Originally Aired: March 11, 2016
Topic: Burton Malkiel: Ed Slott’s Retirement Decision Guide, 2016
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Guest Introduction: Ed Slott, CPA, America’s IRA Expert
- Roth IRA Contributions
- Conversion to a Roth IRA
- Roth 401(k) and 403(b) Plans
- What Happens to an IRA after Death?
- Charitable Trusts and Life Insurance
- Picking the Right Advisor
Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
Dan Weinberg: Welcome to The Lange Money Hour. I’m Dan Weinberg, along with CPA and attorney Jim Lange. Tonight, we’re welcoming America’s top IRA expert. Ed Slott, CPA, back to the program. Ed’s been called the best source for IRA advice by The Wall Street Journal. He runs the popular website www.IRAHelp.com. He’s authored many bestselling books and has been frequently quoted in The New York Times, Forbes, Money magazine and many other publications. Ed also writes several personal finance columns, presents continuing professional education IRA seminars around the country, and he’s created a series of nationally-aired public television specials, including the most recent, Ed Slott’s Retirement Roadmap 2016. Tonight, Ed and Jim will be covering a number of topics, including the status of the stretch IRA, tax tips as we get closer and closer to April 15th, and highlights of Ed’s most recent book, Ed Slott’s 2016 Retirement Decisions Guide. So, with that, let’s get started. Good evening, Jim and welcome, Ed.
Jim Lange: Welcome, Ed!
Ed Slott: It’s great to be here, and I know I like talking to you about Pittsburgh too!
Jim Lange: Well, it’s always a pleasure to have you, and Dan’s description that you’re the number one IRA expert in the country, it’s probably hard to judge that objectively in terms of the size of your audience, the number of books sold, and I don’t have privy to this, but my guess is speaking fees, you are clearly at the top. So, it’s an honor to have you. And your most recent book, Ed Slott’s 2016 Retirement Decisions Guide, is just terrific. It has the current information. It’s not a detailed heavy tome like Natalie Choate’s, which, nothing against it, but it’s really a huge undertaking to read that. Yours is very accessible.
Ed Slott: Well, you know what? Years ago, I wrote a book called Your Tax Questions Answered in the mid-nineties, and it was this kind of book too, and as you know, this was on all taxation, you know, income taxes, deductions, all of that stuff. Now, a kind of book like that should run thousands of pages, but I also did it in…maybe it was two, three hundred pages, and what I told people, and what people liked about it, is that it didn’t have all the stuff that is in these thick books, which almost nobody can read. But it had 99% of the items people went to those books for. Same thing here. It covers everything in the retirement area as far as putting money in and taking money out, and it’s written in question and answer format, and you can get the answers you want to most of your questions right away without digging through pages and pages of legalese and tax law. It’s meant for consumers to say, “You know, I have this question. Where’s the answer? Oh, here it is! Good. That’s all I wanted to know.”
Jim Lange: Well, it’s a great resource for consumers, and then you also write extensively for advisors. I love your newsletter. In fact, I fancy myself somewhat of an IRA expert myself, and…
Ed Slott: Well, you’re up there. You’re tops, and I’ve followed you for many years, and that newsletter’s written for professionals.
Jim Lange: Sure, but the newsletter, and you were kind enough to give me the right to reprint one of your articles on using Roth IRAs instead of 529 Plans. That was eye opening to me. So, you just have all kinds of great information in that, and I know many of our listeners are advisors, and you offer advice both free and not free to advisors and consumers, and they can access that information by going to www.IRAHelp.com. So, at this point, I’m going to recommend that readers don’t even think about it. Get Ed Slott’s 2016 Retirement Decisions Guide and sign up for his newsletter, and this goes to both advisors and consumers at www.IRAHelp.com.
Ed Slott: And also, I think it’s your public television in Pittsburgh, is it WQED?
Jim Lange: Yes it is.
Ed Slott: Yeah. They’re a great station, and they run my programs that have a lot of this information, all educational. So, if you get to catch that on WQED, that’s public television in the Pittsburgh area, I think you’ll like that show.
Jim Lange: And I know that you offer a great opportunity to buy some material, and then all of the proceeds go to WQED, so you both learn stuff.
Ed Slott: Yeah, but I have to correct you. Public television doesn’t like to use the word “buy.” Donate.
Jim Lange: Sorry about that! All right, so you can donate money to WQED.
