Originally Aired: August 3, 2015
Topic: Ed Slott helps IRA Owners Protect their Legacy
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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Ed Slott helps IRA Owners Protect their Legacy
James Lange, CPA/Attorney
Guest: Ed Slott, CPA, America’s IRA Expert
|Click to hear MP3 of this show|
- Guest Introduction: Ed Slott, CPA, America’s IRA Expert
- The Stretch IRA and How It Might be Changing
- Encouraged Planning
- IRA Creditor Protection
- Rollover Limitations
- Roth IRA Conversions
- Differences between IRAs and Employer-Sponsored Retirement Plans
- The Five Step Action Plan to Defuse the Retirement Savings Time Bomb
- Naming Trusts as IRA Beneficiaries
1. Guest Introduction: Ed Slott, CPA, America’s IRA Expert
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 Retire Secure! For Same-Sex Couples. In the wake of recent elections, what is the status of the looming death of the stretch IRA, how might this significant potential new law impact your family, and what affect might the new Congress have on your future tax bills? What pitfalls await investors for new legislation that’s already passed? For example, just last week, Congress announced that rollovers will only be allowed once a year, which will impact anyone with multiple IRAs. For insights on these and other taxing issues, we welcome America’s IRA expert Ed Slott back to the show. Named “the best source for IRA advice” by The Wall Street Journal, Ed hosts the popular website IRAHelp.com. He’s authored numerous books, including Ed Slott’s Retirement Decisions Guide and Fund Your Future. Ed also writes personal finance columns for several publications and presents professional education IRA seminars across the country. His “Retirement Rescue” TV specials run on PBS stations across the country, including WQED here in Pittsburgh. So, stay tuned for an interesting and informative hour, and with that, I’ll say hello, Jim and welcome, Ed.
Jim Lange: Welcome, Ed.
Ed Slott: Hi, Jim. Great to be back on your show. Thanks.
Jim Lange: Well, thanks for coming. You know, sometimes it’s difficult to determine who the true top person is in any field. That said, in the IRA field, looking for the true expert, the number one guy, the guy who has sold more books, trains more advisors, is the busiest speaker and educator that commands the highest fees in the IRA and retirement plan field, that is Ed Slott. Ed has two books that I’d highly recommend to consumers. The most recent is Ed Slott’s 2014 Retirement Decisions Guide: 125 Ways to Save and Stretch Your Wealth. But my favorite, and I guess it’s your classic, Ed, is The Retirement Savings Time Bomb and How to Defuse It: A Five-Step Action Program to Protect Your IRAs. So, anyway, we are really fortunate to have Ed on our show, and I was hoping that you could talk a little bit about the proposed IRA law that would, in effect, kill the stretch IRA, and perhaps you could describe to our listeners what the stretch IRA is now and how that law might impact the stretch IRA?
2.The Stretch IRA and How It Might be Changing
Ed Slott: Well, great, Jim. When you die with an IRA, you know, when Congress first created the IRA, it was created because people had no pensions. Companies were defaulting on their pensions. Actually, the IRA is about to turn forty years old. Technically, it’s already forty years old, but the first time you could make a contribution was in January, 1975. So, in January, it’ll be forty years old. And when people ask, “Where did IRAs come from?” Do you ever wonder about that, Jim?
Jim Lange: I actually have.
Ed Slott: All right. They came from a car! A Studebaker, actually. The Studebaker plant in 1963 promised all these pensions, they went broke, people didn’t get their pensions, people who worked their whole life there, and Congress heard about it and said, “This is a disaster!” This was in 1963. So, they said, “We have to do something about this immediately!” So, over ten years later…
David Bear: Quick in Congress!
Ed Slott: That’s ‘immediate’ in Congressional talk. You know, it’s the same thing now. That was fifty years ago! They created ERISA (the Employee Retirement Income Security Act), and that was one of the first…here’s just a little backstory history for you and all the listeners. That was one of the first acts signed into law by then new president Gerald Ford, who just took office after Nixon resigned. It was signed into law actually on Labor Day. He took office in August, but on Labor Day, he signed it into law, and that created individual retirement accounts so people could take their retirement accounts, say, from a company plan and have something. The IRAs were created because people had nothing. The companies broke their pension promises. So, when the IRA was created, it was created because Congress was worried that people have to have something to retire on, especially when they were promised all this.
Well, forty years later, people got the message, and many people contributed and built up nice retirement accounts, sometimes in 401(k)s, but then they rolled over to IRAs, and Congress never intended IRAs to outlive you. They never even considered it, pretty much, in the law. They figured we’d be happy if these IRAs helped people get through retirement, never thinking about it as an estate planning vehicle. By that, I mean having so much left over, it could actually benefit the next generation, the children. So, that brought the concept of what you mentioned, the stretch IRA, and that happens when somebody dies with an IRA and there’s leftover, and if the beneficiary does things just exactly right, they can stretch or extend distributions, in other words, extending the tax deferral over the rest of their lives. So, a forty-year old might go out forty years. A one-year old, if they did everything right, could go out about eighty years just taking minimum distributions for the rest of their lives.
