Episode 123 – Estate Strategies Deliver Clarity and Peace of Mind with guest Bob Keebler, CPA, MST, AEP

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Estate Strategies Deliver Clarity and Peace of Mind
James Lange, CPA/Attorney
Guest: Bob Keebler, CPA, MST, AEP
Episode 123


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  1. Guest Introduction: Bob Keebler, CPA, MST, AEP
  2. The Death of the Stretch IRA?
  3. IRA Relocation
  4. The Importance of Analysis Using Tax Brackets
  5. Roth Recharacterization and Segregation
  6. What’s an AMT?

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1. Guest Introduction: Bob Keebler, CPA, MST, AEP

David Bear: Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks.  I’m David Bear, here in the KQV studio with James Lange, CPA/Attorney and author of three best-selling books, Retire Secure!, The Roth Revolution: Pay Taxes Once and Never Again, and now, Retire Secure!: For Same-Sex Couples.  Accumulating wealth can be the work of a lifetime.  Developing, implementing and maintaining strategies to preserve that wealth and pass it on to the next generation is the essence of estate planning.  But every situation is different, and cookie cutter approaches are seldom the best option.  For insights on this important issue, we welcome back Bob Keebler to The Lange Money Hour.  A nationally recognized expert in estate and retirement planning, Bob frequently ranks among America’s top one hundred most influential CPAs.  He’s been quoted dozens of times in the New York Times, Chicago Tribune, Barron’s, Wall Street Journal and USA, amongst others.  And he’s written numerous books, including The Big IRA Book, The Rebirth of Roth, and, most recently, 100+ Roth IRA Examples & Flowcharts.  It’s sure to be an interesting and informative hour, so without further ado, I’ll say hello, Jim and welcome, Bob.

Jim Lange: Welcome, Bob.

Bob Keebler: Thanks for having me, Jim.

2. The Death of the Stretch IRA?

Jim Lange: Well, it is really an honor.  I have always considered you, let’s say, the most quantitative and accurate and technically just outstanding of all the IRA experts, including myself, and I just mentioned, you know, when we were getting ready for the show, but I’ll say it on air, that if I had a tough IRA issue, or I needed a private letter ruling, or there was something that was really tricky, and I had any expert in the country to go to, including my own firm, I would go to you because I just think that you’re so good with the really technical stuff.  And the other thing that I really like about you and the way that you work and think and write is that you’re very quantitative.  So, you actually run the numbers.  And we do that, too, but I think that that’s a wonderful thing.  So, one of the areas where running the numbers is probably particularly valuable is, I’d like to talk for a minute about what is known as the death, or, what I call it, the ‘death of the stretch IRA.’  Now, to give listeners a little background, normally, when you die with an IRA and you leave it to a non-spouse, the non-spouse, if they make the appropriate actions, can, in effect, stretch or defer the income tax on that IRA for the rest of their life to some degree.  They have a minimum required distribution of the inherited IRA.  But there was a vote, 51/49, against (luckily), but we feared that the death of the stretch IRA, that is the ability to continue stretching the IRA after death, was going to go away, and we still have that fear.  So, Bob, can I first ask you what is your prediction, if you would be willing to say is this a legitimate fear that people are not going to be able to stretch the IRA after their death?

Bob Keebler: It’s almost impossible to say what’s going to come out of Congress.  If it’s part of an overall bill that’s cast in terms of shoring up the tax system, closing loopholes, this may just end up on the table.  But we really don’t know.  So, the prudent thing to do is when you’re making decisions is to evaluate them in the context of with and without the ability to stretch.  But, Jim, even if Congress changes this, what will happen is we will simply change our planning, and there’s a very good technique that’s almost as good as the stretch IRA, and that’s using a stretch charitable remainder trust where, instead of paying your IRA to a trust for your children, you pay your IRA to a charitable trust for your children.  Your children get distributions from the charitable trust over their lifetime, and when they die, the remainder goes on to charity.  Mathematically, that’s going to stack up not as good as the stretch, but better than just taking the money out over five years.  So, it’s one of those situations where Congress simply cannot outthink hundreds of guys like you around the country that live and breathe this stuff every day.  So, if that door closes, other doors will open.

Jim Lange: All right.  And let’s assume that we fear that the worse does come, and the stretch IRA is eliminated, you’re saying then people could quickly change the beneficiary to a charitable trust.  So, let’s say that the beneficiary is a forty-year old child, or, better yet, a trust for a ten-year old grandchild, and that they could, in effect, stretch the IRA for the rest of their lives, but at their death, if there’s anything left, it would go to the charity of the original IRA owner’s choice.  Is that right?

Bob Keebler: That’s exactly correct, yes.