Ed Slott: And you’ll be rewarded with an extensive gift package, which is phenomenal! By the way, if you ever see the program, there is now a package of twenty CDs and DVDs, I think eighteen DVDs, two CDs, four books, online access, a tax update guide, and a program guide. It is phenomenal what’s in that package, and it’s all right up-to-date. I just finished off the DVDs, updating them and creating new ones for 2016. So, if you see the public television show, you get a double benefit: supporting public television in your area so you can have other great shows that you may not see elsewhere, and get this great information that you really won’t find anywhere else.
Jim Lange: Now, I’m going to just take a shot. I have a feeling you’re going to say no. Can our listeners access that now without even having to listen to the WQED show?
Ed Slott: I think so.
Jim Lange: Where can they go?
Ed Slott: Every station around the country does things differently, but I think if you go to their website, I don’t even know what it is, but I’ll guess it has something to do with WQED.
Jim Lange: We will find that out after the break.
Ed Slott: All right.
Jim Lange: All right. That will be a terrific resource. Of course, you know, Ed might do a little better if you bought his Retirement Guide, but I’d probably recommend both.
Ed Slott: No, no. Go to public television. I mean, they do provide programming in all sorts of areas that you really won’t find anywhere else, and especially my show because it deals with this area of protecting and preserving your retirement savings from taxes, from all kinds of risks, so you can have more and make it last longer. The number one fear in America is in retirement, running out of money, and the number one reason people will run out of money is because they haven’t done the tax planning to deal with the taxes in their IRAs or 401(k)s. So, this program will be a big help. You don’t see this on other shows. For example, there are other networks, even financial networks, as you know, that they talk about finance, but they never talk about this stuff. They only talk about what stocks are up, what stocks are down, buy, sell, hold. To me, that’s meaningless for people who are retired. The last thing they want to do is be a stock jockey in retirement.
Jim Lange: Well, why don’t we go right to what you’re talking about, which is how to save money in taxes. So, it’s now March 2016, and we have a deadline coming up on April 15th, 2016 regarding Roth IRA contributions. So, let’s assume that we have some married listeners, and let’s say that, for the moment (although I’m going to ask later what happens if their income is too high), but let’s say that their income falls within the limitations that they are allowed to make a Roth IRA contribution, both for themselves and their spouse. Let’s keep it simple and assume that they are older than fifty years old, and what should they be doing before April 15th, and is there any advantage to not only making a contribution for 2015, but to make a 2016 contribution and getting an extra year of tax-free growth?
Ed Slott: First, I agree with that. I do that myself. Always try and make the 2016 if you can. If you’ve been like most people, like you say, they have until April 15th, or, it’s actually, I think, April 18th this year, to do a Roth IRA contribution for last year. But now, you missed out on a year of tax-free growth. If you can, you might want to double up one year, and you can put in $6,500 each if you’re a married couple and you both have earnings, or even if one has earnings as long as you both qualify, as you said, under the income limits. So, each of you could do that, in a married couple, and put in $13,000 for last year and $13,000 for this year, and if you say, “Well, who has the money,” well, maybe you have it in a savings account. If you could put in $13,000 each, that’s $26,000, you know, $6,500 for 2015, then $6,500 for 2016, assuming you have earnings and you qualify under the income limits for both years, if you have savings, all you’re doing is changing from one pocket to another. Take $26,000 out of your savings account and put it in your Roth. And remember, when it goes in as a contribution, if you need that money, because you might say, “Well, what if I need it?” If you need it, it can always be withdrawn tax- and penalty-free at any time for any reason. The contribution, that is. So, you hope you don’t need it, but if you do, it’s there, and if you don’t, from now on, it grows tax-free forever. So, that’s a great deal if you can take advantage of it.
Jim Lange: And before we go any further, I want the listeners to think about what a great piece of advice this is that I hardly see anybody doing. So, for a married couple, who have money in savings that they don’t plan to access in the very, very short run, if you can put in $26,000 (that is, $6,500 for yourself for 2015, $6,500 for your spouse for 2015, $6,500 for yourself for 2016 and $6,500 for your spouse for 2016), that is ideal. So, you’re putting in $26,000. It came from savings, that if you were investing it, you were paying taxes on that every year, year after year after year, and the difference between that $26,000 growing taxable, that is, being reduced by the taxes with the dividends, the interest, the capital gains, versus tax-free in the Roth over a long period of time, is really quite substantial, and it’s that kind of advice that Ed gives. So, if you can, get his book, and I love the idea that Ed’s freely promoting something that doesn’t pay him a nickel, which is the WQED offer, where you don’t purchase but you donate.
