Episode 24 – Cutting-Edge Roth IRA Conversion Strategies with Barry Picker, CPA/PFS, CFP

Episode: 24
Originally Aired: March 10, 2010
Topic: Cutting-Edge Roth IRA Conversion Strategies with Barry Picker, CPA/PFS, CFP

The Lange Money Hour - Where Smart Money Talks

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

Please note: *This podcast episode aired in the past and some of the information contained within may be out of date and no longer accurate.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

Disclaimer: Please note that the Tax Cuts and Jobs Act of 2017 removed the ability for taxpayers to do any “recharacterizations” of Roth IRA conversions after 12/31/2017. The material below was created and published prior the passage of the Tax Cuts and Jobs Act of 2017. 

Cutting-Edge Roth IRA Conversion Strategies with Barry Picker
James Lange, CPA/Attorney
Special Guest: Barry Picker, CPA/PFS, CFP
Episode 24

Click to hear MP3 of this show


  1. Introduction of Jim Lange and Barry Picker, CPA/PFS, CFP
  2. Another Way at Looking at Paying Taxes up Front
  3. Why “Running the Numbers” is So Important When Doing a Roth IRA Conversion
  4. Recharacterizing a Losing Roth IRA Conversion
  5. Example of Surprises Found When Running the Numbers
  6. Separating Your Roth IRA Conversion Into Different Accounts
  7. Non-Deductible IRAs

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1. Introduction of Jim Lange and Barry Picker

Nicole:  We are talking smart money.  Thanks so much for joining us.  My name is Nicole DeMartino, along with James Lange, CPA/Attorney and best-selling author of “Retire Secure!.”  Also, today we have another IRA expert joining us, Barry Picker, who is a certified public accountant.  He also happens to have the Personal Financial Specialist designation from the AICPA, as well as the esteemed CFP, Certified Financial Planner.  And I also should point out that CPA magazine named Barry one of the top forty tax advocates to know during a reception, so, you know, Barry, you were with us last August and you blew people away with your excellent advice, so thank you so much for joining us.  It’s really great to have you.

Barry:  It’s great to be back, thank you.

Nicole:  Sure!

Jim:  And I’ll just add a note.  Not only did he give us tremendous advice, Barry’s been giving people tremendous advice regarding Roth IRAs since 1998.  He was one of the very early people to write some really cutting edge information on Roth IRAs and Roth IRA conversions and Roth IRA recharacterizations, and his most recent book is pretty amazing in terms of some of the technical concepts that we’re going to be getting into.  So, I’m just delighted to have you again, Barry.

Barry:  Thank you.

Nicole:  Well, before we actually dive into, Jim, what you were saying, I wanted to congratulate Barry on his newest book too.  It’s “One Hundred Roth IRA Examples and Flow Charts,” and you know, Barry, I took a look at the book myself, and it is excellent.  It’s a great resource, it’s a great tool for people to have in their personal library, so nice job.

Jim:  Yeah, and it’s not the kind of book that reads like Harry Potter.  It’s like the core, you know, explanation through examples.  This is the kind of book that engineers and quantitative-type people will just love.  So, again, congratulations on a fine job.

Barry:  Thank you, and I have to admit that it was actually written with Bob Keebler, and so he gets a lot of the credit for this, also.

2. Another Way at Looking at Paying Taxes up Front

Jim:  Right, and he was actually on the show last month, and he did a great job, but Barry, one of the things that I’d like to start with is, you made a point the last time you were here that was just so good and so insightful, and I guess it was one of those points that when you hear it, you say, “Oh yeah, I kind of knew that,” but you articulate it in such a way.  You said that if you make a Roth IRA conversion, that it’s like making an IRA contribution in the amount of the tax that you paid on the Roth IRA.  So, let’s say for discussion’s sake, I’ll go with a big, easy number to think about, let’s say you make a million dollar Roth IRA conversion, and you pay $350,000 in taxes, so we’re not gonna start small, we’re gonna start big, you said that that is like making a $350,000 contribution to an IRA, as long as you pay the taxes on the Roth IRA conversion from outside the IRA.  I thought perhaps if you could expand on that thought a little bit, because I thought it was so insightful, and just this alone is gonna be a tremendous resource for our listeners.

