A Closer Loook at Inherited IRA with Natalie Choate

Episode: 10
Originally Aired: July 15, 2009
Topic: A Closer Look at Inherited IRAs with Natalie Choate, Esq.

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
Listen to every episode at our radio show archives page.

Please note: *This podcast episode aired in the past and some of the information contained within may be out of date and no longer accurate. All podcast episodes are intended to be used and must be used for informational purposes only. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment strategy or plan will be successful. Investment advisory services offered by Lange Financial Group, LLC.

Click to hear MP3 of this show

TOPICS COVERED:

Beth Bershok: Thank you so much for joining us tonight. We are talking smart money and we have an information-packed show lined up this hour. I’m Beth Bershok, we have Jim Lange CPA, attorney, author of two best selling editions of the book Retire Secure Pay Taxes Later, and a very special guest, and what this adds up to, and I’m not kidding, this literally is true, we have two of America’s retirement planning experts joining forces tonight, Jim and our special guest, Natalie Choate, who is a Boston based attorney. Hi, Natalie, thank you so much for joining us this evening.

1. Introduction of Special Guest, Natalie Choate, Esq.

Natalie Choate: Hi Beth, my pleasure.

Beth Bershok: And the credentials that Natalie comes with, and I’m going to get Jim to speak on this in just a moment, but you know the way Jim describes you, Natalie, is that you wrote the book on IRAs that all top advisors follow. Natalie is also listed in Best Lawyers in America, she was one of the first 10 attorneys to receive the distinguished accredited Estate Planner Award from the National Association of Estate Planners. Literally, Natalie you speak all over the country and this is a little unusual tonight because Jim also speaks all over the country and Jim is in Nashville getting ready for a presentation to advisors tomorrow. So we have Natalie in Boston, Jim is in Nashville. Hi, Jim.

Jim Lange: Hi there.

Beth Bershok: How is Nashville going so far?

Jim Lange: It is hot here.

Beth Bershok: It’s hot here today, too.

Jim Lange: Well it’s about 95 here. But before we get into the substance, I want listeners to understand that Natalie wrote, literally, the bible that every savvy advisor is going to have on their desk preferably, dog-eared, marked up like my own copy, and I will tell you that I had a huge personal transformation from the time before I got, and actually read cover to cover, Natalie’s book at the time I was done because my understanding of IRAs and retirement plans just skyrocketed and the advice that I give young planners is, I tell them I recommend that you read Natalie’s book cover to cover and after that you will just catapult your knowledge and expertise in IRAs and retirement plans.

Beth Bershok: And that’s honestly how you got started, right?

Jim Lange: It is, and the only thing that I did on top of that was, I tried to quantify a lot of the information where the book is mainly, it doesn’t have with the exception of some case numbers in the back. It doesn’t have, lets call it, “running the numbers”, but it’s just an outstanding book and I would recommend it for all financial advisors, whether they be CPAs, or money managers, or estate attorneys, and also for consumers who want control of their own finances and want to really understand a deep understanding of IRAs and retirement plans.

Beth Bershok: Natalie, would consumers have access to that book?

Natalie Choate: Well, consumers would, but I would like to give a return plug, Jim, for your book, which Jim, you wrote the bible for non-professionals for the lay-audience and the way I like to explain it to clients and my non-professional audiences is, that my book is for professionals, therefore it’s probably too simplistic for their needs and they should turn to something like Jim Lange’s book Retire Secure Pay Taxes Later. Jim, you’ve done a great job with this subject and I turn to your book for a few things like the different types of retirement plans, which I don’t really cover in my book.

Jim Lange: Well, I appreciate that.

Beth Bershok: Let’s give the name of Natalie’s book, too, I’m not sure we mentioned it.

Jim Lange: Alright, that’s Life and Death Planning for Retirement Benefits, the subtitle is The Essential Handbook for Estate Planners and you can get that by going to www.ataxplan.com.

Beth Bershok: Which is, Natalie, that’s your website, right?

Natalie Choate: Yes, it is. You can also buy it through Amazon.com.

Jim Lange: Alright, and there’s one other resource that I will mention and maybe we’ll mention it again later on in the hour. Natalie does have a wonderful resource that it could be for advisors or consumers and it’s called The 100 Best and Worst Planning Ideas For Your Client’s Retirement Benefits. And one of the differences is, that I’ve always considered myself a very opinionated writer, you know I’m never shy about saying which strategies I like and which strategies I don’t. Up until I saw this book by Natalie, I didn’t know that Natalie was as opinionated as she is, but that she is quite opinionated and interestingly enough, the only thing I didn’t like about it is that I didn’t write it because it’s so good and it’s so on point. That is also an excellent resource, and I believe that that is also on the website The 100 Best and Worst Planning Ideas For Your Client’s Retirement Benefits.

