got to take everyone’s picture specifically and go down the line. What may be perfect for one person may not be for another. But, people must continue to look at their own situation and make sure that the facts are aligned with their strategy. And so, specifically, ignoring estate tax is very, very, very scary right now, because this year, as we like to say inside the business, is a great year to die, because there’s no estate tax. At least, that appears to be the law of the land, but next year, the estate tax begins again. So, people with larger estates, people with over $1,000,000 or $2,000,000 need to be worried that they need to plan their estate.
Jim: Yeah, I mean, that’s such an odd thing, because last year, I was telling people, “Oh yeah, don’t worry, you know, they’re certainly not going to let it be unlimited in 2010 and then go back to $1,000,000 in 2011.” Certainly, anybody with any sense that even has a modicum of reliability and ability to get things done is going to pass some type of law, whether it’s a $3.5 million extension, a $4 million, or I know recently, it was proposed to go from $3.5 to $5 million, but they didn’t get it together. So, now, we’re in this really odd quandary of unlimited this year, of course, they could still pass a tax and have it go apply retroactively to January 1st, and then $1,000,000 next year. So, that’s a very tough question on how to plan for that.
Jim: So, anyway, what are some of the, do you have any specific things? Do you sometimes recommend life insurance in Roth IRA conversions?
John: Oh, absolutely. If someone has a large IRA, and doing a conversion strategy, first of all, and I don’t know if we still differ on this or not, but last time we talked, there was some concept to many of the listeners that I broached a long, long time ago that the safest strategy is to convert first and ask questions later. Plan on unconverting all of your IRAs from the Roth back if you want to all the way up until October 17th of next year. But, I can’t imagine someone planning their situation without converting first to unconvert next year, or you won’t have all the options. So, I still believe it’s a dangerous strategy to not convert, even if you’re planning on unconverting it all.
Jim: Well, I do have a confession, John. I have moved, to me, you’re like way on the extreme, I have moved much closer to you since we have last talked, and you’re right. I was pretty cautious about telling people to basically, if I can paraphrase your strategy, although it’s actually a common strategy, I wrote about it many years ago as you did and other authors did, which is to separate your Roth IRAs into multiple Roth IRAs, convert all of your traditional IRAs, then separate the resulting Roth IRAs into different buckets or different accounts, if you will, and then consider recharacterizing them by October 17th, and I was a little bit leery of it, and I’m still a little afraid of the mechanics, but I am more comfortable with that idea. So, I will certainly grant you that, and certainly, you and, the other thing is you were one of the very early guys talking about it, and it is becoming more and more common in the financial press also.
John: Well, thank you, and again, we’re talking about October 17th of 2011, the day of course is October 15th, and I love the way our government works that if a tax deadline falls on the 15th and it’s a weekend, then you get to the following Monday. I learned through a very strange set of facts that it doesn’t work that way if you owe a credit card bill over a weekend. Oftentimes, paying it on a Monday doesn’t count. Don’t ask me how I found that out, but the government, being fair, allows you all the way until October 17th, literally with a phone call. The trustees on the morning of Monday, October 17th of next year will unconvert these accounts that have been converted to a Roth IRA. Yet, you could be sitting next October, October of 2011, and say, “My goodness, it would have been a good idea to have converted this one account. Can we go back and convert it?” And what’s the answer? Of course, no, you can’t. If you didn’t do it way back in July of 2010, you can’t do it in arrears.
Jim: Yeah, and John, I’m sitting here smiling and thinking you really do like to live life on the edge, because, to me, I would try to get all this stuff done by the end of September on the theory that hey, there might be a last minute screw up, somebody might file the wrong form, there might be some issue, not to mention, maybe somebody’s on vacation, but it seems that you like to live life on the edge. Convert everything now, or actually, better yet, January 4th of 2010, and then, wait until the last minute to unconvert or recharacterize.
John: At least, you have to know that you have that option.
Jim: That’s fair enough.
John: And I probably will be unconverting the ones that are unconvertible as it were before then, but absolutely, I probably do like a little bit more on the edge. I certainly like the ability. To me, it’s if you don’t convert now, it’s kind of like not wearing your seatbelt thinking “I’m a safe driver. I’m not going to have a wreck.” I think you’ve got to convert now, planning on unconverting because if we do have a wreck, taxes could go up substantially even more than we know that they are, and other things could happen. And just in case, I think the safest position, even if the listener thinks that they’re never going to leave any of it converted, the only position of safety of flexibility is to convert and then wait.