Barry:  Well, Jim, the point there is that when the individual has the $1,000,000 traditional IRA, it could be the fact that the taxes haven’t been paid on it.  There’s $1,000,000 working for the taxpayer, but it’s not all his.  $350,000 of it belongs to the government.  So really, it’s a net account, if it were to be liquidated at that point, of $650,000, but if you convert it into a Roth and you pay the taxes from outside the IRA umbrella, then now, you have $1,000,000 in a Roth IRA, and that’s a pure $1,000,000 because, when you leave it there for a qualified distribution, it will never be taxed, and now you have $1,000,000 working for you, and you don’t have a partner anymore in that $1,000,000.

Jim:  Well, I think that that’s such a good way of looking at it, because you’re, in effect, making a massive contribution to your retirement plan, and is it fair to say that, in effect, that that contribution is the amount of money that you pay in taxes on the conversion?

Barry:  Well, yeah.  And basically, what you’re doing, and what you hope to be doing with a conversion, is that you’re buying out your partner.  Uncle Sam is your partner in your IRA, and you’re buying out your partner so that now, all the future profit, let’s call it that, all the future profit is all yours, because you no longer have that partner.

Jim:  And hopefully, you’re doing that before the investment appreciates, and I like the way you’re putting it.  You’re buying out your partner, hopefully at the low point, and then, all the additional growth is yours income tax free.

Barry:  Right.  I mean, the idea of your IRA is that you have a very good investment, a very good business, if you want to put it that way, and you would like it to be all yours.

Jim:  Well, I just love the way you put that.  I know that last time, we talked a little bit about running the numbers, and I know you are one of the great, and I mean this literally, that you are one of the great number runners in the country, meaning that if a real live client comes to you with a particular set of facts and circumstances that would include, for example, how much money they have inside the IRA, how much money they have outside the IRA, what their income is, what their projected income is, and perhaps even some information about their heirs that you actually, we call it running the numbers, as our firm does, to help them make decisions regarding Roth IRA conversions.  And obviously, without naming any names, could you tell me a little bit about your process and some of the conclusions that you have come up with while running your numbers, and, I know it’s hard to say in a typical situation, but in a situation that perhaps might be similar to some of our listeners?

3. Why “Running the Numbers” is So Important When
Doing a Roth IRA Conversion

Barry:  Well, there aren’t that many typical situations.

Jim:  That’s fair.

Barry:  You know, we’ve had situations where there have been individuals with very large IRAs that make up a substantial part of their estate, and for estate planning purposes for these people, and we are assuming that there is going to be an estate tax, for these people paying the tax now and reducing their estate by the amount of the income tax that is being paid, end up leaving more money for the heirs.  So, that’s a situation that we come across fairly often.

Jim:  Before you go on, because that’s such a great point, and I don’t know if everybody understands how powerful that is, because one of the old IRA strategies, when somebody had a lot of money in their IRA, and they were going to be subject to estate tax, and even today, even if you’re not subject to federal estate tax, you’re still likely subject to, say, in Pennsylvania, PA inheritance tax, or in New York, the inheritance tax over there, or whatever state you happen to be in, one of the old strategies was you would cash in your IRA before you died, and that way, let’s say, for discussion’s sake, you had $1,000,000 in the IRA, you had $300,000 outside the IRA, you cashed in your IRA, you paid $300,000 so you would die with your estate of $1,000,000 instead of $1,300,000.  You still had the same purchasing power, and your heirs still had the same purchasing power, but your estate was only $1,000,000 instead of $1,300,000, so you save the estate tax on $300,000 worth of assets.  Now, what Barry’s saying is hey, let’s take it a step better.  That old strategy was okay, but now that we don’t have the $100,000 limitation anymore, let’s make the $1,000,000 Roth IRA conversion before somebody dies, and that way, they themselves will be better off, and we can get to that, but their heirs will also not only get the benefit of the tax-free growth on the Roth IRA, but they will also get all the reduction in both the federal estate tax and PA or other state inheritance tax.  I assume that’s what you’re talking about.  Right, Barry?