Beth Bershok: Actually, I have to say that I’ve looked through both of those books, and I think the second one you’re talking about is a good book for consumers because you’re really concise in that book. You go through, really, The 100 Best and Worst Planning Ideas. Last week we were both looking through the book at the office. I was looking through it, Jim, The 100 Best and Worst Planning Ideas For Your Client’s Retirement Benefits and we were looking at some of the information that you had put forward, Natalie, in that book, and one of the things that Jim really wanted to cover today was correctly titling the inherited retirement plan. So, Jim, if you could explain, first of all, what the topic is all about, and then we can discuss some strategies.

2. A Closer Look at Inherited IRAs

Jim Lange: Okay, let’s assume, this, by the way, is one of my bugaboos in practice because so many advisors get this wrong, so many attorneys get this wrong and I’ve seen some of the damage done. But let’s just take a very simple situation where dad or mom or let’s call it the person who died, the decedents, leave money to, and lets keep it real simple to start, to their child. Let’s say Joe Senior leaves his IRA to Joe Junior. Joe Senior dies, alright, and there’s no argument, it’s very clearly going to go to Joe Junior and Joe Junior will not have an IRA, he will have a special piece called an inherited IRA. I have seen people botch the titling of that inherited IRA, so maybe I’ll ask Natalie to say how she would actually title that and any special considerations that she has for our listeners.

Natalie Choate: You’re absolutely right, Jim, the number one time mistakes get made in retirement benefits is when money has got to be transitioned from one owner to another, or from one account to another. It’s real easy for it to wind up in an account that is the wrong type. And the result is total acceleration of taxes that was unnecessary. So if we have an inherited IRA, let’s say Joe Junior has gone down to the bank where dad’s IRA was, and he says dad died, here’s the death certificate, I’ve now inherited the IRA. What the bank should say is, okay, now we’ll register that IRA as an inherited IRA in the name of deceased father IRA payable to Joe Junior as beneficiary. Or, it might be registered to Joe Junior, beneficiary of dad. Unfortunately, what tends to sometimes happen is, the bank will say, oh that’s fine, sorry to hear about your father, we’ll just roll this money into your IRA and they put it in an IRA in the name of Junior himself, and that’s not an inherited IRA. And all of a sudden, instead of an inherited tax-deferred asset, what we have is an immediate distribution taxable for the entire account, plus Joe Junior is going to have a penalty for making an excess contribution to his own IRA because he wasn’t allowed to roll that money into his own IRA. So I try to tell people, if you do inherit an IRA, don’t touch it until you have spoken to your attorney, your CPA, your financial planner, someone who knows what they’re doing.

Jim Lange: And one of my fears, and this is a true story, I had a call from an advisor on the west coast and he was doing the investments for both Joe Senior and Joe Junior. Joe Senior died with a million dollar IRA, left it to Joe Junior, he didn’t put it into Joe Junior’s IRA, he just titled it in Joe Junior’s name and it didn’t have Joe Senior on the title. It didn’t have inherited IRA for the benefit of Joe Junior, all it had was Joe Junior. He had already done this and then after he did this, he asked me what he should do, and I just felt sick because I didn’t know of any way out after he had already done this. Maybe you have an opinion on that, but I, actually, in a slightly different setting, ran some numbers on it and if he, let’s say died with $1 million now, all of a sudden that million dollars, like Natalie said, the income tax on that is going to be accelerated, in other words he has to come up, Joe Junior has to come up with taxes on $1 million. Now, and over Joe Junior’s life, the loss of the income tax deferral is roughly $1 million, depending on what assumptions you can use. Was there anything that the advisor could have done at that point?

Natalie Choate: There’s nothing that can be done once an inherited IRA is distributed like that, even if the distribution was a mistake. People say, well, you’ve got 60 days to roll it over. That’s not true for an inherited IRA. You cannot put the toothpaste back in the tube and it’s an inherited IRA. Now if that mistake gets made in your own account, you know if you retire from the company and instead of putting your 401(k) money into your IRA, they put it into your personal checking account, even though you told them not to, that is a mistake that can be fixed because you do have 60 days to roll it into the right account. But after the owner dies, unless the beneficiary was a spouse, the beneficiary does not have that rollover option, unfortunately.

Beth Bershok: Can you two go through the actual titling again? We mentioned that about 10 minutes ago, but how should the titling be worded?