Jim: Well, I think that that is, I will admit I am moving closer to that position. I’m still not really even close to that because I still think of other considerations, but I will admit that I am closer to that and, it’s an interesting paradigm shift because most people would assume I’m not going to convert unless somebody proves otherwise, and what you’re saying is you should convert everything unless somebody tells you otherwise.
John: Absolutely. There’s a couple of very minor exceptions to that, but I believe that with all my heart. But that’s what makes the world go ‘round.
Jim: Alrighty. Well, anyway, we were starting to talk about some complementary strategies with conversions, and one of the ones that often comes up is life insurance, and I thought I would ask you what you sometimes do in practice with some of these combination strategies and, let’s say, life insurance, for example?
John: Absolutely. Well, life insurance, inside a trust, for people who specifically, and I’m talking about life insurance now no longer for protection, and I know there’s a whole world out there for people need protection from life insurance, but my practice has been exclusively for people who are typically older and who’s kids are grown, and their net worth is now their protection. People that are often, for tax strategies, will put life insurance inside a trust. It’s not included in their estate, and they will buy a guaranteed death benefit where the life insurance, when it is paid, is, of course, income tax free, one of the attributes of life insurance, the death benefit is income tax free, and it’s also estate tax free because it’s held in one of these so-called trusts that’s irrevocable, very hard for a Texan to say, but it’s one that you can’t change, theoretically, once you set it up, but built in with flexibility, you then have this money that’s sometimes calculatable as a bond strategy that is superior to DCD’s and bond traunch of the client’s assets, those parts of the assets that we’re utilizing life insurance for people who, typically, are wealthier that $2 or $3 million, they may be $4 or $5 million in wealth, and it look like their account values are going to stay the same or maybe go up slightly. We begin to use life insurance inside a trust, typically now I’m very, very biased because of the low relative difference to buying a guaranteed death benefit where the full faith and credit of the life insurance company, whether it’s Prudential, New York Life, or name the company, guarantees that if you pay ‘X’ number of premiums in a certain amount, then the death benefit is also guaranteed for the life of the person, whether they die at 90 or 95 or 100 or beyond.
Jim: Yeah. By the way, I would second that. I do like guaranteed products, and, in fact, it’s an interesting analogy that you say that that kind of replaces or substitutes the bond or fixed income element of a portfolio because it does, under most circumstances, unless you live to, some of our calculations show, to age 98 or even sometimes beyond, that it tends to have a very high return on investment. Let me ask you this: I know that different people have different strategies, so, for example, Ed Slott likes to have life insurance on the primary IRA owner, and then, at the death of the IRA owner, use the life insurance for the spouse and have some money going down to children and even grandchildren for the IRA and the Roth IRA. Is that a strategy that you like, or do you like a second-to-die life insurance policy, or are you going to be like an attorney and say, “It depends?”
John: I guess I’ll be a little bit. I hesitate to do that, because normally, and I even admitted to Nicole, I have actually withheld evidence, at fifteen or sixteen of these designations…
Nicole: Oh, my goodness!
John: …it’s probably the signs of shortcomings in other parts of my life, and I wanted to keep up with Jim with smarts, but it’s not going to happen. So, what Ed Slott says, and he’s got a lot of great strategies and a good friend of both of ours, Ed has a wonderful way of talking about this life insurance. You insure the big IRA account holder, and oftentimes, the strategy would be when that account holder dies, then the IRA, then you had the ability to convert it potentially, because of the liquidity event to tax-free as a Roth IRA. The problem is, is if the primary insured in that case on a single life policy doesn’t die, well, into a short period after they’re seventy and a half, it can be problematic. One of the things that I point out in the book “The Gospel of Roth” is the half-life is under fourteen years of an IRA once a person turns seventy. In other words, if you could’ve had $2,000,000 in IRAs by converting to a Roth before your seventy, by the time you’re age 84, you’ll only have $1,000,000 in an IRA if you left it in a regular IRA and only took out the bare minimum even if you’re earning nine or ten percent a year in that IRA and taking out the minimums. And so, I hate to say that it might be a bad part of the strategy is people not dying quickly enough, or sometimes, in an irritating fashion, the non-participant spouse dies first, which really kind of ruins the strategy, at least for that purpose, and so, I tend to separate those two. I would, oftentimes, look at those numbers. Second-to-die life insurance is not cheaper. It appears to be cheaper. It’s not always the magical product. What you have to look at is what would the cost of life insurance on either of the lives individually versus second-to-die. It would probably end up using it about 65% of the time for spouses who have the luxury of having a second-to-die policy, and the rest of the time, we’ll use an individual life policy. But, probably, only about 50% or 60% of the time using the participant spouse, a lot of the time, the IRA holder is not as insurable as the other person.