Jim Lange: Well, that’s actually a very interesting approach, and it sounds like that should be able to survive any change in legislation.

Bob Keebler: Well, that’s what we’re hoping, and, you know, we’ll have models ready to go because we’ve already looked at this, and, you know, we’ll quantify it.  We’ll figure out what to do, and that is, like you said earlier, that’s really where this is, and for people listening, if you’re making these decisions, you really want to encourage, you know, financial planners and the CPAs you’re working with to run the numbers, not just tell you what they think, because what I’ve found is, so many times, my initial inclination was wrong.

Jim Lange: Well, you…

Bob Keebler: But I…go ahead, Jim.

Jim Lange: I was saying you know we are big fans of running the numbers, and we do it all the time in our books and our articles, and that’s one of the reasons why I like your analysis so much.  But speaking of running numbers, let’s assume for the moment, because a lot of times…I mean, to me, this is a big deal, this death of the stretch and what people can do about it now, and I’m not quite comfortable with, well, we’ll just adapt if the day comes.  I’m trying to think, well, what can we be doing now?  Let me ask you this.  And I’ve actually seen results in…I don’t think I want to name them because I think they’re wrong, but I’ll just say major financial newsletters that said that the Roth IRA conversion is less viable because of the potential death of the stretch IRA.  We’ve actually come to the opposite conclusion.  I don’t know if you have done any analysis or if your thinking is different on Roth IRA conversions or not.

Bob Keebler: Logically, certainly the Roth will be less viable than the Roth…the Roth you have today is going to be more viable than a Roth that has to be paid out over five years.  That’s easy, okay?

Jim Lange: Umm-hmm.

Bob Keebler: What is not so easy is comparing the Roth to the regular, and my guess is if we knew the money had to come out within five years…so, you know, if a person has one child, they have a million dollars or $500,000 in their IRA (big number), and that money has to come out over five years, what you would do is you would convert to the Roth along the way, maybe from the time you were sixty-five to the time you died at ninety or eighty-five.  And that would be the beauty of that.  You’d spread that out.  So, there will be major changes in strategy, and what we’ll do, if this comes to fruition, we’ll just have to run all the numbers, show some generalities, and then come out with software that’ll allow people to fine tune that.

David Bear: I have a question.  You keep saying five years.  I mean, is that a rule, or is it just a rule of thumb we’re talking about now?

Jim Lange: Well, that’s the proposed…

Bob Keebler: No.

David Bear: That’s the proposed rule.

Bob Keebler: That’s the proposal.

David Bear: Okay.

Jim Lange: Yeah.  And by the way, I should mention to people that it would be very hard to find anybody in the world who is a better Roth IRA expert than you, and I’m just going to take one minute here to plug two of your…actually, three of your resources.  One is a book called 100+ Roth IRA Examples & Flowcharts.”  Another one is called The Rebirth of Roth, and either of those…and by the way, The Rebirth of Roth, when I did my own book, my own Roth book, one of the reviews was, “This is a great Roth book, but not quite as good as Rebirth of Roth.”  And David, what was that?  It was www.ultimateestateplanner?

David Bear: The website, ultimateestateplanner.com.

Jim Lange: All right.  So, this is either for the sophisticated consumer, or the advisor, www.ultimateestateplanner.com.

David Bear: Umm-hmm.

Jim Lange: And as long as I’m doing this, the other resource that I think is terrific, because Bob, you give away more great stuff for free than most people do in paid newsletters, and if I was really anybody interested in IRAs, I would sign up for your website or your e-mail, which is at www.keeblerandassociates.com.  So, when you hear Bob Keebler talk about Roth IRAs and Roth IRA conversions, it’s a good idea to listen to him.  And by the way, it’s just a pure coincidence, of course, that he came to the same conclusion that I did, which is if you are going to have to pay this out in a big sum, that it is better to have Roths.  And we’re actually being a little bit more aggressive with our Roth IRAs and Roth IRA conversions because I do fear that stretch.  Bob, one of the things that some people have said is one way of, let’s say, getting out of or getting around the stretch IRA, is with life insurance, and I know I have not been as big a fan of life insurance as some of the other IRA experts, but when I run the numbers, it looks pretty good, and somehow, I have a feeling that you have already done a lot of analysis on this and was wondering if you had any, let’s say, ideas, or if you’ve done any work on comparing does life insurance make sense in the face of the death of the stretch IRA?