Natalie Choate: The IRS gives a couple of options. It has to be clear that it’s an inherited IRA and who it was inherited from. So it could be titled father deceased, IRA payable to Junior as beneficiary. Or it could be entitled Junior, as beneficiary of father. But it has to clearly say the father’s name, and that makes it clear that it’s an inherited IRA, it’s not Junior’s own IRA.

Jim Lange: And what I use is, inherited IRA of Joe Senior dated, and then I have the date of his death, for the benefit of Joe Junior. Do you think that will pass?

Natalie Choate: That’ll do it.

Jim Lange: Alright, and by the way, as a little extra bonus, now let’s say that you leave an inherited IRA or an inherited Roth IRA to a grandchild 30 to 40, or even 60 years from now that, grandchild will still see your name as he’s cashing his IRA check.

Beth Bershok: That actually is kind of a bonus.

Jim Lange: Yeah, a little bit of immortality there in a positive way.

Beth Bershok: And you have, again, right after the death of the person, the owner of the IRA, you have how long to get that straightened out?

Natalie Choate: Well, at the moment the death occurs, the account does belong to the beneficiary at that point, and they have to, at some point, get the paperwork to catch up with what’s already happened. I don’t think there’s a specific deadline as such for that, but it is important to start taking the minimum distributions very soon after the death. It might be the same year as the death, if father died after reaching 70 and ½, and he didn’t take his distribution for the year that he died. The beneficiary is supposed to run in there and take that out. And then the beneficiaries life expectancy payout starts the year after the owner died, so you’d probably get the paperwork done sometime in that period.

Beth Bershok: Either way, it’s critical to see an advisor who can handle that.

Natalie Choate: I would recommend it very strongly, to see a knowledgeable advisor, someone like Jim, for example.

Beth Bershok: There you go.

Jim Lange: Well, thank you and one of the opinions that Natalie and I share, and it’s in both of our materials, is one of the very interesting things that beneficiaries, and lets assume, a very simple structure where we have Joe Senior, Joe Junior, and then the grandchild Joe Junior II or III rather. Before Joe Junior makes any decisions with regard to whether doing anything with the IRA, one of the things that Natalie advocates is looking at the possibility of a disclaimer. In other words, Joe Junior saying I don’t want or I don’t need either all, or a portion of the inherited IRA that dad left me, and since a well-drafted trust for the benefit of Joe Junior is the contingent beneficiary, I might consider whether I want to leave a portion of that inherited IRA, or inherited better yet, inherited Roth IRA to Joe Junior, I’m sorry Joe II or Joe III, and that is a very interesting decision and there we do have a deadline of 9 months after Joe Senior dies.

Beth Bershok: To make the disclaimer?

Jim Lange: Natalie do you see a lot of that type of planning in your practice and in your travels?

Natalie Choate: I see surprisingly little of that, unfortunately. It’s definitely very good planning, I mean we start with planning at grandpas level, Joe Senior. He names a beneficiary on his IRA he names Joe Junior, but it’s extremely critical to also name a contingent beneficiary and there’s two reasons for that one is, his son could die before him, in which case you need to have a second level of beneficiaries in there to take the account because if you just name one beneficiary, and say, well, if that person dies, I’ll come out and fill out a new form. You may not live long enough to do that. You may not be competent to do that. You could die in a common accident. So you want to have a second layer of beneficiary there called a contingent beneficiary. And the second reason that that’s important is because of what Jim’s talking about the disclaimer, which is Joe Junior now has inherited the IRA and he looks at this and says, gee, you know I’m a professional basketball player, I make $3 million a year, I need to shift money down to the next generation, my children. I will disclaim the IRA I inherited from my father, I will refuse to accept it, and I just sign a disclaimer, and bingo, it’s just like he did pre-decease and the money passes down to his children as contingent beneficiaries.

Beth Bershok: Now, Jim and Natalie, you have to set up the disclaimer situation though before the first death, before Joe Senior’s death, you can’t do it afterwards?

Natalie Choate: The contingent beneficiary has to be already named in the beneficiary form, you’re exactly right.

Beth Bershok: So, if you neglect to do that, you would not be able to put this into motion.

Natalie Choate: It will simply not work very well, or at all, if you don’t have a contingent beneficiary because part of a disclaimer is that the person making the disclaimer can’t say where he wants to go. I mean, it would be nice if you say, I disclaim it and I want it to go to my favorite charity, or my sister.

Beth Bershok: But you don’t have that choice?

Natalie Choate: Exactly, you’re just refusing to accept it and it has to go where it goes without any say so on your part.