Jim: Alright, so, actually, I don’t know if it’s coincidence. We actually haven’t talked about it, but one of my favorite strategies is a second-to-die, or sometimes, a policy on the person who is going to have the longer life expectancy, which tends to be, at the risk of sounding sexist, but it tends to be the woman who tends to be either younger, or the same age and just has a longer life expectancy according to the insurance tables. So, I sometimes like that, because I think you get a huge bang for your buck. Then, what I sometimes do, is that creates a pool of money for the children, and that frees up some money to have some IRA and, better yet, Roth IRA money go down to the benefit of grandchildren, or a well-drafted trust for the benefit of grandchildren, in which case, they can have many years of tax-free growth, and I don’t know if that is something you do also.
John: Absolutely. As a matter of fact, I’m a big fan, and I think you have been for a long time too, of these well-drafted trusts that you’re very familiar with, because you’re drafting them, oftentimes give the children of the people who own the IRAs the ability to disclaim part or all of some of those IRA components where they have the flexibility of making a game-time decision after mother and father have both passed away of how much would be appropriate to go all the way down another generation through one of these so-called IRA inheritance trusts, and I absolutely love that strategy.
Jim: Well, yeah. That’s almost, oh, in fact, I would say that that’s my standard, for example. So, even in our simple “I love you” documents where we’re leaving everything to the spouses, each other first, and then to the kids, even if somebody doesn’t say anything, I’m still going to have a well-drafted trust for the benefit of the grandchildren, and then, you know, when there is a death, or in the case of the life insurance, the euphemism of course is when the policy matures, then we can have the children choose whether they want to keep the money, or the legal word for disclaim it or say I don’t want it, and what I often do is, there’ll be multiple buckets of money. There might be some after-tax dollars, there might be some life insurance dollars, there might be some IRA dollars and there might be some Roth IRA dollars, so sometimes, we like to mix and match after one or two deaths.
John: Right, and by building that flexibility in, and obviously, I know in some of your documents, if you have the adult child, the fifty-something, sixty-something beneficiary disclaiming some of that money for his or her children and the sixty-year old beneficiary gets to remain the trustee, the boss over that traunch that goes on down to the grandkids, that kind of softens the blow there too, to use a life insurance term. They say the death benefit softens the blow of death. I always thought that was a funny euphemism.
Jim: Yeah, and I like using the, let’s say, the adult child as the trustee. So, for example, if I was to inherit some money and I chose not to accept it, and I wanted it to go down to the benefit of my daughter, I would want to have the ability to have the purse strings. Now, Natalie Choate warns that you can’t use, you know, you can’t just use that like a checking account, and you still have to use a certain amount of discretion as the trustee, but I do that in my documents too. So, I will typically name the adult child as the trustee, and that would never happen if you didn’t anticipate the probability or the possibility of a disclaimer, because a normal will or trust, for that matter, will say something like, “Well, if the adult child is deceased, then that money will go into a trust for the grandchildren,” and then usually someone else, like an aunt or an uncle or the surviving parent of the grandchild, but it doesn’t take into consideration that the child is just fine but chose not to accept the money.
John: Right, and I think the distinction, Jim, is when the parents are deciding, “Okay, my 20-year old daughter, I’m not disclaiming to her so she can buy a Corvette, I’m disclaiming into a trust fund for her where I can control the purse strings and she will be able to have, perhaps, a nicer retirement as a result of this.” It makes it an easier pill to swallow when people, you probably see a high percentage, probably as much as half the people utilize those trusts after mom and dad have died by disclaiming some of it.
Jim: Yeah, I’ll tell you what the pattern we have seen. Now, we’ve been in business for 25 years, which is relatively young for a law firm because I started it myself, and we’ve done about 2,000 estate plans, so I’ve drafted an awful lot of them, but we’ve still had a couple hundred deaths, and here’s the pattern that tends to occur over time. At the first death, we typically have money, if the surviving spouse does not want or need the entire amount, we typically have, maybe, some money going to children, but not typically grandchildren. Usually, the children kind of take care of themselves at the first death, but then, at the second death, that’s when it is more typical that we find that money is being disclaimed to the grandchildren. But one of the things that I like about the combination of life insurance and that type of flexibility is that the life insurance would then create a pool of money not potentially to pay estate taxes, but also, even forgetting estate taxes, to satisfy the spending needs of the children generation that allow the children to be more generous in disclaiming money to the grandchildren that will have many more years of income tax free growth in the case of the Roth.