3. IRA Relocation

Bob Keebler: You have to look at life insurance in a couple of different ways.  One is, sometimes we have clients buy life insurance to create liquidity when they die.  In other words, somebody has an estate that’s subject to estate tax.  They do not want to destroy their IRA when they die by having to reach into it to pay the estate tax.  So, we buy life insurance.  Now, normally, 90% of the time, that life insurance is held outside the person’s estate, not subject to estate tax, in a special trust.  Now, further, sometimes, even if there’s not an estate tax, the math suggests…so, the highly quantitative analysis suggests taking money out of your IRA, perhaps when you’re forced to take minimum distributions at seventy-and-a-half, and instead of investing that money in a brokerage account, jettisoning it into a life insurance product makes a lot of sense.  We call that ‘IRA relocation.’  And I’m working on a very large white paper right now for one of the major insurance companies, and that pretty much shows this math works.  So, Jim, usually on the IRA relocation though, we will use second-to-die policies, where on the regular just liquidity, you know, I’m a retired person.  I want liquidity in my estate.  I will buy a policy on my own life, not on mine and my wife’s life.

Jim Lange: Well, that always made sense to me because back in the old days, and I don’t know if this is basically the same thing as what I remember reading, called ‘pension rescue.’  And there were all kinds of analysis about how wonderful pension rescue was, and I was a little bit apprehensive because, usually, the analysis assumed that the beneficiary was going to cash in the IRA on day one after death.  And I said, “Hey, that’s not fair.  If the beneficiary can stretch it out, the benefits of just leaving an IRA or a Roth IRA are a lot greater.”  But if we do have this death of the stretch IRA, that is, the beneficiary of the IRA, or even the Roth IRA, rather than stretching it over their life, has to withdraw the money in five years.  Then, the life insurance option, and particularly the one that you mentioned, the second-to-die makes a lot more sense to me.  But you’ve actually run numbers on that and it looks pretty favorable?

Bob Keebler: Absolutely.  No, there’s no doubt it works very well.

Jim Lange: The other thing that I fear about the death (and I guess I’m sounding like a doom and gloom guy, but I don’t want to get caught flatfooted on this), is I sometimes really fear that this is going to be a real problem for trusts that are typically taxed at a very high rate.  So, let’s say you have, you know, let’s go back to your example of $500,000 or a million dollars to a single beneficiary, and let’s say that that beneficiary is a trust for whatever reason.  Maybe it’s a special needs trust.  Maybe it is a spendthrift trust.  Maybe it’s the I-don’t-want-my-no-good-son-in-law-to-inherit-one-red-cent-of-my-money trust.  Maybe it’s even just a typical minor’s trust for a young grandchild.  And if the idea is that we’re not necessarily going to distribute all the income and we’re going to have some income stay in the trust, I fear just a horrendous tax on that trust.  If the five-year rule does apply, would life insurance, just to create some other type of asset other than an IRA, make more sense in that situation?

Bob Keebler: Well, that’s really what we have to look at is, you know, you have to run the numbers, and you’re going to have to look at different alternatives.  That’s all we would do.  Now, most people are going to benefit from some level of Roth conversion, and that’s really what they have to look at.

4. The Importance of Analysis Using Tax Brackets

Jim Lange: And the way you do your analysis, and by the way, I’ll also mention to everybody that I am part of a professional group, and we have actually had the pleasure of hearing Bob for, basically, an afternoon, coming in, giving a pretty technical talk, and one of the things that you always emphasized during that talk was the different tax brackets related to Roth IRAs and Roth IRA conversions.  Could you tell our listeners a little bit about the benefits of analysis using tax brackets and why that’s so important when you do run the numbers?

Bob Keebler: Well, we can go way back.  This bill came into effect in 1997 when the Roth IRA was invented, and right away, after it came out, we wrote a program.  And what I quickly saw, Jim, was that if your tax rate was the same when you converted your regular IRA to the Roth as when you withdrew the rate, when you withdrew the money, basically, you were no better or no worse off.  Now, that’s before we figured out some other things.  So, if I am at the 28% rate now, and I’ll be at the 28% later, a Roth conversion is basically neutral to me at that point.  Now, when I take into account another seven to ten variables, including how am I going to pay for my conversion, when am I going to retire, will I need the money to live on after seventy-and-a-half, that’s when the Roth IRA gets better.  So, coming back to your comment on trusts, what is absolutely critical, you know, just beyond belief what’s critical, is that I look at what rate I’m going to be in now and later.  Now, if you have a regular IRA payable to a trust, the only thing we know for certain is if we leave the money in the trust, okay, if we leave the money in the trust, then we are going to end up having to pay income tax on that at 39.6% federal rate, plus Pennsylvania or West Virginia state tax, whoever’s listening.  So, you add in that, and what you’re better to do is get the money into the Roth at a lower rate, 25%, 28%, 33%.  It’s just numbers.  It’s really very simple.