Barry:  Yes, but, you know, and Jim, the old way, when the person would cash out the IRA, they were giving up the potential for stretching distributions after death.  So, it was sort of like a trade off that somebody had to decide which way was better.  Now, with the Roth conversion, it’s a win-win both ways.  You get the benefit of the estate tax savings, and you still have the benefit of stretching out IRA distribution, in this case, on a tax-free basis, so that the heirs could be getting multiples of what the account is worth at the time of death.

Jim:  Yeah, I think that’s a very good point, because there are minimum required distributions of inherited Roth IRAs, just like there’s a minimum required distribution of inherited traditional IRAs, but the difference is the minimum required distribution of the inherited Roth IRA is income tax free to the heir, and let’s say, you name a grandchild as the beneficiary, with a fifty-year life expectancy, you only have to take out about two percent of the balance, and the remainder continues to grow income tax free.

Barry:  In that case, most likely, you can get a situation of, let’s say, a fifty year payout that for forty of those years, most likely, the account will actually be growing.  It will only be in the last part of that payout period that you’ll actually see a decline in account balance.

Jim:  Alright, well, I think we have to break in a few minutes, but could you give us maybe one more example of something that you have found with running the numbers?

Barry:  Well, generally, among younger people, there’s no question.  People who are many years away from retirement, that these people are better off doing a Roth conversion, and again, so that the growth in the account is going to be tax-free, and when they get to be their retirement age, they’ll be able to take out tax-free money.

Nicole:  Okay, this looks like a good point here.  We’re going to take a quick break.  When we come back, we’re going to talk a little bit more about running the numbers. And then we’re going to look at a few specific examples in Barry’s book.  So please stay tuned.  You’re listening to the Lange Money Hour with Jim Lange and Barry Picker, where smart money talks.


Nicole:  We are talking smart money.  I’m Nicole DeMartino, and I’m here with James Lange, CPA/Attorney and best-selling author of “Retire Secure!,” and our friend and colleague Barry Picker.  Welcome back.

Jim:  Barry, earlier, you said that you ran the numbers, and you found making Roth IRA conversions for younger taxpayers very favorable.  What has been your experience with retirees, and people, you know, after they are done working, and they no longer have an income from their job or from their business?

Barry:  Well, in those cases, we’re finding that if people are actually living off the IRA money, if the retirees living off the IRA money currently, then in those cases many times, it doesn’t pay to do a conversion.  One of the ways to have an advantage from the conversion is that there has to be a certain timeframe.  That will really make up for prepaying the taxes.  But, for many people, we’re finding if they have very, very large retirement accounts, then figuring out how much of it they actually need and taking the excess and converting that, and making that the legacy for the children and, in many cases, the grandchildren, again works out better for the family overall.

Jim:  It’s interesting.  I sometimes come to the same conclusion, but I often just do it based on tax brackets, which I’m sure is also important in your analysis too.

Barry:  Well, tax brackets are definitely one of the factors that we have to take into account.  So, if you have somebody who’s in a lower bracket, then we can do a conversion to, quote, “fill that bracket.”  And, you know, unless they pay some tax, especially if they can pay it at 15% or less, then convert it into a Roth, then that’s a great thing, and especially because many retirees, if they want to leave it to their children, which they do, the children are in their earning years, and of course, the children are therefore in a much higher bracket.  So, you’re paying tax at the parent’s bracket to give money to the children, who then don’t have to pay tax on it.

Jim:  Yeah, that’s what we have found too.  When we run numbers, we often end up with the recommendation that people do a series of Roth IRA conversions over a period of years, often based on tax brackets.  And we sometimes find that it makes sense to even go one bracket more than your current bracket, so for example, sometimes we have 25% taxpayers go to the 28% bracket, and we find that in the long run, or even not such a long run, that that’s actually a favorable tax strategy for a lot of clients.  I don’t know if you’ve found similar things in your analysis.

Barry:  We found the same thing, especially when we’re talking about a difference of only 3%, because it doesn’t take much to be able to make up that difference.