John: Right. One thing I would caution, Jim, on the analysis of the life insurance is that if the clients will look at it as a bond-type transaction, as opposed to a liquidity transaction, particularly with second-to-die life insurance, understand that if the premiums were $10,000 a year for twenty years, that would be $200,000 of money out, and the death benefit is $500,000, that that same $10,000 per year for twenty years would be worth $500,000 by most of the time at the second death, even invested at 5% or 6%, so it’s not that the insurance is necessarily a windfall liquidity-wise, it’s just after income tax, even 1% or 2% of guaranteed effectively better after-tax return is a magnificent thing when you’re talking about a bond selection. It still is not a windfall. If you want a windfall with life insurance, it’s similar to this year. You need to die sooner than later, which we’ve not yet met that person who’s willing to make that commitment to their plan. I’m sure they’re out there, but the “throw momma from the train” strategy is one that I would even agree is aggressive.
Jim: Well, you’re right, and even using your example, if, let’s say that somebody buys one of these second-to-die policies, pays $10,000 a year, and then they and their spouse die twenty years later, and they have $20,000 out of pocket, and then their children get a $500,000 check, you would think, logically, that somebody should have to pay income tax on $300,000, and you would think, logically, that $500,000 should be subject to estate and state inheritance taxes, and neither is the case, that is, there is no income tax and there is no federal or state inheritance taxes on that money.
John: That is correct, and a good lobbyist for the life insurance industry would say of course, if you put that same amount of money in tax-free bonds and it ended up being worth $500,000, it would be a similar thing, and you wouldn’t want to tax the poor people who needed that death benefit, and it’s been a greatly preserved tax advantage, and one of the few reasons that we utilize it, but it certainly is, without that it would lose a great deal of its luster, would it not?
Jim: Well, yeah, and particularly today, I mean, right now, you’re not going to do very well on a tax-free bond, and I would say over the last ten years of all the investments that I can think of that I have, let’s say, recommended for a client, I’d say that probably the second-to-die life insurance policies have probably been about one of the best investments.
John: Yeah. From a standpoint of relative yield, it’s been phenomenal. It’s longer-term, but its rate of return has been better as a, compared to alternative investments, I agree with you then other strategies we’ve recommended.
Jim: Yeah, and another thing that I think a lot of people that they really have to do when they, if they get into one of these guaranteed policies, I think there is a history of people buying the policy and not necessarily finish paying it to term. So, let’s say for example, in the types of policies I like, I like the lowest premium and the highest death benefit. But what you typically give up is a good cash value. So, if one of my clients were to buy the type of policy I recommend, pay on it for fifteen years and then stop paying after fifteen years. The cash value would not end up being a good return. I think the insurance company knows a lot of these policies are not going to go to term, and they can actually put that in their pricing, so I would caution people, don’t do it unless you are prepared to pay premiums the whole time, and accordingly, I don’t like to do too much insurance where the insurance premium is going to be a burden, and I also like to leave money available for 529 plans and just straightforward money to the kids as they need it.
John: Well, you bring up a great point. Almost 90% of those policies, including second-to-die, do not meet the term, meaning that the clients don’t die with the life insurance.
Jim: Did you say 90%?
John: 90, 9-0.
Jim: You know, I have never heard that statistic. I knew it was high, but wow!
John: Well, guess what? If you’re a life insurance company, you probably want to keep that statistic to yourself.
Jim: Well, I would. By the way, I’ll tell you what that helps explain. That helps explain why, I hate to say it, but the life insurance is so cheap.
John: Oh yeah, it’s the same reason that a Sam’s Club or a Costco can sell a Chili’s gift certificate for $30 for only $25, realizing that they made money on the card by selling it, so there’s cost of that. Selling gift cards, selling long distance cards, selling a basket of minutes for you using your cell phone, these unused things like life insurance are there where, if the majority of the people cancel them, a lot of times because folks are very lucid and they buy these life insurance policies inside these irrevocable trusts at seventy, by the time they’re ninety, they’ve forgotten why they bought them and they didn’t apprise the trustee that this was real important that we pay all twenty years, and there’s no-one there other than a life insurance clerk in a home office who processes the paperwork.