Jim Lange: Yeah.  By the way, for our listeners, now Bob is a Green Bay man, also, I assume, a Packers fan, too, and for Pennsylvania, there actually is no…Pennsylvania is a little bit different.  When they withhold money from your check and it goes into your 401(k), you don’t get a tax break for Pennsylvania.  That is, you don’t get the federal benefit of putting money in a traditional IRA or a traditional 401(k), but then when you take the money out, it’s not taxable.  So, Pennsylvania’s not a great state to accumulate money because you’re taking a hit and you have to pay the taxes up front.  But then, when you take it out, it’s not taxable.  So, Pennsylvania doesn’t tax the Roth IRA conversion.  So, one idea is you do your Roth IRA conversion in Pennsylvania, then you move somewhere like California that has a high state income tax and you’re okay.  What you don’t want to do (which is what a couple of my clients have done) is they earned all their money, and they have big IRAs and big 401(k)s in Pennsylvania, and they didn’t get a tax break then, then they move to California, and then they get hit there because they basically didn’t get a tax break when they put it in, and then they have to pay tax on it when it comes out.  So, that’s probably another example of taking state income taxes into account when you do the analysis of Roth IRA conversions and life insurance, etc.  And I assume that you’re doing that because when you’re…you know, I know I always ask people, you know, where they intend to retire, and sometimes even where…

Bob Keebler: Well…

Jim Lange: Go ahead.

Bob Keebler: Yeah, we have to because…the worst situation is somebody, you know, is in a state that imposes an income tax, they do a Roth conversion and then they move to Florida where there’s no state income tax, and those individuals, you know, it’s very hard to make the Roth work.  Now, on the other hand, if somebody is in Florida right now, they’re living down in Florida, and they’re going to be changing their residency back to Pennsylvania in the future, or back to West Virginia, probably more appropriate, or Ohio, they are going to have to look at does a Roth conversion make any sense before they move, because if they convert when they’re in Florida, they will not pay a penny of income tax to Florida.  And then when they come back up north, if they’re…perhaps West Virginia’s the state that works the best in this example.  If they’re in West Virginia and they take the money out of their IRA, they would normally have had to pay state income tax.  If they take the money out of the Roth, of course, there’s no state income tax on that.

Jim Lange: Right, so where they actually live and where they intend to live are going to be important factors for the Roth IRA conversion analysis.

Bob Keebler: Exactly.  I mean, there’s just no doubt, Jim.  This all has to go into an equation, and that’s why clients really want to talk to someone.  It depends on the numbers.  You know, if you have a very relatively small IRA compared to your net worth, this may not be worth spending a ton of time on.  But, if your IRA is ten or twenty or even a greater percentage of your net worth, you owe it to yourself and you owe it to your children to try to figure out what the best thing is that you can do.

Jim Lange: Well, for whatever it’s worth, that tends to be the majority of my practice.  I sometimes kid that my clients have one to three million dollars in an IRA and a house and a Honda, and that’s basically it.  And then somebody says, “No, I have a Toyota!”  But I tend to attract people that have…and maybe it’s because I have about 650 college professors as clients, and I have a lot of engineers and a lot of mid-level managers and I guess Pittsburgh’s a working town.  And so, a lot of my clients, they never grew up rich.  They never had a lot of money.  They got a job, whether it’s as a professor, as an engineer, as a manager, and they never made a ton of money.  And then they had the mortgage payments, and then they had the house payments, and then they paid for their kid’s braces, and they paid for their kid’s colleges, and it was really hard to accumulate money, but they were the prudent type, so they always put the maximum in their retirement plan, and now they’re 65-70 years old and they literally have one to three million dollars in their retirement plan, which usually is eventually rolled into an IRA, and they often don’t have a lot of money.  So, a lot of times, one of the problems that we have with Roth conversions is coming up with the money to pay the tax on the conversion.  So, in general, I’m not a big fan of doing Roth conversions if you have to use the money from the IRA itself to pay for the conversion.  And I don’t know if you have an opinion on that one.  I’m sure you do, though!

Bob Keebler: Yeah.  No, no, I think you’re right.  I think the issue becomes will you need the money after seventy-and-a-half?  So, you have someone that’s 62 years old, and they are never going to need the $500,000 in their 403(b) plan, and they get a very nice pension from the university.  They’ll be able to live on between that and their Social Security.  They should still look at some level of Roth conversion, maybe just filling up the rest of whatever bracket they’re in.  On the other hand, doing a wholesale large conversion when you do not have outside money to pay the taxes is something you’d have to be very careful of because the math there doesn’t work if you’re jumping too many brackets.