Jim Lange: And a little thing that I like to do is, if I’m Joe Junior and I’m thinking about, and let’s say that Joe III is 5 years old, obviously you’re not going to leave money to a 5 year old, outright. I would be interested in having Joe Senior, when he writes his beneficiary of his IRA, of naming Joe Junior first and then a trust for the benefit of Joe III, and here’s where I think a lot of attorneys don’t really think this outright. If Joe Junior is still alive and he disclaims to a trust for the benefit of Joe III, if I’m Joe Junior, I want to be the trustee of that. That is, I’m interested in making sure that not only the investment is right, but more importantly, the distributions are appropriate. Natalie, is there any problem with having Joe Junior be the trustee for Joe III with a disclaimer because, presumably, with a disclaimer you’re giving up all rights.

Natalie Choate: Well, there would be a problem if the trust gives the trustee a lot of discretion. If the trust for the grandchild says the trustee can decide when the grandchild gets the money, and he has total control, that wouldn’t work with a disclaimer because a disclaimer, like you say, is giving up control. But he could be trustee if the trust has spelled out what the grandchild gets. For example, if the trust says the grandchild must receive money for his health, education, and support, or something like that, that’s an ascertainable standard. The trustee is not just making the rules as he goes along, he’s carrying out a specific standard, and that can be compatible with a disclaimer.

Jim Lange: So, let’s say that and the typical trust, this would be not only IRAs, but also money outside IRAs, that I would typically draft for a minor would be something like, just like you said health, maintenance, support, education, post-graduate education, down payment for a home, seed money for a business, and if you’re a real sport, one summer in Europe. Do you think that’s a little bit too broad, or is that still ascertainable?

Natalie Choate: Well, I don’t want to get pinned down here, Jim.

Jim Lange: Okay, maybe you don’t like that summer in Europe, either that might not be so ascertainable. But the other…

Natalie Choate: One more thing about the inherited IRA. If anybody’s still listening to this discussion, Jim, they must be really interested in inheriting an IRA.

Beth Bershok: Well, we’re going to be moving onto Roth IRA conversions in a moment.

Natalie Choate: Well, good, let me just mention one more thing that gets often overlooked in the inherited IRA situation and that is, if you have inherited an IRA or any kind of retirement plan, and the person you inherited it from on their death had a taxable estate, so they had a large enough estate that estate taxes were paid, which as of right now a death in 2009 would mean the estate was over $3.5 million. But if you did inherit this IRA from someone who had a taxable estate, then when you take money out of the IRA, you get an income tax deduction for the estate taxes that were paid on the IRA.

Beth Bershok: Well, that’s a twist.

Natalie Choate: That is a twist, and it’s the most overlooked deduction in America. Someone who inherited a million dollar IRA, like the example you gave, they might be entitled to an income tax deduction to as much as $400,000 to offset that income. And it’s a strange thing that beneficiaries often don’t even find out about this deduction, nobody tells them.

Beth Bershok: And that could be a huge deduction.

Natalie Choate: Absolutely huge, and its money that gets left on the table.

Beth Bershok: Thank you for pointing that one out, Natalie. We’re going to be back, we’re going to take a quick break. I do want to touch on Roth IRA conversions when we get back, I know both of you are big on Roth IRA conversions. We’re going to discuss the concept and some of the strategies. Jim Lange and Natalie Choate, it is The Lange Money Hour: Where Smart Money Talks.

Beth Bershok: We are back talking smart money, I’m Beth Bershok and an interesting set up tonight. We have Jim Lange in Nashville getting ready to speak to a group of advisors tomorrow. We have Natalie Choate in Boston, where she practices law. These are really two of America’s retirement planning experts tonight strategizing on retirement and estate planning. And I wanted to point out quickly, too, that we have another workshop scheduled for the end of August, it’s going to be August 29th, and we’re about to talk about Roth IRA conversions and that is the theme of the workshop on August 29th. We cover some other things including Lange’s Cascading Beneficiary Plan, but the main focus is Roth IRA conversions and the tax law change in 2010. This is going to be August 29th, it’s a Saturday, two events, one at 9:30, one at 1:00 at Pittsburgh Golf Club. And you can get all of the details by going to our website which is www.retiresecure.com. Okay, Jim, I know that is one of your absolute favorite strategies, Roth IRA conversions, and I’m guessing, Natalie, the same situation. And first explain, if people are just catching onto this, because there’s a big tax law change coming up in 2010, what that 2010 tax law change is all about and I’ll let you handle that, Jim.