Nicole: Alrighty, John and Jim. We need to take a short break, alrighty? And I want to remind our listeners out there that we are taking calls. You have Jim and John at your disposal here. If you have questions about Roth IRA conversions or the life insurance that they’re talking about, feel free to give us a call. We also get a lot of calls, if you want a second opinion on something you’ve already done, so we also take that. The studio line is 412-333-9385. We’ll be right back.
Nicole: Welcome back to the Lange Money Hour, Where Smart Money Talks. I’m here with Jim Lange and John Bledsoe.
Jim: Okay, John. We were talking about life insurance, and one other thing that I would want to mention, and I’ll give you a chance to comment on it and making any other comments before we go on to the next topic, is I don’t like when people get too much insurance to the point that either the premium becomes a burden to pay, or, I’ll tell you what I really don’t like. I don’t like it if there is a situation where children need money now, and too much of the budget went to life insurance, so the parents feel that they can’t afford any more money going to a child as an as-needed gift. So, I like to use the three types of gifts, which is life insurance and my personal preference, under most circumstances, is second-to-die on a guaranteed basis low premium and a high death benefit, 529 plans, which are tax-free, education trusts for children, and then, straightforward gifts.
John: Right, I concur with that, by the way.
Jim: Alright. Do you have anything else on life insurance or any other complementary strategies before we move on to other areas?
John: No, go ahead and go on to the next one. I think that’s been pretty well exhausted.
Jim: Alright. I’ll tell you a couple of things that I really liked about your book, and by the way, we haven’t given a proper plug for your book. The book is “The Gospel of Roth,” and it’s just an excellent book that I can recommend to readers and listeners without question, and you can get that at Amazon.com, and John, is it better if they get it through you or through Amazon?
John: Amazon.com is great. They’ve been selling a lot of our books. The reason it’s called “The Gospel of Roth” is my daddy was a preacher, and I thought it was a funny play on words that gospel means good news. So, it’s not a religious book. It is hardcover, but don’t carry it to church with you.
Jim: Well, as long as we get some religious overtones, how about if we talk about a few of your ten IRA commandments?
John: Oh, I like that!
Jim: Alright. I notice on page 228, and see, I’ll tell you one of the things that I really like about your book, that frankly, you did a better job than I did, which is, I have a lot of technical analysis, and I tried to add a lot of stories to make it more readable and to make it more interesting, but what you’ve done, sometimes on just a single page, is you’ve just given some straightforward advice, and one of the pieces of advice that you gave was the ten IRA commandments.
Jim: And I don’t know if you have a favorite one, or if you want me to zero in on one of the ones that I wanted, but…
John: Go ahead and tell me your favorite, and then I’ll tell you mine.
Jim: Well, one of the ones that I don’t see in practice is, now some of them, I think, are so obvious that you would think that everybody would do them, like for example, to contribute at least as much to your retirement plan as any employer would allow. That’s your third commandment.
Jim: But your fourth commandment, and I don’t know if it’s necessarily so brilliant, but it’s something that I don’t, I see a lot of people that do not obey this commandment, and that is “Thou shalt maximum non-deductible IRAs, then convert them immediately to a Roth every year.” So, let’s say for discussion’s sake, that your income is too high to make even a Roth IRA contribution, not a conversion, but a contribution, because you’re still working, and we have a lot of listeners in that situation, but they still want to put money in their retirement plan, and they sometimes don’t think of or they don’t know about a non-deductible IRA, and given the right circumstances, that is, you don’t have any other traditional IRAs around, you can convert them to a Roth every year.
John: Absolutely, and so, even if you’re making a million dollars a year, you can still take another $5,000 if you’re below fifty, or $6,000 if you’re fifty or above, and the same for your spouse, make a non-deductible IRA contribution and then convert it to a Roth. Therefore, all the growth of that vehicle will be tax-free, and what’s interesting to me, Jim, and you probably notice the same thing, the people that tend to have the most are the ones that take the most advantage of everything, and it’s sort of like the people that, they come in to see you, they’re the wealthiest, and they’re probably the quickest to say, “How much is this going to cost me, Jim?”
Jim: Well, I’ve heard that once or twice.