Well, this is not what Congress ever intended. As I said, it was intended to help people for a time and not to pass on to the next generation. So, every time the government needs money and wants to create revenue, they hit this provision known as the stretch IRA, and they say, “You know what? This whole business of beneficiaries? This law was never intended. IRAs were never intended for beneficiaries. It was intended for the people who saved and worked for their retirement, not to pass on to kids. So, we’re going to say, ‘To heck with this lifetime stretch IRA. From now on…’” And everything I’m saying, if you just tuned in, is a proposal, and I don’t even know what bill it’s in anymore because it’s been in so many bills that never got passed. It’s a proposal to limit it to five years after death. Now, that’s something. I’m in the Yogi Berra camp. You ever hear of Yogi Berra?
Jim Lange: Sure.
Ed Slott: You know, I believe he was the outfielder…now, I’m trying to relate to the Pittsburgh law here, I believe he was the outfielder in left field in Forbes Field when Bill Mazeroski hit that home run, which, to this day, is still the only seventh game walk off World Series winning home run. And Yogi Berra was usually a catcher, but I believe that day, he was in left field. And last time I was in Pittsburgh, I actually visited the little chunk of Forbes Field they have there.
Jim Lange: You’re making a hit with the Pittsburgh fans, Ed!
David Bear: Yeah, you got your Pittsburgh props down right.
Ed Slott: All right. Anyway, Yogi Berra had this great saying. He had a lot of really funny sayings, but one always hit me. When you talk about proposals or things that might happen, he said, “I never make predictions, especially about the future.” That’s like one of his other sayings. He said, “You know, the place is so crowded, nobody goes there anymore!” So, I don’t like to make predictions, especially about the future, and that’s why I don’t usually like to talk about a proposal, but this is something, I think, that if a bill ever gets passed, this could easily be tacked on and the stretch IRA could be eliminated. Why? First of all, nobody even knows it exists, for the most part. I mean, there wouldn’t be any angry voter outrage. Not only that, the only people that would be outraged are beneficiaries, and there’s not really a big beneficiaries lobby. You know, I can’t see them standing outside the Capitol with ‘Save the Stretch IRAs: Help Beneficiaries’ signs. Could you see that? First of all, that would be like work, and the beneficiaries don’t like work! So, there’s not really a strong lobby against it. So, I could easily see this happening, but I could also see it backfiring on the government, as well. So, yes, I think the days of the stretch IRA are numbered, but it’s not necessarily a bad thing.
Jim Lange: Well, actually, we had some correspondence, if you remember, and this is private, not public.
Ed Slott: Yes.
Jim Lange: And I’m going to quote you to you: “Eliminating the stretch IRA will wake people up to do the planning they probably should’ve been doing all along.” So, that seems to indicate that whether they change the law or whether they don’t, there is some particular planning that you’re going to encourage, and I was hoping that you could tell our readers and listeners what planning you had in mind?
Ed Slott: Yeah, that’s right. People are coasting by. There are great opportunities in the tax code. Some people know about the stretch IRA, and the government thinks they’re going to get all this money. I forget what the estimate was, billions in revenue, which will never happen. I don’t even know where they got that number. First of all, the truth is, as you well know, unless somebody has a good advisor, most beneficiaries don’t even make it to five years.
Jim Lange: That’s true.
Ed Slott: You know, most of them have the money spent on the way to the funeral before the body’s cold, really. So, the whole thing that they’re going to get this money upfront…but anyway, it will cause people like you and I to talk about it like we’re talking about it now and cause people, like I said, to wake up and do even better planning. So, the government’s going to lose all this money, not gain money, because the first thing I would tell older people, who, in the past or now, I’m still encouraging to do Roth conversions, because I believe, like you, that tax-free is always better, especially when you’re pulling it out, to pay once and never again. I’m a big believer of that, as you know. But I would tell older people, say, seventy or older, don’t even bother doing Roth conversion anymore because why would I pay…the benefit of the Roth conversion is the longevity, the long tax deferral. Why would I pay tax now if five years after death, my kids have to cash it in? So, the government would lose that revenue.