Ed Slott: Right! Now you got it.
Jim Lange: All right. So, that is a great piece of advice. All right, so, you know, this is a high rolling station, Ed, and we have some high rollers here, so some of the people listening to this show are over and above the income contribution for the Roth IRA, and they go, “Oh darn. You know, I make too much money. I’m not allowed to put in a Roth IRA contribution for myself or my spouse.” And let’s keep the facts simple. Let’s assume that they don’t have any other IRA at all. Is there some type of backdoor mechanism that they can get into a Roth IRA anyway?
Ed Slott: Well, there is. It’s become known as a ‘backdoor Roth,’ but what I’ve been saying on programs and on shows, don’t call it a ‘backdoor Roth.’ The only reason people use that term is because the end result is you can have the same amount of money in a Roth, even though you’re over the income limits, by doing a workaround, or whatever you want to call it. So, they call it a backdoor, but it’s really two separate transactions, and it should be done separately. First transaction: let’s say you’re a married couple. If your income for 2015 is under $183,000, that’s not an issue. It’s not an issue for most people. But let’s say you’re a high earner and you have $200,000 or $300,000 of income and you can’t do a Roth. Well, maybe you qualify…you definitely qualify if you have earnings, wages, self-employment income, you qualify to contribute to an IRA, a traditional IRA. Whether it’s deductible or not doesn’t matter. It’s probably better if it’s a non-deductible IRA. So now, you’ve made the $6,500 contribution to a traditional IRA, and we’ve been talking about $6,500 because we’re assuming the person’s age fifty or over to get that extra $1,000 in. So, $6,500 to a traditional IRA, and then, at some point, at any point, you really could just convert it to a Roth, and now, when the smoke clears, you have the $6,500 in a Roth. There are a couple caveats though with that. First, you have to make sure that you’re eligible to contribute to an IRA. To be eligible, you have to have the self-employment or wage earned income from wages or self-employment, but unlike the Roth IRA, IRAs have age limitations. For an IRA, you cannot contribute for the year you turn seventy-and-a-half or older. So, if you’re seventy-five, you can’t do this because you don’t qualify in the first place for a traditional IRA. Also, and this is a technical difference, when the money ends up in the Roth, it ends up in the Roth as a conversion, not a contribution, and that only makes a difference if you’re under fifty-nine-and-a-half and think you might have to access that money within five years. Then there could be an issue. But if you’re doing this, you’re doing this for the long term, so that shouldn’t be an issue. If you qualify under all those caveats and you had no other IRAs, you could do a $6,500 traditional IRA contribution, then later convert it to a Roth, and the conversion would be done tax-free. So, in effect, you’ve got the $6,500 in the Roth IRA. That’s a workaround, or people call it a backdoor Roth.
Jim Lange: Okay. Let me ask you a tougher question, and you might not even want to take this one on. You said wait a while, and I’ve actually seen different answers in the literature on how long you have to wait. In other words, could you make that non-deductible IRA contribution, and then make a Roth IRA conversion five minutes later?
Ed Slott: I wouldn’t do that.
Jim Lange: Yeah.
Ed Slott: I wouldn’t make it look like a simultaneous transaction. It is two separate transactions. You know, I know some of the listeners might not know his name, but you know the tax expert Kaye Thomas? You see his website?
Jim Lange: I sure do. He’s been on the show. Very bright guy.
Ed Slott: He quotes somebody else, or maybe it’s his quote because he has the exact time you have to wait. Have you heard what he says?
Jim Lange: I actually haven’t.
Ed Slott: Oh, okay. He says it’s based on what you’re comfortable with. How long you should wait is based on your level of comfort, and he uses this analogy: the waiting period to convert that non-traditional IRA to a Roth is the same amount of time as the waiting period to remarry after a spouse has died.
Jim Lange: That’s a great one, Ed!
Ed Slott: He says whatever you’re comfortable with.
Jim Lange: I love the human side and the humor of your advice. It really is great.
Ed Slott: The point he’s making, it’s a gray area. Nobody knows. But practically speaking, I would wait, at a minimum, at least a month, and here’s why. You want to be able to show that that contribution to the traditional IRA shows up on at least one statement, that you could print out a statement and say, “Here it is. It’s in the IRA.” So, you have a moment of time you can show it was in there. Then after that, I think you’re fine. That’s just a practical tip, but nobody really knows the answer. I will tell you this: I know not to do it simultaneously. Then you’re asking for trouble.