John: Yeah, and so, the people that maximize their retirement savings, and $5,000 is a lot of money and $6,000 is a lot of money, but if you’ve got a very big estate, it may not be that much. Yet, the people that have done it faithfully, I’ve probably, like you, learned more from my clients than they’ve learned from me, watching these people save the money, and watching them take advantage with some discipline of all these things, I think it’s a terrific amendment, and I think a lot of people have done it long before you or I ever thought of it, and I like that a lot. Kind of in that same vein, I’ll tell you, my favorite on is number ten, “Thou shalt not incur penalties.”
Jim: You don’t like penalties, John?
John: I don’t like penalties, whether it’s with Chase Bank, or whether it’s with the IRS, and I make too big a deal sometimes over penalties, but I notice the really rich people, they don’t pay interest. They don’t pay things late. They pay them on time, because they realize that these penalties eat you alive, and I don’t like these tax penalties, and I think the message is if you’re below fifty-nine and a half, seriously, if you’re not fifty-nine and a half yet, and by the way, you can probably tell by how youthful my voice is, I’m a long ways from fifty-nine and a half, almost seven years from fifty-nine and a half.
Jim: If you saw your picture, you might think you’re thirty.
John: You might. Thank you, Jim. You would have absolutely no business touching the money that you’re using for your retirement. When you change jobs or have a hankering to buy something, as we say down here in Texas, don’t do it. Just stop. Do not touch the money before you’re fifty-nine and a half, maybe even after you’re fifty-nine and a half, to go buy something, and it’s just horrible to me, the large amounts of people that have worked three or four or five or six years for a company, for a school district or somewhere, and then they change jobs, they get a check in the mail for $7-$8-$9-$11,000 and they put it in their checking account, and the money vaporizes, and they realize when they file their tax return the next year that doggone it, not only did I have to pay income tax prematurely, I had to pay a 10% penalty. I just hate those penalties.
Jim: Well, I would agree with you. Before we get to one other commandment, I’d like to fill out the entire spectrum of what I would say is the best way to accumulate money for retirement, which is, number one, maximize what your employer is willing to match. Number two, if you have access to it, is to put money into a Roth 401(k) or, if you work for a hospital or a non-profit, a Roth 403(b). That’s another one that I often see people not taking advantage of that they have access to. Then, if there isn’t a Roth 401(k) or a 403(b), then do the Roth IRAs if your income is low enough, and if your income isn’t low enough, then do traditional 401(k)s, and then do the non-deductible. I just wanted to complete that loop.
Jim: Alright. Is there another one that you wanted to talk about as long as we’re talking about commandments?
John: Well, it went along with this, and it actually got out. It would be the eleventh commandment, so maybe Moses lost a few of them along the way.
Jim: Alright, well, what’s the eleventh commandment?
John: The eleventh commandment would be “Don’t have any debt.” Try to avoid debt at all costs, and as soon as you can get out of debt, for some of us, we were in our forties when we got out of debt, but that’s when we got really rich. If you want to say you’re debt-free, you can’t do it legitimately unless you’ve got everything converted to a Roth IRA, because if you’ve got an extra $300,000 or $400,000 in a 403(b) or a 401(k) or an IRA rollover that’s not a Roth, you’re not debt-free yet. You’ve got a debt to the government on a commensurate amount of taxes against that. If you want to be truly debt-free, eventually have all your money converted to Roth IRAs, pay the taxes out of other funds, and you’ll be totally debt-free.
Jim: Well, that brings up an interesting point. We got a call last week, and I’ll give you the same question the caller gave me. A guy named Ed from Florida, who has been following me, and he said all kinds of nice things about my book and my website, etc., said, “Hey, let’s assume you don’t have the money to pay the tax on the conversion, and right now, you know, you can borrow money pretty cheaply, so let’s say that you’re one of these guys that has a lot of your money in your IRA or your retirement plan and you don’t really have a lot of liquidity outside your IRA or your retirement plan. Maybe you have some equity in your home, maybe you would be a good risk for a lending institution. How about if you borrow the money to pay the tax on the Roth IRA conversion?” And rather than me telling you what I said, I think I’ll just throw that one out to you.
John: Oh, I bet I know what you’re thinking. I bet we’re going to disagree again. That’s more fun.
Jim: Well, that’s okay.
John: Well, let me make up some facts here. Let’s say Ed from Florida, and I’ve been to Florida a few times, and there’s a bunch of old people in Florida. Let’s say Ed is over fifty-nine and a half. Can we do that?