3. Roth IRA Conversions

Jim Lange: Okay, to oversimplify, when you have a traditional IRA, and you will be required at age 70 to start taking money from it, that’s called a minimum required distribution. All your distributions whether you wait until age 70 or you don’t, will be taxable. You will have to add the income or the amount of the distribution from the IRA to your tax base, and have to pay tax on it. With the Roth IRA conversion, what you’re doing is, you are taking your existing IRA, or a portion, which is probably my preferred strategy, a portion of your IRA, you’re paying tax on it, upfront, which goes exactly against everything that accountants have been saying for all of these years. We’ve always been saying, defer taxes, defer taxes, defer taxes. Now we’re accelerating taxes because we’re taking a traditional IRA, we’re paying tax on it now, and we now have this Roth IRA. And the Roth IRA is going to grow income-tax free, no minimum required distributions for you, no minimum required distributions for your spouse, if you die and leave the IRA or Roth IRA to your spouse, and like we had spoken earlier, there will be minimum required distributions for the next generation or even the next two generations, but they will be income tax-free distributions. So I’ve been a great fan and I think you know there’s not too many shows that we’ve gone more than 10 or 15 minutes without me saying something about Roth IRA conversions.

Beth Bershok: It’s true, Natalie.

Jim Lange: But I would love to hear what Natalie thinks about Roth IRA conversions, and some of the strategies that she’s recommending to people now.

Natalie Choate: Well, I think Jim, both you and I could speak 45 minutes to an hour just on Roth conversions. I always start by saying, there’s no question, it would be nice to own a Roth IRA. To own an account where all your accumulations are totally income tax-free and you don’t have any required distributions during your lifetime? I mean, who wouldn’t want that? So the question just becomes, if it’s so great, why doesn’t everyone have one? Well, how much do you have to pay to get it? And when you start billing things, how much you have to pay to get it? That’s when you start saying is it worth it. So it’s kind of easiest to start with the people who can get one free. If you have to pay a very low tax to get one or no tax, then it’s a no-brainer that you should do it and there’s a limited number of situations where people can do that. People who have after-tax money. but they’ve already paid tax on inside their plan, can find a way to convert that money and it will make their Roth IRA conversion either cheap or zero tax. And I know, Jim, I said let’s not get into this, that was the very first thing I discussed.

Beth Bershok: I noticed that.

Natalie Choate: Just to take an example, let’s say Sally is working at a company, she’s retiring she has a 401(k) plan and she has after-tax contributions in that plan. Maybe she has $100,000 in her employee contribution’s account, and $70,000 of that money is her after tax contributions to the plan. She’s already paid the taxes on the $70,000. Under the new law, she can transfer the whole $100,000 employee contribution account directly into a Roth IRA, and that’s $100,000 Roth IRA she’s created, but because so much of her account was already after-tax money, she only had to pay income tax on the earnings in there, the $30,000, and so, she’s got a very low tax Roth conversion and for someone in that position, you got to say, you should do it.

Beth Bershok: You know, and Natalie, since you brought this strategy up, I think this is a great time to talk about, Jim, your strategy, which is, I really don’t know who else is talking about this, it’s your strategy for using a one person 401(k).

Jim Lange: Okay, I will get to that in one second. I just want to add one other example where people miss. Natalie said it is wonderful if you don’t have to pay for it, and there’s an other very commonly missed situation when that happens, and it’s very often towards the end of listener’s lives. So, let’s say, that maybe even the listener is looking out for their aging parents or parent. Let’s say that the parent is maybe in a nursing home, or has care at home and has very expensive medical bills. In fact, their medical bills are far more than their income. Let’s say their medical bills are $60,000 or $100,000, and their income is much lower than that. In that case, I’ve seen a lot of tax preparers and CPAs just do kind of straight forward tax return, showing the medical deductions, showing, in effect, a big negative income, and basically wasting that deduction. Where what I would want to do is, take advantage of exactly what Natalie says, if it doesn’t cost you anything, who wouldn’t want a Roth IRA. So, let’s say, for discussion sake, you have an extra $60,000 of medical expenses over and above all your income, even after adjusting for the limitations and the percentages, it might very well make sense to make, at least, a $60,000 Roth IRA conversion, end up at zero, so you’re not paying any taxes. And now you have a Roth IRA. So, in the event that you ever have income in the future or more likely the benefits for your heirs can just be astounding, I mean it can, literally, be measured in millions of dollars, if we’re talking over the lifetime of the heirs.

4. The One-Person 401(k) Strategy

Beth Bershok: Now before we get to the one person 401(k) strategy, Jim and Natalie, would either one of you recommend to a client that they do a Roth IRA conversion if they don’t have the money to pay the taxes, if they had to take it out of the plan to do that?

Jim Lange: I want to hear what Natalie has to say.

Natalie Choate: Most projections that I see show that if you have to cash out some of your retirement plans to pay the income tax on the Roth conversion, it’s not a good winning strategy. You probably will not come out ahead doing that. So, if you’re going to do a Roth conversion, and you do have to pay some taxes on it, it’s best you want to be able to pay those taxes with outside money, from what I’ve seen. Jim?