Now, Jim, the other thing we’ve been doing a lot of is what we call ‘segregated’ conversions, and in the segregated conversion, we will, if we have five mutual funds in our IRA, will actually do five different conversions, and if one of those goes up in value during the Roth period, we will leave that money in the Roth.  Otherwise, there’s a privilege under the law called recharacterization where we can actually go back and undo our conversion, and when we undo our conversion, then we’re basically going back into the regular IRA like we never did anything in the first place.  We don’t have to pay any tax on that.  So, it’s a rare thing in the tax law where you can kind of have your cake and eat it too.  In other words, you can do a conversion, and if it works, you leave your money in the Roth.  If it doesn’t work, you recharacterize.

Now, the good news is if you do these conversions early in the year, you will have until October 15th of the following year to determine whether or not this was a good idea.  So, the one thing that we’re looking at is that’s almost a year-and-a-half from now, so a lot could happen in the market, in politics, in the global economy, and we’re looking at having a lot of clients with significant wealth do conversions, not knowing whether they’re going to keep the money in the Roth or whether they’re going to go in a different direction and turn it back into a regular IRA.  But when you’re talking to your listeners and to your clients, of course, this is something that really does stack the deck in favor of a Roth because it’s almost a situation where you’re going to be able to analyze in hindsight whether or not this worked.  The other thing you could possibly do, if you did a conversion and Congress changed the law during this period of time, we can also recharacterize.  There are no restrictions.  You don’t need a reason to recharacterize under the law right now.

David Bear: All right.  Well, you know, let’s take a break right now.


David Bear: And welcome back to The Lange Money Hour with Jim Lange and Bob Keebler.

Jim Lange: And we are here with really one of, or if not, the top technical Roth IRA experts in the country, and I just wanted to mention a couple of resources for our listeners.  For the sophisticated listener and for the financial advisors, I would highly recommend a book, it’s really a set of worksheets and examples called 100+ Roth IRA Examples & Flowcharts, and it’s a book that Bob has written, and the other one, which is, you know, maybe the best, most technical, but really great Roth IRA book is called The Rebirth of Roth.  Both of those are available at www.ultimateestateplanner.com.  And for those of you who just want great free information, I cannot stress enough to go to www.keeblerandassociates.com.  Bob has a newsletter that I think is a lot better than a lot of the paid newsletters, and it’s free, and it’s just blowing me away, the great stuff that I get from that newsletter.  But before the break, we were talking about what Bob called the ‘Roth segregation strategy,’ and we have been using something very similar.  We have different terminology called the ‘Roth launcher,’ and interestingly enough, back in the late nineties, when Roth IRA conversions both came out, both Bob and I pretty much simultaneously came out with an article about this strategy, and it’s still working today, and even though I know you went through it once, Bob, I’d like to just dissect it for one other minute because I think it’s so powerful, and if we could maybe just go backwards a little bit and talk about what a recharacterization is, because a lot of people don’t even know about that.  So, could we start with just what is a Roth recharacterization, and then we’ll get to the real benefits of this Roth segregation strategy.

5. Roth Recharacterization and Segregation

Bob Keebler: What the law says is when you convert to a Roth IRA, if you convert today, you have until October 15th of the following year to do a recharacterization, which is a big, big deal because if your accounts go down in value, there’s virtually no reason why you wouldn’t recharacterize.  There’s almost no reason because what you want to do, if you converted a hundred dollars and it fell to sixty, there’s no reason you would want to pay taxes on a hundred when you could recharacterize and only pay tax on sixty.  So, that is a very critical thing.  So, what we want to do above all else is evaluate our Roths after the fact.  So, I will have clients do Roth conversions, and we will not know if we’re going to leave the money in the Roth or whether we’re going to recharacterize until the following October.  Now, there’s a number of steps along the way.  There’s a number of plays we have to look at.  But this takes almost all the risk out of a conversion because, Jim, if I convert today and it goes up, I’ll probably leave it in my Roth.  If it goes down, I will almost certainly recharacterize.  And if it stays in the middle, that’s when I’m going to run a lot of numbers and figure out what is the best thing for me.

Jim Lange: All right, so that’s the basic Roth recharacterization.  So, basically, what you’re saying…and by the way, a quick mechanical point.  All right, so let’s say that it’s 2014, we make a Roth IRA conversion, and let’s just say, for discussion’s sake, no matter how much we actually convert, our true intention is to keep, let’s just say, for discussion’s sake, $100,000 of the conversion.  So now, it is April 15th, 2015.  Now, again, we have until October 2015 before we have to make a decision.  Would you typically tell people to get an extension and then pay an estimate based on $100,000 of conversion, and then actually do the tax return in October, or would you actually do a tax return and then do an amended return?

Bob Keebler: No, we typically extend.

Jim Lange: Yeah, that’s what I like to do, too.

Bob Keebler: Now, we might pay into taxes with that depending which way we think we’re going to go.  Where you have to be very careful is in states where they tax Roth conversion.  It doesn’t sound like Pennsylvania is like that.