Jim: That’s a good assumption.
John: Okay, Ed from Florida, over fifty-nine and a half, you go with it, Ed, with this concept. Again, convert everything and ask questions later. Your day to go firm on that is October 17, 2011, and as a matter of fact, your first day, if you want to be a great, patriotic citizen, pay the least amount of potential taxes, this year the maximum bracket is 35% on the federal level. Next year, it goes up, because the Bush tax cuts are over, to 39.6%. Therefore, if you’ve done your proper allocation of withholding, you really don’t have to come up with the cash, even if you’re going to do it for this year as a conversion, it would be April 15, 2011. So if you’re going to take a loan, don’t be borrowing the money now, Ed. You need to borrow the money on April 15th, 2011 at the earliest. If you want to take advantage of this two-year no interest plan the government’s got, the old Blue Light Special, the first time you’re going to need to borrow half of the money essentially that you’re going to pay in taxes is April 15, 2012. So, if Ed has a large amount in CDs or bond-type investments that are relatively liquid, and they’re paying 4% and he’s borrowing money around 4%, Ed is pretty safe on borrowing money next year, realizing that if interest rates go up, he could pull money out of his new Roth IRA conversion and pay it off. And that’s one of the great myths that we’ll get into in a minute, but I think that, for some people, it’s a good idea. If Ed’s young, if he’s a Texan, or if he’s from one of our real young states, then Ed could potentially look at this thing and say, “I need to work extra hard and save money between now and April, 2012 so I can pay more of the money out of pocket and perhaps unconvert the rest and take it on a three or four or five year period to convert because I’m younger.
Jim: Well, it sounds like we’re going to have to add a twelfth commandment, “There are exceptions to the first eleven commandments,” because you said don’t borrow, and now you’re saying it’s okay to borrow.
John: I’m saying I don’t like debt. I want you to be debt-free, but I’m saying a debt to Chase bank, and this is not a Chase commercial, but we just had a national conference call with them, I’m saying a debt to Chase bank is better than a debt to the IRA. Poor Ed’s in debt and he doesn’t know it anyway. He owes the government. And so, Ed’s not debt-free unless he’s fully converted. So, maybe he’s picking the lesser of two evils. And I don’t like Chase at 12% interest, but I like them a lot at 4% or 5%, and Ed may be a good customer that gets a great loan, maybe even a home equity line of credit, or something.
Nicole: Well, we’re going to take one more quick break before the end of the show. You’re listening to the Lange Money Hour, Where Smart Money Talks.
Nicole: Alrighty, we’re back and thank you for joining us. We’re talking to John Bledsoe. We’re actually going over his ten commandments in the back of his book, “The Gospel of Roth” that you can get on Amazon.com, and I think Jim, you said you were making a twelfth commandment before we left?
Jim: Well, I think we already covered the twelfth commandment, which is there’s some exceptions to the first eleven.
John: There may be many more commandments that’ll be covered in the sequel and in Jim’s book.
Jim: Alright. You also have a nice kind of a catchy section on Roth IRA mistakes, and I thought that was a good one. There’s one or two that I like here, and I thought that maybe I’d give you a chance to tell our listeners about one or two of your favorite mistakes, either the most common or the biggest.
John: Well, while I find the page, tell me the ones that you like.
Jim: Alright, well, I’ll tell you the one I’m writing about right now in the book that I’m writing about, which is, and I’m going to expand it a little bit. It says “taking advice from the wrong people,” and I’m going to expand that to be “taking advice from the wrong people or using the wrong software program to calculate a Roth IRA conversion.” And I have, and I don’t want to mention any big companies because I don’t want to get sued, but there are some very big companies that are truly household names that have free or low-fee, most of them are free right now, Roth IRA calculators on the web, and if you were to dutifully go through the questions that they ask and plug in the information that they ask for, you would get a completely different result than I would recommend. Even if we don’t do this “convert everything” strategy, and we’re going to use, let’s say, a more traditional strategy of figuring out how much to convert, and I really have a major problem with a lot of the software. The other thing is, as you know, John, I run around the country giving talks to hundreds, actually thousands, of financial advisors, and sometimes the companies hire me for an all day, eight hour talk, but more often, I’m speaking for an hour, and there’s quite a few advisors out there who really don’t understand all the concepts that I think are necessary to understand to really give people appropriate advice.