4. Recharacterizing a Losing Roth IRA Conversion

Jim:  Okay.  I’ll tell you what I’d like to switch over to is a strategy that you’ve written about, that Bob Keebler’s written about, that I’ve written about, and you go way back, because you’ve were writing about this, or at least a variation of this strategy, way back in 1998, and that is the strategy of making a Roth IRA conversion, and then, at some point in the future, with a deadline of October 15th of the year following the year that you make the conversion, of recharacterizing that.  I’m wondering if you could tell me a little bit about what you are doing in terms of proactive strategies and separation of accounts in order to get the most for the IRA owners using the strategy of a series of Roth IRA conversions and some recharacterizations or, I prefer to use the word undo to describe the legal concept of recharacterization.

Barry:  Well, there’s two ways that we’re doing this.  One is asset segregation, basically where we’re doing a series of Roth conversions, and possibly all at the same time, but we’re segregating the traditional account by asset class, such as, let’s say, large cap, small cap, maybe fixed income, and we’re converting each of those into a brand new, separate Roth IRA.  So, an individual may do a series of conversions, and end up with five or six Roth IRAs at the same time.  And then, looking later, again we have up until October 15th of the year after, so for 2010 conversion, we have until October 15th, 2011 to look back and see, well, of these asset classes, did any of them have a bad year?  Did any of them lose money in the interim between the time that we did this conversion and the October 15th, or an earlier date?  And those we recharacterize, we basically undo those, because you’re paying tax on the value at the time of the conversion, and if the value goes down, then we want to undo that.  We had an example last week of an individual who did that, and he had a very, very large position in one stock.

Jim:  That is, he did that in 2009?

Barry:  No, he did this in 2010.

Jim:  Okay.

Barry:  He did 2010.  He had a number of very large positions in a traditional IRA, and he converted each one into a separate Roth.  And this particular stock, he had, I think, 350,000 shares of it, of which 100,000 he sold off, and the other 250,000, there was a news event on the stock and the stock lost about 60% of its value right away.  And he then sold the remaining shares and said that he was gonna go do a recharacterization, and I said to him that there was no rush to do it, because of the rules on reconversion that he could not reconvert this money again until the beginning of 2011.  And so, even though he’d lost a significant amount of money, he should wait until the latter part of the year just incase, by some miracle, he was able to reinvest in some great winner that more than made up for the loss.  So, there’s a matter of timing when you want to do your recharacterization.

Jim:  Well, I know I love that strategy of making multiple conversions, and then looking, at first I thought that you were advocating only looking, say, in October 2011, but now, as I understand it, you’re also advocating a strategy where people make a Roth IRA conversion, and then reevaluate it during 2010, let’s say in November.

Barry:  Actually, you’re correct, Jim.  November’s actually the time that we’re telling people to look, because the rule is that you can’t reconvert until the later of the following year, the year after the original conversion or the 31st day after the rechracterization.  So, by looking in November and recharacterizing in November, then right at the beginning of January 2011, you can grab that IRA account and convert it again into a Roth.

Jim:  Right, and the other possibility too, on the other hand, in that case, then that recharacterization or that conversion would be effective for tax year 2011.  Would it also be a reasonable strategy to, let’s say somebody had, again, we’ll go back to the million dollars because it’s a nice, easy number, and they had ten accounts, and they were all $100,000 each, and they all had negative correlations, that is, the investments tended to do the opposite of what the other ones did, would it be a reasonable idea then to, perhaps, convert seven of them, for example?  Then, so let’s say we convert seven in March or April of 2010, and we leave three out.  Then, we take a look in November of 2010, and let’s say that we have had some go down, would it be an interesting idea to recharacterize those in 2010, and then perhaps convert some of the ones that we didn’t convert, that is, you’re not allowed to convert, recharacterize and convert the same ones, but you are allowed to convert, recharacterize and then make a Roth IRA conversion of something that you had not converted?  So, have you ever seen or heard that strategy?

Barry:  Well, that’s the other strategy we advocate.  We look at it slightly different, but it’s the same theory.  Let’s say the person with the million dollar account decides based upon brackets and everything else, and how much money they have outside, whatever, that $250,000 is the good number to convert this year.  So, they segregate that $250,000 worth of assets and convert it.  They leave $750,000 in their traditional IRA.  And then, let’s say, we get to November and that first $250,000 has gone down in value.  So, we’re going to recharacterize that.  But, before we do the recharacterization, because it’s just easier and cleaner this way, before we do that recharacterization of this Roth IRA, we’re gonna take, let’s say, another $250,000 worth of what’s left in the traditional, and convert that into a second, brand new Roth IRA, we’re not gonna touch the first one right now, and we’re gonna create that second Roth IRA, and then, once we do that, then we’ll recharacterize the first one, because then there’s no question that we have not reconverted the same money.