Then, I would tell people to heck with this stretch IRA. I’ve got a better solution for you: take the money down now at low tax rates. The government will think they’re making all this money because their budget projections are only current for two years or so, just like with the Roth IRA. They think they’re making all this money. Pay the tax at low bargain basement rates and leverage that money into life insurance. And again, in case people don’t know, I don’t sell life insurance. I don’t sell stocks, funds, insurance annuities, none of that. I’m a tax advisor. But as a tax advisor, the tax exemption for life insurance is the single biggest benefit in the tax code. So, what’s going to happen, it’s going to encourage…you know, it’s like if they eliminate this, and it gets some play, some press, it’s going to wake the sleeping giant and force people or trigger people into doing even better planning.
So, instead of the government getting a tax on millions in the IRAs over time, they might get some tax upfront, but when the smoke clears, the beneficiaries will turn, say, a $300,000 IRA…actually, the parents will, who have the IRA, they’ll take it down if they don’t need the money, of course. They’ll take it down. After tax, maybe have $200,000, which depending on health and age, could buy a million or more in life insurance. So now, the kids will have more and more of the tax free. They don’t have to worry about all these stretch IRA rules, and if you need a trust for the children, like some large IRA owners want because they want post-death control, they don’t want their kids squandering it or a divorce or creditor issues, or maybe have a minor beneficiary, many reasons you might need to name a trust. Life insurance is a much more trust friendly asset than an IRA. It’s much easier to leave life insurance in a protective trust than an IRA. So, people are going to end up with much better planning. They’ll have more money for the beneficiaries, more of it tax-free, and the government once again will be the big loser because they try to stop something that they think is this big benefit, which it is if you use it right, but most people don’t.
Jim Lange: And for whatever it’s worth, I’ve run some numbers and showed that, depending on your assumptions, that the family can literally be a million dollars better off…
Ed Slott: Right!
Jim Lange: …by doing your exact strategy that you’re talking about.
Ed Slott: And tax-free.
David Bear: Well, you know, at this point, let’s just take a quick break to pay some bills.
David Bear: And welcome back to The Lange Money Hour. I’m David Bear, here with Jim Lange and America’s IRA expert, Ed Slott.
Jim Lange: Ed is the author of Ed Slott’s 2014 Retirement Decisions Guide: 125 Ways to Save and Stretch Your Wealth, and that actually just came out this year, and my favorite is Ed’s classic book, The Retirement Savings Time Bomb and How to Defuse It: A Five-Step Action Plan Protecting Your IRAs. Ed, we were talking about life insurance, and one of the things that we didn’t mention is it enjoys creditor protection. But IRAs and Roth IRAs, and I’m mainly talking about when the IRA owner and Roth IRA owner are alive, also afford excellent protection from creditors. What is the story with IRAs and Roth IRAs after the IRA owner dies, and have there been any changes in this area in the last couple years?
Ed Slott: Well, first, there’s different degrees of creditor protection. I think what you’re referring to is more bankruptcy. Under bankruptcy is one kind of creditor protection, when you declare bankruptcy, what can be taken, but there’s other judgments: lawsuits, divorce, things like that. But with IRAs, creditor protection in general is under state law. Now, for bankruptcy, IRAs are federally creditor protected under all states, but that’s for the IRA owner. Once the beneficiary inherits, they’re no longer protected. That was a Supreme Court ruling, actually a 9-0 ruling, and in this country, where everything is so divided and hyper-partisan, I mean, when all nine justices agree, it tells me IRAs are what can bring the country together. Now, all nine justices agreed that inherited IRAs are not creditor protected under bankruptcy, and there’s been a lot of cases with people who inherited (probably children) IRAs declaring bankruptcy. So, I’m always wondering how is it that so many people who inherit money go bankrupt. Doesn’t inheriting mean you got more? So, obviously, they squander the money or they make bad investments, you know, sometimes getting too much money at one time can be a problem.
David Bear: Sounds like the lottery winners.
Ed Slott: Yeah, right, same kind of thing. You know, you wonder about these things, like this one case that went to the Supreme Court. I think they invested in a pizza place or something. Anyway, they lost their money, went bankrupt, and the court said, “No. Your inherited IRA is no longer, or is not, protected in bankruptcy.” I keep saying ‘no longer’ because it was a question. Some courts said yes, some said no. That’s why it went up to the Supreme Court. So, that’s something that’s important to know. If you have built up a large IRA and are worried your kids will blow it, you might have to leave it to a trust, but that can get a little thorny. It won’t be protected if the kids go bankrupt, and that’s something everybody should know, and that’s in all states because that’s a Supreme Court judgement.
Jim Lange: Well, speaking of changes in the law, there’s now some limitations on rollovers…
Ed Slott: Right.
Jim Lange: …or I prefer to use the word ‘trustee-to-trustee transfers.’ Could you tell our audience what the old law is and what the new law is, and why it’s so important that they hear this?