Jim Lange: No, it doesn’t.

Bob Keebler: And in those states, you don’t have as much to worry about.  But in other states (perhaps West Virginia falls into this category) where you have to pay tax on your conversion, then you got a different deal because what we have to do is figure out the timing of those state payments, and usually, you want to get the state payments in the year where you do the Roth conversion.  But that becomes a big issue because unfortunately, with this five dimensional tax system we have, every time you make a state payment, you run into the opportunity to fall into the AMT.  And we can talk more about that, but…

Jim Lange: Interesting way to put it, an opportunity to run into the AMT!  Like an opportunity to go to the guillotine!

Bob Keebler: Right!  No, that’s exactly what happens.  So, Jim, what your listeners really need to know is we have a five dimensional tax system.  This is what I’ve been talking about for a couple of years here, since all these bills were passed, is that there’s the regular tax, then there’s the AMT, there’s the tax when you’re in the highest rate, at the 39.6% rate, and then on top of that, we have basically the net investment income tax, plus in the wrong circumstance, you actually lose some of your itemized deductions.  People call that the Pease limitation.  But these are the types of things we need to think through, and you know, unfortunately, each of them play into a Roth conversion decision.

6. What’s an AMT?

David Bear: Just for our listeners, can you explain what an AMT is?

Bob Keebler: Sure.  Basically, under the law, sometimes there are really two systems.  One is a shadow system.  And the first system is the regular tax.  We’re all familiar with that and the rates, okay?  Now, there’s a secondary system designed to make sure that we don’t take advantage of all the opportunities in the regular tax code to save taxes, and that’s called the alternative minimum tax.

David Bear: Right.

Bob Keebler: So, every time your accountant does your return, he or she is going to complete a second form called the alternative minimum tax form, and what you have to do is, you have to take your income for regular tax purposes, and then you have to add back things that you took advantage of, like you have to add back your state income tax deduction.  That would be one.  Sometimes, you have to add back certain types of municipal bond income called private activity bonds.  There are about fifty different potential additions back in the AMT world, the biggest of which is the state income tax.  So, I think what you have to do is…see, this is why you need to actually make sure your financial advisor or your CPA is taking into account AMT and the regular tax and the loss of the itemized deductions.  Most of the calculators out there that you’re going to find online are not smart enough.  They just don’t do the job.

Jim Lange: All right.  Well, getting back to the segregation strategy, so now we know the mechanics that we’re typically going to…and let’s keep it easy for Pennsylvania.  Let’s assume we don’t have a state income tax issue.  That we’re going to do an extension on April 15th of the year following the year that we converted, and let’s just say though that you have run the numbers and it looks like the appropriate amount to convert is $100,000, and let’s say you have $500,000 in your IRA.  Can you go through mechanically what you would do if you were interested in this segregation strategy?

Bob Keebler: Sure.  The first thing you would do is, you’d sit down with your financial advisor and determine what type of assets you have in there.  Now, if you have all bonds, then you’ll just do one big conversion.  But let’s say you have some large cap stocks, mid-cap stocks, small cap stocks, value stocks and international.  Okay?  So, you have five different funds, one through five.  You would do a separate conversion for each five, so that at the end of the day, you would have five different IRAs.

Now, why does that matter?  Because what the law says is then, later, up until October 15th of 2015 in our case right now, I would be able to turn some of these back into a regular IRA in a process called recharacterization.  So, let’s say that one went up by 20%, one went up by 15%, one went up by 5%, and one went down by 15% and one went down by 20%, okay?  So, I have two down.  Almost certainly, those two that went down, I am not going to want to pay tax on.  I’m going to recharacterize those.  The ones that went up by 15% and 20%, in all likelihood, I would keep those in the Roth.  And the one that was 5% up?  That’s something, Jim, you’d have to really put the pencil to and figure out whether it made sense.

So, what we’re trying to do is stack the deck in your client’s favor by isolating the different funds, and almost invariably, something is going to go up during the year.  We just don’t know what it is.  Otherwise, everybody would always pick that.  So, we don’t know what that is, and we’re just going to kind of…we will really bet on five horses, if you will.  It’s the best analogy I came up with.  And so, the ones that go down in value, we’ll recharacterize like we never did anything in the first place.  The ones that go up, we’ll leave in the Roth.  I don’t know if that helps, Jim.

Jim Lange: I actually think the horse analogy is perfect.  It’s kind of like buying a ticket for every horse in the race, and you get to keep the horses that win, and the ones that don’t, you get to take back.

David Bear: Well, you could also win all five, too.