Jim Lange: Traditionally, I’ve agreed 100% with Natalie. I have a lot of clients who have all their wealth in IRAs and retirement plans, and have said that they weren’t really a good candidate for a Roth IRA conversion. But one exception that I might consider now is, if you believe that income tax rates are going to go up substantially, one of the ways you can possibly consider, is making a very limited Roth IRA conversion, paying the tax from the IRA, which, theoretically, should be a break-even, and normally I would not recommend it unless there was a tremendous very foreseeable benefit, but that might be a potential tax hedge against a higher tax rate. Now I think Ed Slott would probably prefer that you take some money out and buy some life insurance, and he very well might be right. Ed fears higher taxes and his response is to consider some life insurance, and I can’t disagree with him, but one of my gut instincts is, Roth IRA conversions, and obviously, if you have the money to pay the tax, that’s when it really works.

Beth Bershok: Jim, can we talk about your strategy, the one person 401(k), which is, Natalie, this is a strategy that’s really relatively, Jim has been using relatively recently, and it involved a Roth IRA conversion again without paying taxes. So do you want to explain how that works?

Jim Lange: Alright, how about if I explain and then I’d be really interested in what Natalie has to say about it.

Beth Bershok: I am too.

Jim Lange: I really am because this strategy is in my book and I’ve given it at different talks, and usually when I’ve mentioned it to other people, and even people who are very knowledgeable about IRAs, they go, hmm, I’ve never heard about that, but I guess it sounds okay, but I don’t know. So, let’s set up this situation. Joe Senior, while he’s still alive, is retired from his main job and he has, and let’s even say, by now, the money is already in an IRA, so we’re outside of the IRA company 401(k). We’re inside the IRA world, and let’s say that when he did do the trustee-to-trustee transfer from his 401(k) to his IRA, that there were still after tax dollars. That is money that was putting in that he could not deduct because of the income tax deduction limitations on how much he was allowed to deduct, but was still profitable for him to put that money into his 401(k) and the other money that could get there the same way, and conceptually, it’s the same thing as the non-deductible IRA, which is probably another thing that we can talk about, which I’m also a big fan of, for high income tax payers. But anyway, let’s say that there is, and let’s use Natalie’s number of $70,000 of money that he has already paid taxes on in his million dollar IRA. Now, let’s also assume that he is also doing some type of work, maybe he’s doing a little consulting for the company that he left, maybe he is working at the golf course, and maybe he is a little bit involved in even his children’s business or a family’s business, or let’s say, somehow, that he makes and it doesn’t have to be a huge number, let’s say he has $10,000 of earned income. What I have been doing is, I have been recommending that he set up a one-person 401(k) plan, so it’s many ways very similar to the 401(k) plan that he had at work, but this is a one-person plan because he’s the only beneficiary, he’s the only active participant in this plan, and then he then takes and then, let’s say, he makes a small contribution, based on his income, but much more importantly, we’re now going the opposite way of what most traditional advisors have recommended, which is, after you retire, take your 401(k) and roll it into the IRA. Here I’m interested in going the opposite way. I’m interested in taking the 401(k), I’m sorry the IRA, under the new portability rules, transferring that money to his IRA.

Natalie Choate: To his 401(k)?

Jim Lange: Oh, I’m sorry, thank you, his one-person 401(k). Alright, but interestingly enough I like the type of one person 401(k) that says we are happy to accept traditional IRA money, but we will not take after-tax dollars inside the IRA. So we will take the $930,000 of traditional IRA into the one person 401(k), but the $70,000 of after-tax dollars that has to stay where it is. Then, because we don’t have the proration rules to worry about, and Natalie said she didn’t want to get into this because it was too technical and that’s for a very good reason, but I’ll maybe gloss over that part a little bit, but anyway, if we can then isolate $70,000 of after-tax dollars inside an IRA, make a Roth IRA conversion of that without having to pay taxes, now we have a Roth IRA for $70,000 and we have $930,000 in a one person 401(k), and not only have we made the Roth IRA conversion for free, which over time is going to be hundreds of thousands of dollars that’s, actually, after a long time after a couple people died. But the advantage of the one person 401(k) over and above the IRA is and this part is a little bit controversial, that you might have slightly better creditor protection because of ERISA. But the other thing is, you now have another benefit, in that, if you die with an inherited 401(k) plan, your heirs can make a Roth IRA conversion of the inherited 401(k), but if you just left the money in an IRA, they are not allowed to make a Roth IRA conversion of the inherited IRA. So I’m sometimes going the exact opposite way that a lot of advisers are, and I really don’t have any authority at all for this.