Ed Slott: Yeah. First you have to understand…and again, this is kind of inside baseball jargon that you and I talk when we talk about trustee-to-trustee transfers and sixty-day rollovers, but to the public, it just means I have an IRA with a certain bank or broker, and I want to move it to a different account or a different investment. How do I do that? And generally, it’s done through a rollover, but there’s two ways of moving the money. The preferred way is a direct transfer, or known as a trustee-to-trustee transfer, where it goes from, say, Schwab to Merrill Lynch, or this advisor to that advisor. It goes direct from one bank to another without anybody touching the money in between. There’s no problem with that, and that’s the way the money should be moved. The problem comes in when you take a check from one bank. You say, “I want to take my IRA out and go to the bank across the street.” If you have a check made out to you, that’s what we’re calling a rollover, a sixty-day rollover, if you do that and you take the money, you have sixty days to get it back into an IRA, but now, you can only do that once a year, and a year is 365 days, not a calendar year, as a result of a new ruling that just came out, which was based on a court case where somebody tried doing more than one rollover. I think they were pushing the envelope. The guy’s name was Bob Rau. It’s funny. He was a tax attorney and he lost his own case and ruined everything for everybody! It used to be you could do separate rollovers, sixty-day rollovers (remember, trustee-to-trustee transfers, never a problem and still won’t be a problem), where you could do one per year but from each IRA. That’s no longer the case. In fact, starting January 1st, you can only do one of them from any IRA, including Roth IRAs, once per 365 days. So, you’d better be careful. My advice is only do direct trustee-to-trustee transfers. And if they absolutely say the bank or the fund company insists on making out a check, have them make it out to the place where you’re bringing your new IRA, the receiving institution. Make it out to the institution, not to you. That will qualify as a trustee-to-trustee transfer and you won’t have a problem.
Jim Lange: Isn’t there also a problem with federal withholding tax?
Ed Slott: Well, not really, because that’s only on the plan level. If you take money out of a plan, there’s mandatory 20% federal withholding, not so the case on IRAs. I mean, you could request it, but I probably wouldn’t. So, you probably won’t have an issue with an IRA, unless you opt in for 10% withholding or whatever you want. I wouldn’t do that. I would do direct transfers. IRS wanted to cut down on people like this attorney Bob Rau, who is trying to game the system, you know, trying to get a lot more use out of his money during the sixty days. The sixty-day rule was created as a convenience in case you wanted to change investments. But people started using it, pushing the envelope or gaming the system, whatever you want to call it, to get use of their money, some people even started calling it a ‘sixty-day IRA loan.’ There is no such thing because loans in IRAs are prohibited. So, the court basically threw the book at this, and the IRS has now followed with new rules that are effective January 1st.
Now, this is really serious. You may think, “Oh, that’ll never happen to me.” You do a second rollover now. Let’s say your life savings is in an IRA, and you have $500,000 in an IRA and you move it to another IRA, and then you forget and you do it again, the second time within a year, even from a different IRA or even from a Roth IRA. That second distribution of those funds is taxable. Well, if it’s from a Roth IRA, maybe not, but the second rollover is taxable, and there’s no relief. IRS doesn’t even have the authority if you went to them and said, “Oh, I didn’t realize I did two in one year.” They don’t even have the authority to provide relief. So, there goes your IRA. You no longer have a retirement account if you blow this once per year IRA rollover rule. Now, certain transfers don’t count as one for the once per year. If you move from a 401(k), for example, to an IRA, that’s not IRA to IRA. So, that doesn’t count as one. Or vice-versa. If you go from an IRA back to a plan, that’s not IRA to IRA, so that doesn’t count as one. If you move money from an IRA to a Roth IRA, that’s a Roth conversion, so that doesn’t count as one. Only IRA to IRA and Roth IRA to Roth IRA. Don’t do these sixty-day rollovers. Talk to somebody. After January 1st, they’re going to lower the boom, and my prediction is, a lot of people are going to lose their retirement savings over this.
Jim Lange: And is it fair to say that this is one of the, let’s say, traps for the unwary do-it-yourselfer?
Ed Slott: Yes. You know, what we’re talking about, it’s common to us because you and I follow these things, but this is basically under the radar. You didn’t see a news story about this, unless you look deeply into financial publications, which most consumers don’t do. It was mostly in the professional publications. Even there, it didn’t make big news. So, yes, a lot of people, exactly as you said, do-it-yourselfers, they might not even know about the new rules. They do a second rollover, bang! They have no more retirement account and they owe the tax on everything. It may have taken them thirty or forty years to accumulate this account, and now it’s gone in a flash.
David Bear: Well, when you say gone, you don’t mean the principle disappears. It just becomes totally taxable.
Ed Slott: It becomes totally taxable, but it’s no longer an IRA.
David Bear: Right.