Jim Lange: Well, but that’s probably not likely.  And the other thing is, you know, if we’re using the $500,000 analogy, even if all of them go up a little bit, you still probably aren’t going to want to pay tax on $500,000 even if they went up, again, because of the tax bracket issue that Bob keeps talking about.  So, if you’re a 15% taxpayer, or even a 25% taxpayer, and you’re going to have a big bump in your bracket, the underlying investment would have had to have gone up an awful lot for you to make up the hit in the tax bracket.  But Bob, you said something earlier, and I wanted to clarify something for our listeners.  You said that if the rate was going to stay 28% when you made the conversion, and when you eventually withdrew the amount, I just wanted to clarify that that only includes the assumption that you are taking the money out of the IRA to pay the tax on the Roth IRA conversion, and if instead (which is what I usually advocate), rather than paying tax on the Roth conversion from the IRA, that I’m going to take money from outside the IRA, what I’ll call after-tax dollars or a non-IRA, non-401(k) brokerage account, or cash or CDs or whatever it is, and I’m going to use that money to pay the tax on the conversion.  Then you’re going to get into a more favorable situation.  Is that a fair statement?

Bob Keebler: Absolutely.  That’s exactly right, Jim.

Jim Lange: All right, because that’s what I always assume, so, you know, when you said that there are all these factors about whether it’s a good deal or not, and sometimes it is and sometimes it’s not, but  it usually is.  That’s assuming you’re paying the tax on the conversion from the IRA itself.  But if you have money from outside the IRA, you’re probably…and let’s assume, again, a flat income tax all the way through, you’re probably starting on some pretty good assumptions and likely advantages.  Is that also true?

Bob Keebler: Right.  No, if you have outside money, that’s a wonderful place to start.

David Bear: Well, and at this point, let’s take another break.


David Bear: And welcome back to The Lange Money Hour with Bob Keebler and Jim Lange.

Jim Lange: Well, it’s a great pleasure to have Bob, and Bob is just full of resources, and I’d like to mention a couple.  For the more sophisticated listener and for our financial advisors who are listening, there are two Roth resources that I just think are outstanding.  One is 100+ Roth IRA Examples & Flowcharts, and the other one is The Rebirth of Roth, both excellent pieces of work, and they can be found at www.ultimateestateplanner.com.  For listeners who are interested in great free resources, and by the way, I don’t see any reason not to do this, Bob has a newsletter that, in my opinion, is much better than some of the other paid newsletters, and his is free!  And I’m just blown away by the quality of the stuff that I get from his newsletter, and listeners can sign up, again, without cost, by going to www.keeblerandassociates.com.

David Bear: How often do you put out the newsletter, just out of curiosity?

Bob Keebler: It’s event-driven.

David Bear: Event, okay.

Bob Keebler: I mean, you know, probably every ten days…

David Bear: Oh.

Bob Keebler: …but when something truly meaningful comes out, that’s when we try to get something out.

Jim Lange: Yeah, and again, you have all types of very valuable information.  One of the things that you’re constantly doing is you’re adding value for your listeners, readers, clients, etc., and one of the things that we do in our practice, and I’d love to hear this from somebody other than me, because I’ve been doing it a lot, and that is, what’s not unusual at all is…particularly, with people who work in large companies that have been there for a while, like in Pittsburgh, maybe at Westinghouse or at PPG, and let’s say they come in and they have a million dollars in their IRA, or a million dollars in their 401(k).  But let’s assume, by this point, it’s been rolled into an IRA.  And it turns out that when they were working, they were contributing money to their retirement plan in excess of what they were allowed to deduct.  So, let’s just say, for discussion’s sake, that they contributed an extra $5,000 per year in excess of what they were allowed to deduct, which, by the way, is conceptually identical to a non-deductible IRA.  So, people who have non-deductible IRAs, you’re in the exact same boat as the people I’m talking about that have, in effect, after-tax dollars in their 401(k) or 403(b) that were eventually rolled into an IRA.  So, let’s say that a guy comes to you and he’s maybe retired by this point.  He has a million dollars in his IRA, and of that, let’s say $50,000 is after-tax, or, you know, we would say that it has a basis of $50,000.  What advice would you have for somebody in that position?

Bob Keebler: Well, there’s a couple of planning things.  First of all, if you did a complete Roth conversion, you would only pay tax on $950,000, because he has $50,000 of basis.  So, just to make it even better, for some people, they might have, say, $110,000 in their IRA, of which basis is $50,000, where anytime you have a basis ratio of over 30%, meaning you have $100,000 in your IRA, of which $30,000 is basis, you’re probably a good candidate for a Roth conversion because you do not have to pay tax on your basis.  For the person with a very large IRA, there are a couple of strategies available.  One: if you just move from company to company and you’re still working.  You should see if you can roll that money back into a pension plan, because the rule with the pension plan is a very funny rule.  Even though you can take basis out, you can’t put basis back in.  And in that case, Jim, you’d roll the $950,000 back into the pension, and you’d orphan that $50,000 of basis, meaning you could do a Roth conversion and pay no tax.