Beth Bershok: He just made it up.

Jim Lange: I really did, but it made sense to me, and I would be very interested in what Natalie has to say about it.

Natalie Choate: Well those ideas are covered in my 100 Best and Worst Planning Ideas, which is actually now up to 194 Best and Worst Planning Ideas. I agree with you, totally, and I think those are excellent strategies. The creditor part I’ll stand off on, but creditors rights and retirement plans is another entire subject, but you’re absolutely right, right now the tax law does permit you to roll the pre-tax money from an IRA, up stream, into a qualified plan and leave like a stub IRA, with nothing but the after-tax money in it, which you can then convert to a Roth IRA, tax-free. You’re not really getting away with anything because you did already pay tax on that money, but it’s nice to get a Roth IRA for your money. And then you’re, again, absolutely right, our tax law is written, I think by Lewis Carol, because a beneficiary who inherits a 401(k) can convert that to an inherited Roth IRA. A beneficiary who inherits a regular IRA cannot convert that to an inherited Roth IRA.

Beth Bershok: I know that’s one of those glitches, Natalie.

Natalie Choate: It makes no sense at all, but that’s what the tax law says right now. Now they could change it tomorrow at the stroke of a pen, but we’re working these corners now, and our knowledge is to help clients take advantage of this which is required.

Beth Bershok: Now that strategy you both are talking about is a little complex, but you both spell it out in your literature.

Jim Lange: And I feel like a student who didn’t do their homework because I have an older version of the 100 Worst and Best Ideas.

Beth Bershok: We now need the 194.

Jim Lange: Well, yeah, and more importantly, it has you see my version is all marked up so when the new version came out, I thought, well, there might be a couple changes, but I like my old one because it’s all marked up and it has stars and it has Xs and I didn’t get the new version but that just shows me that I should be getting that.

Beth Bershok: We need to get that. Hey, Natalie and Jim, we’re going to take a quick break. When we come back, I have a question that was emailed today about Roth IRA conversions that I’m going to toss out to you. It is The Lange Money Hour: Where Smart Money Talks.

5. Caller Question About Roth IRA Conversions

Beth Bershok: Talking smart money and we are with Jim in Nashville tonight because he’s getting ready to address some advisors tomorrow. We have

Natalie Choate, two of America’s retirement planning experts, literally, tonight on The Lange Money Hour: Where Smart Money Talks. We’re down to our last ten minutes and I want to make a quick note that at the end of the show we are going to toss out the offer again for a financial physical. This really is an amazing financial physical, and we are going to give them free for a few people. So hang on for the next few minutes and we’ll tell you how that can work. Now Jim and Natalie, we had an email earlier this afternoon that I wanted to toss out to you. It’s a gentleman who’s considering a Roth IRA conversion in 2010. He had a question for you, too, so let me give you his information, and you two can sort it out and see what you think. He is a professor at WVU. He’s 59, he’s going to work until he’s 65. His retirement assets are with TIAA CREF, and Vanguard tax-deferred annuity. He’s considering converting these accounts to a Roth IRA in 2010 when the income limitations are lifted. He claims that the total amounts come to about $1 million and he realizes that he has to pay taxes on the conversion. So his question for you is, first of all, can the types of accounts that he has be converted to a Roth IRA in 2010, that’s the first thing?

Jim Lange: Well, I would say that that’s going to depend on what the rules of his retirement plan and the contract that TIAA CREF has with West Virginia University

Beth Bershok: So, it may not be possible?

Jim Lange: Yeah, particularly if he was working at the University of West Virginia the whole time. It is very possible that they’re going to have a rule that says that, with regards to any money they put in, or even money he put in before age 59, that he isn’t allowed to roll that over, or into an IRA, or a Roth IRA, until he either turns past 59 and ½, in which case, he’s likely to only be able to do it with his portion, which would be fine. That’s one potential limitation. There’s another limitation with TIAA, but that one I don’t want to get into. And so there might be a limitation, not regarding to the IRS, but what the WVU’s rules are. On the other hand, it’s possible, let’s say, that he had been somewhere else before. So let’s say he had been at the University of Pittsburgh before, and he had been making in the University of Pittsburgh, had been making retirement contributions to him there. Then that will be under a different set of rules because, with regards to the money at University of Pittsburgh, he would be deemed retired, and I believe that, in that case, he would be able to make a Roth IRA conversion of his, and it’s most likely a 403(b) plan.

Natalie Choate: I agree that as far as the tax code is concerned, 403(b) plans are among the type of plan that you can convert directly to a Roth IRA. However, you have to look at the plan itself, and most people who are still working are going to find that their company plan says you can’t take money out while you’re still working, so forget it.