Ed Slott: It’s regular money, and they keep the crumbs that are left. When you add a big account balance to your regular tax bill, it probably puts you up in a higher bracket. You know, you could lose, depending on federal and state taxes, more than half of it, and whatever is left is no longer in an IRA, and it’s not being…the tax shelter’s loss maybe is a better way to say it.
Jim Lange: And Ed, you just mentioned it wasn’t in a lot of financial journals or IRA journals.
Ed Slott: Yeah.
Jim Lange: Well, one that it is in is actually your newsletter, which I think is the best IRA newsletter on the market.
Ed Slott: Me too!
Jim Lange: By the way, I am serious. You know, we have a consumer audience, but we also have a professional audience, and, to me, I can’t even imagine any IRA…actually, any financial advisor (because IRAs are such an important part of being a financial advisor) not getting that newsletter, not having your books, and also, your workshops are wonderful, and I think you have a two-day workshop coming up in February. Is that right?
Ed Slott: That’s right.
Jim Lange: All right.
Ed Slott: In Las Vegas. You can find that on my website, IRAHelp.com. Everything’s up there.
Jim Lange: Yeah, and I will also take the liberty of mentioning that Ed not only gives an excellent technical workshop, but he also gives a lot of practical ideas on running your business and attracting clients, and obviously in an entertaining and informative way.
Ed Slott: Yeah, but it’s not as funny when I tell people they just lost their retirement savings. It takes some of the humor out of it!
Jim Lange: I would imagine that would take…
David Bear: Yeah, what would you say?
Ed Slott: Well, hopefully, it doesn’t happen on my watch, but, you know, anything is possible! But I could see a lot of people whose advisors are unaware of losing exactly what I said before, losing it because either they’re do-it-yourselfers (as Jim said), or their advisors weren’t aware. And for your consumers that are listening (you talked about our workshop), I would ask your advisor if they have any training in this area. The problem is, they all say they know it all, and if they tell you they know it all, that’s when you know they don’t know it all.
Jim Lange: Well, I think one way to do it is to see what books they have on their bookshelf…
Ed Slott: Yes.
Jim Lange: …and I’d like to see, you know, a couple Ed Slott books, maybe a Natalie Choate book…
Ed Slott: Right.
Jim Lange: …a Bob Keebler book, I’ll take the liberty of saying my book, but I’d want to see those books on…
Ed Slott: Well, I’d go even further because what does a consumer know to ask? They go into an advisor’s office. “Do you know anything?” “Oh, of course! Look at the books.” So, I’d go one step further. Just like you say, look at the books. I add my own personal BS detector. So, the advisor might say, “Oh, I know it all! Look at all the books I have!” I would say, as a consumer, “All right. Put one down and open it.” If that book cracks when it opens, that’s the first time that book’s been opened. I’d run out of that office.
Jim Lange: That’s a very good way of doing it. I know my edition of yours, and, in particular Natalie Choate’s book, which is about as much fun as eating sawdust to go through, but it’s just a great source of technical information, wouldn’t crack. So, I actually like that. Open the book.
Ed Slott: Yeah! Listen for the crack. That’s your sign!
Jim Lange: All right. So, one of the things that you have been an advocate of for many years, I guess actually going back to 1998, is Roth IRA conversions.
Ed Slott: Right.
Jim Lange: And you had just mentioned that if that new law passes, they might not be as attractive.
Ed Slott: For older people.
Jim Lange: Okay, for older people. So, why don’t you maybe take our audience through who might be a good candidate for Roth IRAs or Roth IRA conversions and who might not be.
Ed Slott: Easy. Younger people. The younger, the better. Younger people have the most to gain from Roth conversions for several reasons: number one, they can start early. They have the value of time. I always say, “The greatest money making asset any individual can possess is time,” and young people have more of it than anyone else, and they should be capitalizing on it. So, if you can start out even with a small amount growing tax-free, that means all of those earnings grow for you, as opposed to a tax-deferred IRA or 401(k). All the earnings are growing for you and Uncle Sam. In other words, you have a partner on every dollar you earn for the rest of your life. The key planning move is to get rid of your partner so you can keep it all. Who wants to share? You know, we were taught when we were kids that sharing is good, but enough is enough! Start as soon as you start working, the earlier you can, the younger you are, start doing Roth IRAs if your income permits, and Roth 401(k)s at work. This way, you’re starting out great. I’m sixty now, so I didn’t have that opportunity until 1998, and still, I didn’t even have that opportunity because of income, and 2010 was the first year I was able to convert because they repealed the income eligibility limitations. Now, everybody can convert, and it does mean paying taxes now. But for younger people, they have less. They’re probably in a lower bracket. It’s nothing. All they’re giving up is a tax deduction. And if you get the tax deduction, it sounds good upfront, but then you pay for it for the rest of your life. I’d rather, as your book says, pay it once. You won’t even feel it and it’s tax-free forever, because, in retirement, to me, there’s nothing better than a zero percent tax rate. You can’t beat a zero percent tax rate, and that’s why I converted everything I could January 4th, the first business day of 2010 when the floodgates opened and the law was repealed.