Jim Lange: Yeah.  Does everybody see what he’s doing?  So, he’s taking the $950,000 that he hasn’t paid tax on.  He’s getting it out of his IRA, and we won’t get into the technical part about the aggregation rules and the segregation rules, but he’s isolating the $50,000 after-tax, then he’s doing a Roth conversion of that.  So, in effect, he’s making a Roth IRA conversion for free of the $50,000 that represents the after-tax dollars inside his IRA.  I just think that’s wonderful.  But anyway, I’m sorry.  I didn’t mean to interrupt!

Bob Keebler: No, no, no.  And so, that’s something.  Now, the other thing is very common.  When a married couple comes to see me, one party may have a hundred thousand in an IRA with a basis of zero, and the other party might have a hundred thousand in an IRA with a basis of, say, 55.  So, you want to test this for both the husband and the wife, okay?  So, you need to test this for both husband and wife to figure out what is the highest ratio. And anytime, again, the ratio’s over about 25% or 30%, take a good look at whether you should be doing a Roth conversion.

David Bear: Well, for people like me who don’t really understand this, could you just define what ‘basis’ is?  You’ve been tossing it around, but it is…?

Bob Keebler: Basis is what you’ve already paid tax on.

David Bear: Okay.

Bob Keebler: So, it’s an amount that you wouldn’t have to pay tax on if you took it out of your IRA.

Jim Lange: And then, I’ll add one little wrinkle to the strategy, although I somehow suspect if I let you speak longer, you’d say the same thing.  So, what we are doing, let’s say somebody is retired, what we are doing is, we are…if they have some sort of possibility of income, maybe they do a little consulting job, they do something where they earn some income. Then, they set up their own 401(k).  In your example, you were using an employer’s 401(k), but they can set up their own 401(k).  Then, they can roll the pre-tax amount into that 401(k), using your language, ‘orphan’ the after-tax dollars, or with David’s analogy, that has basis, and then we make a Roth IRA conversion of that.  And that has worked out exceedingly well, and basically for free, you are taking an asset that was growing tax deferred and you’re converting it to something growing tax-free.

Bob Keebler: That’s exactly right, and that’s the beauty of this, and if you have a high enough basis ratio, you can do that with minimal tax on the conversion.

Jim Lange: So, right now, we’ve talked about a number of techniques.  One is, let’s say, the Roth segregation strategy.  Another one, you know, working with tax brackets, trying to find out what the basis is in the IRAs, and particularly if you have a lot, looking more aggressively, looking at numbers for life insurance, and is it fair to say, Bob, that most of this really is about running the numbers and trying to figure out quantitatively what is going to work out the best, and that you can save clients hundreds of thousands, and sometimes millions, of dollars, let’s say, maybe not in their lifetimes, but over the lifetimes of their children and grandchildren?  Is that a fair statement?

Bob Keebler: In the right circumstance, that’s about what you can accomplish.  That’s right.  The beauty of the whole thing is we’ve done enough of this where we can do it pretty safely, and we try to make sure no one gets hurt.  We try to, you know, be very positive with this.

Jim Lange: Yeah, and this might be a little bit self-serving, but one of the services that we provide is that we work very closely with a number of money managers, but one in particular, one who uses low-cost indexes, is very open to this idea of doing multiple conversions, segregating, and then taking a look.  You know something?  I’m getting some looks, so…

David Bear: It’s getting to be that time.

Jim Lange: It is, but I just wanted to tell listeners one more time, I would really recommend going to www.keeblerandassociates.com and sign up for Bob’s newsletter, which will come free of charge and has a lot of great information.

David Bear: Okay, and with that, I guess we’re going to have to close for today.  So, thanks to Bob again and thanks to Dan Weinberg, our in-studio producer, and Lange Financial Group program coordinator Amanda Cassady-Schweinsberg.  As always, you can hear an encore broadcast of this show at 9:00 this Sunday morning, here on KQV, and you can access the audio archive of past programs, including written transcripts, on the Lange Financial Group website, www.paytaxeslater.com.  Click on ‘Radio.’  And while there, check out the series of short videos from Jim’s interview with John Bogle, founder of the Vanguard Group.  You can also call the Lange offices directly at (412) 521-2732.  Finally, mark your calendar for Wednesday, May 21st at 7:05 when we welcome back financial literacy advocate Julie Jason for the next new edition of The Lange Money Hour.




jim_photo_smJames 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.