John: Yeah, it’s a crying shame. In fact, I’ll go one step further. A Roth calculator run today can not be right. Period. It’s broken. It can’t work. We’re speaking today in almost July of 2010, and we need to know a couple of things for sure to run a Roth calculator that’s accurate. We need to know what the account level is next year around September or October of 2011. Has that account gone up or gone down? If you converted $100,000, is it worth $120,000 or is it worth $80,000. It means a big, big difference to the outcome, and if you don’t know that number, and you can know it before you decide to convert and leave it converted, then you can’t possibly have an accurate assumption. The other thing is what are tax rates that are announced next year, what are they going to be prospectively? And again, you can’t know that. Even the politicians don’t know it. Every estate planner you or I knew missed this deal on it actually being free to die in 2010. We all thought the government was going to come in at the last minute like they do to keep the lights on, and they didn’t because of political dickering back and forth which has gone on for far too long. And in my opinion, these Roth calculators are a lot like looking at the Almanac and planning your vacation because there’s a specific week for the weather to not rain in a certain part of the country. Good luck to you, because predicting it more than 48 hours in advance on whether or not it’s going to rain or shine is a little bit of a folly, and it perhaps is even worse with Roth IRA calculators. I think they’re just wrong, and I think some of them are inherently mathematically incorrect, as well, and I think that eventually, we’re seeing our first class action lawsuits, by the way, arise where the people have made it so confusing for their folks to convert. It’s kind of like that bible analogy. They give them a Gideon bible with 1,100 pages in it assuming that nobody was going to read it, and they give them these calculations that paralyze them as opposed to letting them convert some of their money to Roth IRAs and then letting them wait and see and then next year, decide to unconvert it where they have those options. If you get paralyzed by the analytical part and do nothing, you’re far worse off and you may be at a great time to convert now because your account may be lower than it was in January. You may have lucked out by waiting, but if you convert now, you’ll have the ability to unconvert at today’s level, which may prove to be a real bargain.
Jim: Yeah, and another thing that the calculators don’t take into consideration is, they measure in total dollars. So, for example, they would look at a million dollars in an IRA as a million dollars, and I would look at a million dollars in an IRA as a million dollars minus the taxes on the IRA when you cash it in, and if you use what I would call purchasing power as your measurement tool, and you do a series of financial projections that you’ll typically do a much greater Roth IRA conversion than if you are trying to use total dollars. So, for example, a younger person will have so many years to make up for the tax that they had to pay to get a Roth IRA conversion if you measure in total dollars, but if you measure in purchasing power, what will happen is it will prove beneficial to older IRA owners.
John: Absolutely, and again, that’s one of the myths that you and I had a long, long, long time ago, and that is that the IRA statement is not indicative of your purchasing power. It’s the gross amount. So, if you’ve got $100,000 on your statement in an IRA, you don’t have $100,000 you can spend. You’ve got $100,000 minus your tax bracket, say $70,000 that you can spend. The purchasing power needs to be ferreted out, and so you can compare the apples to apples when you look at your situation to decide whether or not you should leave some converted or not, or planning your own retirement future.
Jim: Yeah, and I noticed that you have an interesting analogy in your book, and that is that with a Roth IRA conversion, you are, in effect, buying out your partner, Uncle Sam.
John: Yeah, I like that.
John: I like that because much of these hedge funds have been castigated by charging the two and twenty and the usury-type rates against the investor’s money. Well, Uncle Sam is just as bad. Uncle Sam is saying, “Don’t convert today, Jim. If you don’t want to, it’s no big deal. We own 35% of it now, and if we go up on tax rates in the future, we’ll own a bigger percentage, and if you double or triple the value of your IRA, we’ll own a bigger percentage then. It’s almost like doing business with those Mafia people that, of course, don’t exist anymore, but they used to.
Jim: Certainly not in Texas, right?
John: I would couch that with I’m just joking, if you’re listening out there.
Nicole: Well, on that note, I think we’re going to close the show, John.
John: If I’m in a wheelchair next time, Nicole, I want you to feel sorry for me.
Nicole: Well, I’ll certainly know what happened.
Nicole: Well, John, thank you so much for joining us this evening. John Bledsoe, the author of “The Gospel of Roth,” and you can get that on Amazon.com. We’ll see you again in two weeks. We’ll be back with another live show. We will be hosting Natalie Choate, author and Boston-based attorney. Thank you for joining us. Thanks, Jim. Thanks, John, and you’ve been listening to the Lange Money Hour, Where Smart Money Talks. Good night.
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.