Jim:  I like that.  I’ll tell you what I really like about the way we’re discussing this, is that really, most IRA owners could very well likely benefit from a Roth IRA conversion strategy, and it’s not just a one-prong strategy where you make a conversion of ‘X’ dollars and then you forget it.  It’s potentially a series of conversions and recharacterizations and conversions of different money, and that’s what I try to really impress upon people, that this isn’t a one-time shot that we really want to take almost a global view, and come up with a good, long-term Roth IRA conversion strategy.

Barry:  Well, the way I put it, Jim, is that the question for most people isn’t should I or shouldn’t I.  The question really is, is how much and when?  In other words, we go with the assumption, not the assumption, but basically, for most people, the answer is yes, there is some strategy of Roth conversion that works for you.  We just have to figure out which one that is.

Nicole:  Alright, and on that note, we’re actually gonna have to take a quick break.  We’re talking about Roth IRAs and conversions and recharacterization of those IRAs, and I’m here with Jim Lange and Barry Picker.  It is the Lange Money Hour, where smart money talks.


Nicole:  We are talking smart money today.  I have Jim Lange here with Barry Picker, and the last time that we left off, we were talking about recharacterizations.

5. Example of Surprises Found When Running the Numbers

Jim:  Okay, Barry, before, we were talking a little bit about running the numbers, and you told me over the break that you had an interesting surprise that you found when you ran the numbers, and I had one too, so I thought maybe we would switch into that and you could tell me some of the surprises that you found with running the numbers.

Barry:  Okay, Jim.  We’ve found situations where the individual had large IRA money, and they really didn’t have any money outside the IRA.  Many times, when people talk about the advantages and whether they should do a Roth conversion, you hear people say that don’t do a Roth conversion if you don’t have the money outside the IRA to pay the taxes, and we’ve come across cases where that just isn’t true.  The individual has a large IRA, they’re up in years, they’re in their sixties, maybe seventies, and the overall financial picture is that they should do a Roth conversion, even though it means they’re going to have to take money from their retirement plan in order to pay these income taxes, and it just works out, going through the numbers and going through the entire family situation, that even though you’re going to be using IRA money to pay the taxes, it is still advantageous, both for the individual and for the family.

Jim:  Well, by the way, that does kind of fly in the face of conventional wisdom, and the numbers that I have run said if you were in the exact same tax bracket forever, no matter what, if there was no such thing as a minimum required distribution, and you didn’t care at all about the next generation, that if you make a Roth IRA conversion, and you pay the taxes from the conversion from inside the IRA, that it’s a dead break even.  But, I guess if you’re saying hey, in the real world, tax rates do change, minimum required distributions do go up after time, and estate planning is an important factor, and when you ran those numbers, apparently, you found that, at least, some people should be making Roth IRA conversions even though they don’t have the money to pay the taxes from outside the IRA.  Is that right?

Barry:  That’s correct.

Jim:  Alright, well, that is interesting, because that’s very similar to a surprise that we found in running numbers for Roth IRA conversions.  We always assumed that doing these larger conversions was often going to make sense, but one of the things we found was, if you have a large IRA, and you make too much of a Roth IRA conversion, what will happen is, your minimum required distributions in future years will be much lower, and sometimes your tax bracket will be lower because of the lowered minimum required distributions because you made the Roth IRA conversion, and it was actually counterproductive to make too much of a Roth IRA conversion.  And that kind of surprised me.  But as long as we’re talking about number running and Roth IRA conversions, let me tell you something I wrestle with, and maybe you have an answer to it.  We all know that if tax rates go up that the Roth IRA conversion is going to be even more advantageous, but, typically, I’m a little too conservative to just assume that, except for the tax rates that we already know are going up.  Do you factor that into your analysis, Barry?

Barry:  Well, generally, like you, we just assume the tax rates that we know, and then we just anecdotally mention the fact that if tax rates go up, which we expect that’s going to happen, at least to the highest brackets, then it just is that much better, but we don’t necessarily quantify that.