Beth Bershok: So he may have to wait until he retires at 65.

Natalie Choate: Right, and then, even then, as Jim points out, TIAA has their own layers of restrictions that you can only take out so much per year.

Beth Bershok: And I have to tell you, he made a side note here that he’s still trying to figure out if he can afford to pay the taxes. If he can’t afford to pay the taxes on $1 million, would either one of you recommend partial conversion to a Roth IRA, with just some of the money, assuming that he is allowed to do that with his plan?

Natalie Choate: Well, I’ll weigh in on that with one thought. I almost would never recommend to someone to convert all of their retirement plans to a Roth. There’s some people who say I’m not converting any money to a Roth because I don’t trust the government, they’re going to change the rules and blah, blah, blah. My point of view is, if you don’t convert anything, you’re betting all your money on one outcome. But the same is true if you convert everything, you’re betting all your money on the Roth. To me, that just is not a wise thing. You need to balance and diversify and I’d like to see people have some money on each horse. Some money in a traditional retirement plan, some on a Roth, and some outside the plan, Jim?

Jim Lange: And I would agree with that, and let’s assume, for discussions sake, to simplify, let’s assume that the million dollars was in an IRA and he had complete access, and let’s assume he did have a couple hundred thousand dollars outside the IRA, so he could afford to make the Roth IRA conversion. Well, there’s a whole bunch of interesting factors here. One is he might be better off waiting until he’s 65, being in a very low income tax bracket, when he’s 65 and considering doing the Roth IRA conversion then. The downside of that is that he’s not going to have those, say, 6 years of tax-free growth. The other thing is, depending on what his projected income tax rate is, I always like to say that the answer to those kinds of questions, and this sounds more like an attorney then an advisor, is, it depends, and what it would depend on is, I would actually like to call it running the numbers, where we do projections. So let’s say that we start with the two extremes, one is status quo, he doesn’t do anything. Two, he does everything. Well, I’m almost certain, like Natalie says, that that will not end up being his best advantage, but what might be possible is a series of small conversions every year and then maybe bigger ones after he retires, or I’m not sure what the results of running the numbers are, but that is the case where I think running the numbers would be very useful.

Beth Bershok: Jim and Natalie, we are, believe it or not, almost out of time. We’re going to have to start wrapping up. I didn’t want, Natalie, give your website again because the two publications Jim talked about and though they are used by advisors around the country, could be picked up by consumers, and you can get some really good information out of those publications. So what is your website?

Natalie Choate: It’s www.ataxplan.com. So, www.ataxplan.com.

Beth Bershok: You guys have covered some amazing strategies tonight, some very complex strategies, too, so a couple of things I would say. The rebroadcast of this show is going to be Sunday morning, here on KQV, from 9-10, and we are going to have this posted to www.retiresecure.com in about a week or so, so you’ll be able to listen to these again. Natalie, thank you so much for joining us and for taking your time tonight, really, really appreciate it.

Natalie Choate: Thank you, Beth and Jim, it was a pleasure.

Jim Lange: It was, and I’ll just say one other thing, I really encourage people to, particularly, The Best and Worst Planning Ideas for consumers. I think that would be great. And if you’re a financial professional, and I know we have quite a few listening, this is just almost a requirement to have both these books. And Ed Slott talks about things that you should ask your potential financial advisor. One of the things I would ask them is, can you please show me your dog-eared edition of Life and Death Planning for Retirement Benefits?

Beth Bershok: And if they don’t have it, run.

Jim Lange: Then you have to know you might be a little bit on your own for IRA strategy advice.

Beth Bershok: There you go, thank you again, Natalie, so much. Hey, I do want to point out we are doing financial physicals. Now, Jim, we’re doing this for just the first five people that call in tonight and the first five people that call in on Sunday. The financial physical includes, and this is comprehensive because like Jim says you can’t just take on little piece, you have to look at the whole package. So this will be a look at estate planning, retirement planning, income tax planning, investments, insurance coverage, Roth IRA analysis, which we have been discussing for the past half an hour, and this is free to the first five people that call in. We are limiting this to folks in the State of Pennsylvania. Yeah, we really do have to do that so the office number is 412-521-2732. Tonight, if you call this, you can dial my extension, which is 219. 412-521-2732. And, you can also email Beth at www.paytaxeslater.com. Go to the website, as well, for more details in our upcoming workshop. It’s www.retiresecure.com. Jim, our next show is going to be fascinating, too. We have Neale Godfrey joining us, who is going to be discussing how to get your children financially fluent. She is a national expert and we’ll be talking to her. It is The Lange Money Hour: Where Smart Money Talks.

Save