Jim Lange: All right, and that is saying something because with your busy speaking schedule and writing schedule and your newsletters, I would assume that that was not at a low tax rate.
Ed Slott: No.
Jim Lange: So, you took a serious hit.
Ed Slott: But you know what? It was the deal of the century. I think it was on your show, I encouraged everybody to do it because if you did it…so I did it in January, 2010. I didn’t owe any tax at all for 2010. So, it’s like the government gave me an interest-free loan to build a tax-free savings, and I only paid half the tax in 2011 and half in 2012. That was the deal. The government gave you an incentive to convert because they needed the money. So, they said, “No tax in 2010, and you’ll pay half in ’11 and half in ’12.” So, I didn’t even finish paying it off until the end of 2012.
Jim Lange: And the other thing, I do understand about Roth IRAs and Roth IRA conversions for younger people, but let’s say that there aren’t a lot of younger people listening. They’re watching their…well, they don’t even watch TV anymore.
Ed Slott: Well, encourage your kids and grandkids.
Jim Lange: All right. What about the idea of setting up a Roth IRA, maybe for your kids and grandkids?
Ed Slott: I did that for both my kids, and I did it when they got their first job, the earlier the better. Now, there’s a couple of schools of thought. I’ll tell you what I did when my older daughter was fifteen. She’s twenty-five now and just finally got out of college and got a job.
Jim Lange: Finally!
Ed Slott: But, you know, today, you can stay in college forever. Masters this, Masters that, anything to stay in school, you know. Anyway, her first job was working at the local library one summer when she was about fifteen, and she made $350. So, it was ten years ago, and I opened up a Roth IRA for $350. Now, some people might say, “Well, shouldn’t she put her money in?” Yes, but she had no money because she spent it. She was one of those kids who got her first check and asked me, “Who’s this guy FICA and why is he taking my money?” You know how kids do when they get the concept of what a net check is as opposed to a gross check? And also, I put the money in for a couple of reasons: I wanted to set up the account for her. I know the power of compounding over time, and it’s okay that she spent her money. As a matter of fact, she even asked me when I was trying to explain it to her, she said, “Wait a minute. So, it works like this: I make $350 this summer and I spend it. Then you replace it and put it in a Roth IRA that grows tax-free for me forever? Is that the way it works?!? What a country!”
David Bear: What a parent!
Ed Slott: I said, “No, that’s the way it works under this roof, because I want you to see the benefits of saving for a time, and as early as possible.” And the other reason I did it is because by creating the vehicle, now that she’s finally on her own, she’s more likely to continue the process as she sees the growth. She has a much larger Roth IRA than probably most of her friends, just from whatever she made, I put in there.
Jim Lange: Well, I think that’s a great thing that you did that, and I would encourage our listeners to do that also. I am a big fan, just like you said, of tax-free.
Ed Slott: Right.
Jim Lange: And the tax-free vehicles we have are Roth IRAs, Roth 401(k)s, Roth 403(b)s, Section 529 plans (which is a different type of tax-free)…
Ed Slott: Right.
Jim Lange: …and then we were talking about life insurance before.
David Bear: Well, this sounds like it’s a good time to take another break.
David Bear: And welcome back to this edition of The Lange Money Hour with Jim Lange and America’s IRA expert, Ed Slott.
Jim Lange: Who is also the author of Ed Slott’s 2014 Retirement Decisions Guide: 125 Ways to Save and Stretch Your Wealth, which I do recommend. That just came out this year. My favorite book of Ed’s though, which I really think that just about really every IRA owner should have, and certainly every advisor should have, is Ed’s classic book The Retirement Savings Time Bomb and How to Defuse It: A Five-Step Action Plan Protecting Your IRAs. And also, Ed, we talked a little bit about your newsletter, which I think is so good, and in your November newsletter, you really provided a service, and I sometimes have a bad habit of lumping IRAs and 401(k)s and 403(b)s together and just kind of pretending that since they generally have the same tax treatment, that they’re the same, but you actually pointed out no, they’re not the same. Could you tell our listeners some of the differences between an IRA and an employer-sponsored retirement plan?
7. Differences between IRAs and Employer-Sponsored Retirement Plans
Ed Slott: Yeah, there’s a bunch of differences. First, there’s different contribution limits. IRAs limited to $5,500 (or $6,500 if you’re fifty or over). With 401(k)s, you can contribute $17,500 (and another $5,500 if you’re fifty or over) for a total of $23,000, and if your company allows, say, after tax contributions, you can go up to $52,000. So, that’s a big difference. You can put a lot more into company plans. Also, I hate to say this, you can borrow from a company plan, but don’t do it!