Jim Lange: All right, well, I think that that’s some great advice for our listeners. So, this is, in essence, a Roth IRA conversion. Now, since you, in effect, are doing a non-deductible IRA, you don’t have to pay tax on the conversion.
Ed Slott: Right, right.
Jim Lange: But I know that you are also a fan, not all the time in all situations, but I know that you are also a fan of converting to a Roth. Now, I have some listeners and some clients who would say, “Well gee, if you convert to a Roth, doesn’t that mean that you have to write a check to the government now? Why would I want to write a check to the government now when I don’t have to? Isn’t the idea to defer, defer, defer?” How would you answer somebody’s objection to that?
Ed Slott: Right, and that’s how accountants like me and you are trained. CPAs are always trained to defer, defer. We’re hardwired from day one in college and your first accounting, always pay taxes later. Oh, I’ve heard that before! Always pay taxes later. You know, put it off until later, but I’ve become, over the years since the Roth came out, a recovering accountant. There is some benefit sometimes for paying taxes now if the tax we’re talking about will eventually be paid later anyway, and maybe on a higher balance at a higher rate at a time that you don’t want to be paying taxes: when you’re retired, when you don’t have new income coming in, when you’re the most vulnerable and you need every dollar and you’re worried about running out of money. The last thing you want to worry about is what if the tax rates go up, or look how high my IRA has gone up. The bill is coming due.
So, I don’t want for myself, and for clients, you don’t want that bill coming due in retirement. It’s like having a debt over your head. You can get rid of it now by paying the tax, in some cases, at huge discounts. It’s like taxes are on sale, because the rates are probably as low as we’ll ever see them and your balance is probably as low as it’ll ever be, especially now with some of the things going on in the market, this may be a good time to act. Because if you let it go, the tax will be due anyway, whether you like it or not. In fact, once you’re seventy-and-a-half, you’re forced to start taking the money out whether you want to or not. And every day that you don’t get that money out of the IRA, it’s growing as a debt to the IRS, to the government. So, you might have a higher tax rate at a higher balance, and that money will be forced out. So, I would say take the medicine now, pay taxes now instead of later at probably a much lower rate. My general guidance on this, I always say to people, “Any road that leads to higher taxes in the future should have a stop sign there. You shouldn’t go there.” And we don’t know if taxes will be higher in the future. That’s something you may have to decide for yourself. You may say, “You know what? I know my situation. I don’t think my taxes will be higher in the future.” And that’s a decision you may want to make, but you should at least ask the question and do the evaluation, and maybe there’s some middle ground there where maybe you do partial conversions, a series of partial conversions over many years to start migrating that IRA money into tax-free territory. So, you have more and don’t have to worry about taxes in retirement.
Jim Lange: Well, you just mentioned my favorite strategy, which is…and we, of course, run the numbers and we try to quantify exactly how much you can convert and when you should convert. But our favorite strategy is just like you said: do a series of Roth conversions, typically after you retire, so you don’t have your income from your wages or your self-employment, so you’re at a low tax rate there. You’re less than seventy-and-a-half, so you don’t have your income from your minimum required distributions, and then if you combine that with holding off on Social Security…
Ed Slott: Exactly! That is what I tell everybody.
Jim Lange: Yeah, that is a great strategy. We’re going to talk more about how to save money on taxes, IRAs and a lot more. We are here with Ed Slott, the author of Ed Slott’s 2016 Retirement Decisions Guide, which I just think is a wonderful book that, in Ed’s words, answers 99% of your questions. He also is the author of The Retirement Savings Time Bomb…and How to Defuse It, which is my favorite of his books, and he has resources for both consumers and advisors at www.IRAHelp.com. So, Ed, we were talking about the best ways people could get money into retirement plans, and we talked about Roth IRA contributions and a little bit about Roth IRA conversions. What about people who are still working and they have access to a Roth 401(k) plan or a Roth 403(b) plan. Do you have any advice for those listeners?