Jim:  Okay.  And even though that you often do recommend multiple conversions, and then perhaps, a series of recharacterizations, you still like to run the numbers to have a game plan before you go into the whole thing.  Is that correct?

Barry:  Yes.  It’s sort of like a football game.  You need to know what you’re going to do in certain situations.  So, you have to have a game plan, and the game plan has to include what’s going to happen if these accounts go up, what’s going to happen if these accounts go down, are we going to do a series of conversions through the years, when is the time to recharacterize, under what circumstances will we recharacterize, you know, it’s a whole game plan.

Jim:  Well, I love the way you do that.  In your book, on page 19, you have a really nice timeline chart for recharacterizations, and then, you even have some of the strategies on page 21, and I think that that page alone is worth way more than the cost of the book.  Maybe you can talk a little bit about the way you are doing the conversion and recharacterization and what you call the Roth Segregation Strategy on page 21, and then actually, the way it works out on page 21 and page 22, and then your example 45 showing the effective tax rate I think is just so powerful.

Barry:  Well, the segregation strategy is what we spoke about before, that, in this example, the individual has a traditional IRA of $500,000, and he’s going to convert it, and we kept this one simple.  Basically, he created two separate Roth IRAs with two separate stocks, and that’s another way to do a segregation strategy, is based upon securities, because the rules say that you can’t cherry pick if you have two stocks in one IRA and one goes down and one goes up, you can’t just take the one that went down and recharacterize and get rid of the income for that one.  So, in this example, we did two separate stocks of $250,000 each, and one goes up in value and one goes down in value, and we just take the one that goes down in value and we recharacterize that and eliminate that amount of taxable income.  And then, just hold it, and hopefully, we’ll do a conversion in the following year.

Jim:  And I just love that, and then you kind of continue on with that on the next two pages, and come up with an effective tax rate where you, by doing a series of conversions and recharacterizations, you actually end up paying less tax, or looked at another way, you’re getting a bigger Roth IRA conversion for your buck.

Barry:  Well, that’s the whole point here.  Again, because the gross, after conversion, is tax free, and of course, any decline after the conversion, and you’re losing money, so you want to get rid of that account that has a decline after the conversion, and then reconvert it at the lower value.  The history of the market is that there are ups and downs, but the long-term trend is up.  So, we love to do whatever strategy we can to try to hit the low point of value to get the conversion, because then, as you put it, you get more bang for your buck.

Jim:  Well, I’ll tell you the biggest bang for your buck that I can think of, with perhaps the exception of buying my book, is looking at page 24 in your book, I cannot imagine anybody not getting at least ten times, or even a hundred times the value of the cost of the book, and I might ask Nicole to just put in one more time how they can get this book before we go into that.  How can somebody who is interested in getting the “Hundred Roth IRA Examples and Flow Charts,” what can they do, Nicole?

Nicole:  If people are interested in getting the book, you can either make a call to 1-800-809-0015, or you can order the book on Barry’s website.

Jim:  And what is Barry’s website?  Barry, maybe you can help us with that.

Barry:  It’s www.pwacpa.com.

6. Separating Your Roth IRA Conversion Into Different Accounts

Jim:  Okay.  You know, I almost hesitate to give people this information on page 24.  When I first saw page 24, which is basically a recharacterization comprehensive example, it just blew me away.  I thought it was literally brilliant, and believe it or not, Barry, I, at first, you know, John Bledsoe and I had talked about some of these strategies earlier on, and I really wasn’t quite on board with it, but then, when I saw you and Bob Keebler and the logic that you presented on page 24, example 48, recharacterization comprehensive examples, I really am changing, at least with some clients, the way we are doing these conversions, and I actually think that this is just a great thing.  And the other thing is, I’ve wrestled with my money manager, who isn’t necessarily thrilled with doing it this way because it’s more work for him, and luckily, they have agreed to do it, at least with the larger accounts, but I actually thought that your example on page 24, the recharacterizations where you have different dates and different actions, and I thought, perhaps, maybe you could even just go through one example, and I know that our listeners don’t have the advantage of having the book in front of them, although, frankly, I hope they will soon, but if you could perhaps take one example and go through what you have recommended.