Jim Lange: I know you hate to say it!
Ed Slott: You could borrow from a company plan. You can’t borrow from an IRA. As a matter of fact, I just talked about that. If people say there’s something called a ‘sixty-day IRA loan,’ don’t believe it. That’s a prohibited transaction, and if you have one of those, you actually lose your IRA. The whole thing’s considered distributed. But one of the big advantages of IRAs and Roth IRAs as opposed to company plans, and the big difference is the company plan is run by the company for employees. You don’t run it. With your IRA, you run it. You have total access. Any time you want to get to your money in an IRA, you can get to your money, even before fifty-nine and a half. Now, there could be a penalty, but you always have access. That’s not the case with a company plan.
Also, company plans have creditor protection. We talked about that earlier. ERISA plans have universal federal creditor protection for everything in there. IRA’s creditor protection may not be, depending on your state. It’s determined at state level by state law. Also with a company plan, if it’s an ERISA plan (that’s a tax law we talked about earlier), you might name your spouse as your beneficiary. With an IRA, you can name anybody you want as your beneficiary. And the company plan has one unusual provision. If you’re still working there, you can delay your required minimum distributions, as long as it’s not your own company. You don’t own the company. With an IRA, after seventy and a half, you have to start required distributions. Also, we’re speaking of required distributions, with IRAs, they’re a lot easier. You can aggregate your IRAs. In other words, if you have five IRAs, you can take the required amount for all of them out of any one or any combination. If you have a company plan like a 401(k), you have to take it from that plan. If you have three different plans, you have to take it from each. So, it’s a little more complicated with a company plan. So, those are some of the differences.
8. The Five Step Action Plan to Defuse the Retirement Savings Time Bomb
Jim Lange: Well, I see that we still have some time, and I’m really happy because I want to talk about the five step action plan that you can use to defuse the retirement savings time bomb, and in order, you have listed: time it smartly, insure it, stretch it, Roth it and avoid the death tax trap. Do you want to take maybe any one of those or any two of those and…
Ed Slott: They’re all good! Well, the timing is important because of the tax rules. These IRAs are strangled, for lack of a better term, by all these complex tax rules, and you have to navigate this web of rules or pay penalties. And the reason the rules are so tough is because the IRS wants to make sure they get their money. Remember, this money hasn’t been taxed yet, except for a Roth IRA. So, they want to make sure you’re taking it when you’re supposed to and you’re not taking it when you’re not supposed to. There’s so many rules. If I were going up to Congress, I would get rid of a lot of these rules. They’re very complicated for people.
Also, insure it, we talked about that. I think IRAs today are a bad asset. I made my living on IRAs but it’s a tax infested (not invested) asset. It’s loaded with taxes. Now is the prime opportunity when tax rates are relatively low. They’re as low as they’ve ever been in about fifty years or so. I would get that money out and leverage it into a much better asset like life insurance, or even go to a Roth IRA. So, that’s why I say insure it, and that’s why I say Roth it. I like tax-free. Anything you can do now to turn taxable money into tax free is a good move because the minute you do that, all the earnings come back to you, and you don’t want to share your earnings with Uncle Sam if you don’t have to. You can pay for the privilege. You know, I call it ‘there’s a mortgage on your IRA.’ If you pay it off early, you own it, and everything it earns, you keep, and that’s the best way to go into retirement.
You know, I started this program talking about Bill Mazeroski and Yogi Berra with his predictions, and I was thinking about it. Here’s another bit of trivia. I remember, I was always into the Bill Mazeroski home run even though I grew up in New York as a Yankee fan on the losing end. But I was six years old then, and that was the first Collier’s yearbook I ever got. My parents had the Collier’s encyclopedia. For your young listeners, it’s called an ‘en-cy-clo-PED-i-a.’ It was a book. It was a whole series of books you looked things up in. Now, there’s Google. But anyway, I remember that picture of him rounding the bases. So, I always took interest in the Pittsburgh Pirates and Bill Mazeroski. So, I remember, it was just about a year ago, and during this program, I looked it up because I couldn’t remember the date. It was just about a year ago, in November last year, when he sold his uniform. Do you remember this?
David Bear: Yes.
Ed Slott: He sold his uniform, looking up now, for $1.7 million, sold his World Series uniform (I’m reading from this Pittsburgh Pirates thing), his game seven walk off home run fetched a total of $1.7 million. Can you imagine?
David Bear: The value of compounding.
Jim Lange: Yeah.
Ed Slott: Yeah! Now, that’s better than a Roth IRA, but how many people can hit a seventh game walk off World Series home run? So, if you can’t do that, use the strategies we talked about.