Ed Slott: Well, it’s the same idea, but there are a couple of advantages. Number one, there are no income limits. So, if you have the income, you can put away a lot more for 2015 or 2016, actually. You could put up to $18,000, and if you’re fifty or over, that’s $6,000. So, you could dump $24,000 in. Actually, you could go up to, if you had the money, $53,000, depending on the plan, if they allow after-tax money. That’s a different story because that doesn’t go into that side of the plan, but, I mean, there’s an opportunity to put, say, $24,000 in a Roth 401(k) or a Roth 403(b). Now, the benefit is you have more money growing tax-free, and there’s also benefits in the fact that it’s in a company plan rather than a Roth IRA. On a federal level, you have creditor protection under an ERISA plan, if it is an ERISA plan. Not all 403(b)s are, but some of them are. That’s just one side benefit, just something good to know. Also, you can, as I said, dump more money in. So, if you’re a young person and you have the available resources, obviously, you have to have the money to put it in. It comes off your salary, and then there’s catch up contributions, which you don’t get if you’re young. If you’re under fifty, it’s $18,000. So, the bottom line is you can put in more and have it grow tax-free, and that’s a lot more than the $5,500 or $6,500 that you could put in a Roth IRA, and there’s no income limits on the Roth 401(k).
Jim Lange: And that’s something actually I’ve recommended parents put into their children’s account. So, let’s say their children graduated from college (and they’re one of the rare children graduating from college that actually get a job and have earned income), that the parent, in effect, could subsidize their children’s retirement by giving the child money to put into a Roth IRA or to give them enough money that they can live and have money in the Roth 401(k) or Roth 403(b) be converted to a Roth. So, that’s another nice way to do it. Let’s talk about that generation, and let’s say maybe people are in their sixties or seventies or something like that, and around here in Pittsburgh, it’s a working town. You have a lot of people who have been working for a lot of years, and we have a lot of clients, they never started out with a lot of money, and they did pretty well. They got a job, maybe with Westinghouse or a university or a mid-level manager somewhere, and they did pretty well, but they were paying for the children’s braces and then later for the college tuition and their mortgage and the car payments and it was hard to save money, but they continually socked money away in their retirement plan and their 401(k). So now, they are older. They have a substantial amount of money, probably the majority of their money, in an IRA or a 401(k). This generation is typically not great spenders, and there’s a very reasonable chance that they’re going to die with that IRA. Can you talk about what happens at death for an IRA owner? What happens to that IRA? And then, what are some of the potential implications of some of the proposed laws regarding how that would change?
Ed Slott: Well, before we get to that, I want to go back to something I said on that Roth 401(k). When you started talking about the older workers who have been working twenty-thirty years, they probably didn’t have an opportunity to put money in a Roth 401(k). So, they were probably heavily weighted in 401(k)s. 401(k)s, if your company plan allows, and they have a Roth 401(k), can be converted to a Roth 401(k), but I would be careful about that because one of the downsides of a conversion from a 401(k) to a Roth 401(k) is that you can’t change your mind after the fact. There’s no undoing or reversing a recharacterization provision, which is unusual because for a Roth IRA conversion, you can undo it. So, it’s just one thing to keep in mind if you’re doing that. If you wanted to get money in a Roth 401(k), you could convert it, but you’d be stuck paying the tax whether you wanted to or not.
Now, back to the what happens at death, well, once you have an IRA, there’s something called the stretch IRA. We’ve talked about it many times. You’ve written books on it. So have I. And it’s the ability of a beneficiary, generally not a spouse, we’re talking about a non-spouse, somebody other than a spouse: a child or grandchild that inherits your IRA, to stretch that IRA. You leave over an IRA. If they’re named as the beneficiary on the beneficiary form, not in the will, but on the beneficiary form, they can what’s called ‘extend distributions’ over their lifetime and make that inherited IRA, if they take just the minimum amounts each year, make that inherited IRA last for the rest of their lives, or over their IRS determined life expectancy. For example, a forty-year old has a 43.6 year life expectancy, and a ten-year old grandchild has a 72.8 year life expectancy. So, they could stretch it, taking distributions, minimum distributions, that ten-year old over 72, almost 73 years if they do that. Of course, they could take all the money right away, which some beneficiaries do. So, there goes that theory, and they spend it right away. But if you did this stretch (that’s what it’s become known as, there’s nothing in the tax law called a stretch IRA, it’s just a name that was given to using the beneficiary’s life expectancy, and it’s become known as the stretch IRA), they could turn the IRA they inherited from mom dad into millions more than mom or dad ever had over enough years.