Barry:  Well, basically, here we have a $500,000 account that we’ve converted into five different Roth IRAs each worth $100,000 at the time of conversion.  We then look at these five accounts first at November 30th, and again, we pick that date because the earliest that we could reconvert, if we wanted to, would be on January 1, 2011, but you also have to wait at least to the 31st day, so that’s why we pick the end of November.  On that date, we see that two of the accounts have gone up in value, one is even and two have gone down, so we, on that date, recharacterize the two accounts that have gone down, and then we reconvert those two accounts right at the beginning of 2011.  Then, we look again at on April 15, 2011, and we see that that third account that had been even and we’d held it, has now gone down.  So, in April of 2011, we recharacterize that one, wait 31 days, and then convert it again.  In the meantime, the first two accounts have gone up in value, so we hold those through, and never recharacterize those.  Those are the ones that we pay tax on $200,000, $100,000 on each of the accounts, but they’ve gone up in value, and we manage to pick up, in this example, by the beginning of 2012, $30,000 of tax-free income on each one.

Jim:  And that’s really just an incredible result that shows how much better people can do if they are on top of this and using the appropriate strategies.

Nicole:  I’m sorry, I have to butt in one last time.  We’re gonna take a quick break.  When we come back, we’ll probably finish looking at the book, and then I know that you wanted to touch on the one person 401(k)…

Jim:  And the after tax dollars inside an IRA and a non-deductible IRA.

Nicole:  Okay, we’ll touch on that when we come back.  This is the Lange Money Hour, where smart money talks.


Nicole:  We’re talking smart money this evening, and we’re here with the Lange Money Hour.  I’m here with Jim Lange and Barry Picker.  We’re looking at some specific examples out of Barry’s new book, “One Hundred Roth IRA Examples and Flow Charts.”  It is such a tremendous tool, a great resource to have in your personal library, and if you want to order the book, 1-800-809-0015, or you can hop on Barry’s website, www.pwacpa.com.

7. Non-Deductible IRAs

Jim:  Barry, one of the things that I know that you’ve been doing, is something that I have been a big fan of for many years, and that is to proactively take advantage of non-deductible IRAs.  So, if somebody is still working and they make too much money to make a Roth IRA contribution to contribute money to a non-deductible IRAs, but perhaps even more interesting for people who already have non-deductible IRAs, or they have after-tax dollars inside their retirement plan, which is conceptually the same, that is they didn’t get a deduction for the money, the money’s grown tax deferred, and someday, when they, or perhaps even their heirs, make withdrawals, part of it will be taxable and part of it will not be.  But, you had alluded earlier to, in effect, buying out our partner Uncle Sam, and I know that you have some strategies regarding after-tax dollars inside an IRA, and after-tax dollars, which is the same as a non-deductible IRA, and after-tax dollars inside a retirement plan.  So, I thought I’d ask you what you do with those monies, and then maybe I’ll compare that with what I’m doing, and maybe shed some light on the subject for our listeners.

Barry:  Okay, well, what we try to do is take advantage of a provision in the law having to do with how you can transfer after-tax money.  So, if you have after-tax money in a retirement plan, you can move that along with the taxable money into an IRA.  And if you do that, whatever is after-tax money in the retirement plan becomes after-tax money in the IRA.  But, what’s interesting is that provisions in the law that says you can move money from an IRA into a retirement plan says that you cannot move the after-tax money that’s in an IRA into another retirement plan other than an IRA, which you can, but let’s talk about a company plan.  So, if you have money in an IRA that includes after-tax money, then what we like to do is move the before-tax money from that IRA into a company retirement plan, and then we have an IRA that only has after-tax money, and then we convert that IRA, because we convert it tax-free, because there’s no taxable income in that IRA.  And when we do that, we’ve now seeded a Roth IRA for free, and there’s no tax on the money going into the Roth, and hopefully, there will never be any money coming out of that Roth.  I think it’s a great plan.