Jim Lange: All right. And again, that’s time it smartly, insure it, stretch it, Roth it and avoid the death tax trap.
Ed Slott: That’s it.
Jim Lange: So, Ed, you know, you’re always full of information. I tried to pick some of the areas that you might want to talk about. Is there something that I didn’t talk about that you think that our listeners could benefit from?
9. Naming Trusts as IRA Beneficiaries
Ed Slott: Yeah. This is for people that have larger IRAs. I talked about it before, but I’m seeing more problems with naming trusts as IRA beneficiaries. Not that there’s anything wrong with it. There are reasons to name a trust: you have a minor as a beneficiary, you have a $2 million IRA and you don’t want them blowing it, or you have a disabled beneficiary, an unsophisticated beneficiary, an incompetent beneficiary. Maybe you want creditor protection on a divorce or a second marriage or to help the spouse or a child manage the money. There are all kinds of good reasons to name a trust. Mostly, it’s about post-death control, and an IRA doesn’t fit nicely into a trust.
As you know, you have to follow a whole slew of rules that are much more complicated than the rules I just talked about for required distributions. So, I’m seeing more cases, and I can say that when I see the results of (and you may have seen it too) this whole slew of private letter rulings that’s been coming out where people named a trust or, by accident, they named the estate and they want to get it out of the trust, it costs them a fortune. You know, you really have to look at this. Number one, see if you need a trust, and you might for those reasons. But if you do need a trust, you’re going to need an attorney that really knows their stuff, and I know Jim Lange really knows this stuff. So, if you’re in the Pittsburgh area and you need an IRA trust, the average estate planning attorney is not going to do it. You need a specialist. One of the best ways to describe this is a medical analogy. You know, you have a general practitioner doctor. He’s a nice guy, but he’s not a cardiologist. He’s not a neurologist. He’s not a specialist. Sometimes, you need a specialist. This is one of those times. So, if this is you, I’m telling you, you have a large IRA and you want to protect it? We’re seeing a lot of these trusts backfire because for two reasons: one, the attorney didn’t have the specialized knowledge to set it up right, and even if they did, we’re seeing problems on the backend where it’s not properly implemented.
For example, somebody dies and they empty the IRA into the trust, and that’s the end of it! Here, they’ve spent $10,000, $20,000, $30,000 in all the planning, and it’s gone in five seconds after death, and sometimes at the highest trust tax rates. So, if that’s you, you may want to talk to Jim Lange over there in Pittsburgh and make sure you get this done right. I would really warn you to have it checked because most of these things that I see go bad, it’s too late after the fact. That’s when people come to me.
Jim Lange: Well, thank you for the generous words.
Ed Slott: But you know what I’m talking about.
Jim Lange: I sure do because I have seen it, Bruce Steiner talks about it, and there’s some good people who are doing some good work. But there’s a lot of people doing some not so good work. So, Ed, you mentioned you’re sixty years old. To me, you’ve always been THE most popular IRA expert, writing multiple books, having a fantastically busy travel schedule, training both consumers and practitioners, and I know that you are, again, having one on, I think, February 20th in Las Vegas. What are your plans for the future?
Ed Slott: Well, we’re going back to public television. You know, they tell me our show is in the top ten public television, as far as fund raising, of all time. That shows you how many people need this information. It also shows you how many are not getting it from their financial advisors. Most of the people who are watching, for example, in Pittsburgh, WQED and all over the country, and that’s one of our favorite stations. They always put me in the hotel right by the Forbes Field thing, so I get to look at that! I don’t know what that area is called, but…
Jim Lange: It’s called Oakland.
David Bear: Oakland, yeah.
Ed Slott: Oh yeah? Yeah, it’s a nice area. But it shows you how many people have these issues. Most of the people that watch public television are somewhat sophisticated, have good savings, they have a financial advisor. When I see them at seminars I do around the country that are sponsored by public television, they always tell me the same thing. I always ask them, “Why are you here?” They pay money to be there, not to me, to donate to public television. I say, “If you already have a financial advisor, why are you here?” And the answer’s the same everywhere around the country: “Because the stuff you were talking about? I wasn’t getting this kind of information from my current financial advisor.” In other words, they’re on the other end of the pendulum. They’re taking the money out, looking for that exit strategy. The average financial advisor may help them make money, but as you know, it’s what you keep that counts. At some point, you’re going to take that money out. You’d better have a plan. Otherwise, you’ll get what I call the ‘government plan.’ That’s not a good plan.
Jim Lange: Thank you so much, Ed.
Ed Slott: Thanks, Jim, for having me on. I always love being on your show because you’re one of the few hosts that actually knows what I’m talking about!
James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans. Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger’s Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.