Now, that’s a good deal if the kids are disciplined and only take the minimum amounts and don’t empty the account right after death. Now, there are ways to protect against that with a trust and so forth, but besides that, there have been proposals to eliminate the stretch IRA because Congress has felt for many years that this is a benefit for beneficiaries. Congress feels the beneficiaries didn’t earn that money. It’s not their retirement money, it’s their parent’s. We gave these tax benefits so the people who earn the money could save it and make it last for as long as they are around. We never meant this as an estate planning vehicle to leave hundreds of thousands or even millions to the next generation. So, they’ve been looking at knocking out or eliminating this stretch IRA, the ability to extend it over forty, fifty, or even eighty years, and limit it to just five years. Now, I think that’s something that will probably happen. The provision’s been written for many years already, and it’s just waiting to be inserted into a tax bill that nobody notices. So, I think that’s going to happen. It’s not the worst thing in the world. As a matter of fact, it may encourage beneficiaries, or people with IRAs that were thinking of leaving it to their kids, to do much better planning than leave it to the kids to do a stretch IRA.
Jim Lange: Well, let’s say that you have a substantial IRA. You know, you’re a saver. You have maybe a seven figure IRA, and you’re saying, “Oh man, you know, the way that this is starting to look is that when my wife and I die,” and assume that the IRA, let’s keep it simple, is a million dollars exactly, and let’s keep it simple, it’s going to one beneficiary, that beneficiary’s going to have to pay income tax on that whole million dollars in five years of the IRA owner’s death, as opposed to the stretch IRA, which might go for the next thirty, forty, fifty years. And that, no matter how you play the tax game, you know, you’ll recognize a little bit this year, you’ll recognize a little bit that year. It’s still going to end up probably in the forty percent bracket, so boom! The kid has to pay $400,000 in taxes and of course, this is miserable for somebody who’s spent literally their whole life saving this money. What are some of the strategies that somebody might consider, even now before they even change the law, that perhaps fit in with what you think they should’ve been doing all along?
Ed Slott: Right. Instead of leaving it to the children as IRAs, maybe leave it to them as better vehicles? A Roth IRA is one option, which means you could convert part of it over the years and the children inherit a Roth IRA and it’s tax free, but it still has to come out. The rule, if eliminated, would affect Roth IRAs. So, that’s not the optimum strategy. Two better strategies would be, and I know something you wrote about it, as a matter of fact, I think it was in the recent issue of Trusts and Estates magazine. I think you had an article about the charitable trust, right?
Jim Lange: Yeah, I did.
Ed Slott: Yeah. So, we’ve talked about that before, and believe it or not, leaving your IRA to charity, and I know people listening saying, “No, no, no. I want it to stay in my family.” Well, what if I told you that there is a way, if you are charitably inclined, to leave it to a charitable trust and have that trust pay out your children or child for the rest of their lives, and the child would end up getting more than they might have gotten under a five-year payout, and you get a big deduction. The charity gets taken care of. The only loser really in the simplest sense is Uncle Sam. So, if you’re charitably inclined, that’s one way to go, where you could actually end up with your family getting more money than they would’ve had if you just left it to the child directly.
Jim Lange: Yeah, and by the way, this is the first time that I can think of an instance where you can actually leave money to charity and your family gets more money than if you otherwise. Now, one caveat is if your child dies very young and the charity gets the money, to oversimplify, the trust basically says income to child for child’s life, and at child’s death, whatever’s left goes to charity. If the child dies very soon, the family’s going to be worse off, but if the child lives a long time, they’re going to be better off. And I am seeing Dan giving me the break signal.
We are here with Ed Slott, the author of Ed Slott’s 2016 Retirement Decisions Guide, something that will answer really the vast majority of questions that you have regarding retirement. Ed is also the author of my favorite Ed Slott book, which is The Retirement Savings Time Bomb…and How to Defuse It: A Five-Step Action Plan for Protecting Your IRAs, and a wealth of resources for both advisors and consumers by going to www.IRAHelp.com. He is the top IRA expert in the country by any objective measure in terms of books sold, speaking fees, has a huge presence on public TV, and his most current book is Ed Slott’s 2016 Retirement Decisions Guideanswers a lot of questions that a lot of people nearing and actually who have already retired have. He is also the author of my favorite Ed Slott book, which is The Retirement Savings Time Bomb…and How to Defuse It: A Five-Step Action Plan for Protecting Your IRAs, and he is also the author of the website that has enormous resources for both consumers and for advisors at www.IRAHelp.com.
Ed, before the break, we were talking about what we think is coming, which is the death of the stretch IRA, if you will, where a non-spouse beneficiary would have to pay income taxes on the entire inherited IRA within five years of the IRA owner’s death, that would inevitably push that beneficiary into a very high tax bracket and literally wipe out the legacy that the IRA owner had intended for his children. We talked a little bit about charitable remainder trusts, which is a good strategy, which, by the way, I would not do until they actually passed the law.
Ed Slott: Oh yeah.
Jim Lange: But there’s also a strategy that you have been an advocate of for years, and if that stretch IRA is killed, which we think it is going to be killed, this strategy would become even that much more powerful. Could you talk about that please?
Ed Slott: Yeah. I’m talking about life insurance, but not any life insurance, permanent life insurance, that has value, and just so people know, I don’t sell life insurance. I’m a tax advisor, a CPA. I don’t sell life insurance, stocks, bonds, funds, annuities, none of that stuff. But as a tax advisor, I have to tell you, the tax exemption for life insurance is the single biggest benefit in the tax code, and it’s available to everyone. And in fact, everyone who qualifies for life insurance qualifies for the tax exemption, and that’s something that can be much better than a stretch IRA. For example, if they kill the stretch IRA, which means if you have a sizable IRA that you want to bequeath to your beneficiaries, your children or grandchildren, and they have to cash it out and get taxed all in five years after death, which is not the rule now, but it may be the rule at some point (that’s why you want to plan ahead), you might be better off taking some of that IRA money down now and paying tax now, pay tax now, but at much lower rates and on a much lower balance, and putting that money into a life insurance policy and leaving that to your children. They’ll end up with a lot more money than you would have left them with the IRA. Also, they’ll end up with less taxes. They won’t have to worry about all these tax rules after death, the stretch IRA, and if you’re saying, “Well, they could still blow the money,” you could leave that money to a trust that holds the life insurance, and life insurance is a much more flexible asset to leave to a trust. It’s very trust-friendly, unlike an IRA, which has to jump through a lot of hoops, a lot of tax laws, and there’s so many ways you can make a mistake. Plus, you could have high trust taxes if funds are held in the trust and not given to beneficiaries.
So, turning IRAs into life insurance is a good long-term move, and the children will end up with more, and more of it tax-free. Now, the reason I say permanent insurance, because you might be saying, “Yeah, but what’s in it for me? What if I need the money?” And that’s where the beauty of permanent insurance as opposed to term is that let’s say you did need the money. You could go into that permanent life insurance policy because, in effect, it’s also a savings account for you during life. But the great part about it is if you need the money, you pull it out of the life insurance policy, the value built up over many years, and you can pull it out tax-free so you won’t have to worry about taxes in retirement. You’re better off, in most cases, having your money in there than in a taxable IRA, which is a debt growing for the IRS. So, that’s a much better plan, and I think if they eliminate the stretch IRA, more people will do what they probably should have been doing all along and look at that as a way to have the family end up in a better financial position, both during your life and for your children after death, with less worry about these complicated tax rules and less worry about paying income taxes and keeping more of the money and making it last longer. Plus, life insurance has benefits that most IRAs don’t. You don’t have to worry about the stock market and investments and tax risks and creditor protection, and you have more guarantee, more safety, more control. You’re not subject to required minimum distributions. You have liquidity and access to your money. You have guarantees. You know, it’s like the wish list everybody wants, and it’s in the tax code. It’s just most people don’t understand the tax benefits within a life insurance policy besides the death benefit.
Jim Lange: Well, you actually referred to an article that I just published with Trusts& Estates regarding charitable remainder unitrusts. The follow-up article is actually taking your IRA and doing both Roth conversions and exactly what you’re talking about, and the example that I used in the article, I take out enough money from the IRA to pay the premium on a second-to-die life insurance policy. So, you’re taking a little bit of money, maybe just like one percent of the balance, out of the IRA, paying income taxes on it, having what is left, using that money to purchase a second-to-die life insurance policy. The life insurance policy, like a Roth, frankly, is growing income tax-free for the rest of your life and the rest of your children’s lives. It comes without any income tax to the child or grandchild, it comes without any inheritance tax, either PA inheritance tax or, if you’re a high roller, any federal estate tax, and the numbers that we were arriving at, there’s differences of literally millions of dollars between just, in effect, playing dead and watching your IRA…well, you won’t be around to watch it, but your IRA just being eviscerated with a forty percent income tax rate versus being smart about it. And the numbers are really very compelling. So, we’re on the same wavelength, the life insurance, and I know that you’ve also used strategies that aren’t second-to-die, but the same basic idea where you are paying a little bit of tax upfront from the IRA using what is left, and then using that money that now becomes after-tax dollars to buy a life insurance product.
Ed Slott: That’s right, and you’ll end up with more and more available to you and less to worry about. Now, you won’t get the big gains you might get in the stock market, but coming into retirement, that’s not the big issue. It shouldn’t be the big issue for most people. For most people, not losing money is more important than making money.
Jim Lange: And I would add, in today’s world, when a lot of parents like myself and people who are older, you know, we think about what the future’s going to be like for our children, and unfortunately, we might be in a time when it might be tougher for our children to even do as well as we are. And you don’t necessarily want your child to be a multi-millionaire, but you want to have at least a certain base level of protection so that even your child, not just you, will have, let’s call it, food on the table, a roof over their head, and maybe gas in the car. So, this is certainly the most tax-efficient way to do this.
Ed Slott: Yeah, it’s something you should look at, and I know people say, “But who can afford it?” Really, you have to think of it as an investment, as an asset, an investment you make. You know, an IRA by definition is a diminishing asset. It has to go down in value. I mean, you could make money, but each year after seventy-and-a-half, you’re forced to take it out by law to make it a diminishing asset while insurance is a growing asset.
Jim Lange: All right, well Ed, you have been a terrific guest. We have time for one more question, but before we get to that, I am going to take one more minute to recommend that listeners get Ed Slott’s 2016 Retirement Decisions Guide. My favorite of Ed Slott’s books is The Retirement Savings Time Bomb…and How to Defuse It, and he has great resources for both consumers and advisors on www.IRAHelp.com. And Ed, I know that you work with a lot of advisors, probably thousands of advisors, in your career and I think that you have developed a handy dandy list of questions for somebody who is thinking about using a financial advisor. So, let me ask you two questions: one, should people do this on their own and save a little bit of money in fees, and two, if they are interested in using an advisor, what will be some of the questions that they could ask the advisor to make sure that they’re getting the right advisor?
Ed Slott: Well first, I think the rules are too complicated to take a chance and do this on your own. There are too many places where you could make what I call a ‘fatal error’ where you lose your retirement savings. It may have taken you thirty years to build it up, but for example, under some new tax rules that you may not be aware of, you might do a second rollover not knowing you did anything wrong, and now you just lost your $500,000 IRA because it wasn’t done the right way. There are technical rules, that it’s a landmine of problems, and many of these mistakes cannot be corrected. They’re irreversible, etched in stone. The tax code is very unforgiving when it comes to movement of retirement money. So, I would caution anybody that’s worked a long time to save, build and invest in their retirement savings to keep it protected by using professional help. But which professional?
I have to tell you, most financial advisors are also not up to the task. They might have helped you in what I call the first half of the game where you built up that money saving and working, but in the second half of the game where you’re taking that money out and you want to preserve it and have a legacy maybe for your children and grandchildren, you need a better type of advisor. I wouldn’t say, maybe not better, but better educated that has specialized knowledge in how to navigate these complex tax rules. Most advisors do not take any training. As you know, Jim, I’d say 99% of advisors don’t, and that’s a big claim, and you might say, “Wait a minute. Ed, are you saying only one percent of advisors know anything about this?” No. It’s much less. I rounded up!
Jim Lange: You’re a generous guy, Ed!
Ed Slott: Yeah! And I think you know what I mean that the average advisor, they’re taught to invest and help people make money, but this money, IRA money, 401(k) money, is loaded with taxes. That’s the biggest risk within this, almost like a cancer on the account. It’s a terrible thing and you have to know the rules. And one mistake by an advisor and there’s a real problem. So, I always make sure that consumers ask advisors if they’ve ever been to any training on these IRA rules, on the distribution side, on the tax rules, and ask them for specifics. Have you ever read a book about it? And the advisor might say, “Oh yeah, I’ve read a book.” Well, use what I call my BS detector. If they said they’ve read a book about it, ask them to show you the book. If it cracks when they open it, that’s the first time that book’s been opened. I’d run! This is your life savings at stake.
Jim Lange: Ed, this has been a terrific show. You’ve given our listeners a lot of great information, very, very practical-type things on what they can literally do right now. I will thank you. We have been with Ed Slott, the author of Ed Slott’s 2016 Retirement Decisions Guide, my favorite Ed Slott book, The Retirement Savings Time Bomb and How to Defuse It: A Five-Step Action Plan for Protecting Your IRAs, and the author of a great website that has resources for both consumers and advisors, and I get the Ed Slott newsletter and it’s terrific, and that can be found at www.IRAHelp.com.