Jim:  The numbers that we have run on that indicate that if you were to make a $50,000 Roth IRA conversion of after-tax dollars or non-deductible IRAs, which we don’t find is all that atypical in, let’s say, a million dollar account, that in 40 years, you, or if you’re not alive at that point, your heirs, will be $500,000 better off, so that strategy can give somebody $500,000 worth of value in the future, and the great thing about it, it doesn’t cost any tax dollars up front.  Now, what we often end up doing to, now, we still have the aggregation rules and the proration rules to worry about, we usually get around those using a one person 401(k) plan, and I was wondering if you do the same thing.

Barry:  We do the same thing.  The idea is that in order to move the money out of the IRA, you have to have a plan that will accept the money.  If you’re working for a company that whose plan will not accept the money, but you have some self-employment income, then you set up, as you mentioned, a one person 401(k).  The thing that we tell people to be careful about is that this has to be a 401(k)-type plan, which does cost a little bit more money to set up than, let’s say, a SEP IRA, but a SEP IRA will not work for this, because a SEP IRA is still an IRA plan, and the idea is that you have to get the money out of the IRA and into something else, and that’s what your one person 401(k) is.

Jim:  Right, but to put it in perspective, you know, we’re really just talking, even including the administration fee, we’re still talking about a hundred or a couple hundred dollars a year, not thousands and thousands, and the benefits can be measured in thousands and thousands.  Is that fair?

Barry:  Oh, the fee is not even in the discussion.

Jim:  Right, right, okay.

Barry:  It’s so not important to what we’re doing.

Jim:  Right, now sometimes, I have a lot of retirees as clients that have substantial amounts of after-tax dollars inside their IRA, and what we have tried to do, and sometimes the problem that we have for setting up the new one person 401(k) plan, is they don’t have earned income.  So, then we go out and literally look for ways for them to find earned income.  If they already have it, that’s even better.  But, for example, doing a little consulting with a company they used to work with, or if there’s a family business, to have the family business give them some legitimate income that they can report as self-employed income, or maybe work at the golf course, or, you know, I have a lot of college professors, and some of them will write a paper, or they will give a talk or something like that, but we have found that that strategy is just so wonderful in terms of making a Roth IRA conversion for free.

Barry:  We’ve not had too much trouble getting people to have some amount of earned income to get that plan off the ground.

Jim:  And the other advantage of that is, there’s two other advantages that aren’t even necessarily well known, if you have, for example, as your major holder of your retirement plan be this 401(k) rather than a traditional IRA, there’s two advantages that we’ve found.  Number one is that if you die and you leave it to a non-spouse, let’s say, your children or your grandchildren, they could actually make a Roth IRA conversion of an inherited 401(k) plan.  So, if you just left them an IRA, they would not be allowed to make a Roth IRA conversion of an inherited IRA, but they are allowed to make a Roth IRA conversion of an inherited 401(k).

Barry:  That’s correct.  It’s such a strange quirk in the law, but that’s what the law is right now.  It’s very strange.

Jim:  It is strange, but that really, in my book, I actually say that that might be the, in effect, replacement for the IRA to some extent, is the one person 401(k).  The other argument that I’ve heard, and I’ve heard this go both ways, is that some people feel that that one person 401(k), which is an ERISA plan, provides better creditor protection than a traditional IRA.  I don’t know if you have heard that also.

Barry:  I’ve heard it.  We’re lucky here in New York that our IRAs are very well protected, so it’s not that much of an issue here, but again, you have to keep in mind that when people retire, sometimes they move to other states.  With an IRA, you’re subject to the creditor protection rules of that new state that you move to, which may not be as good as some other states, whereas your 401(k), as you mention, has ERISA protection, which is federal, and that will follow you wherever you go.

Jim:  Right, and I find that to be an advantage.  By the way, one other quick note on people moving from where they are now to a different state.  To me, we actually factor that in for Roth IRA conversions.  So, for example, in Pennsylvania, you don’t get an income tax deduction or a break either from making an IRA or making a contribution to your retirement plan.  But then when you take the money out, you ultimately don’t have to pay taxes on the distribution, or even the growth, or the IRA or 401(k).  So, Pennsylvania is probably not necessarily a great place to work because you don’t get the tax deduction, but it’s a good state to retire because you do get the tax deduction.

Barry:  And here in New York, which is different, and the retirement income is taxed with some exclusion.  We actually have people where we hold off doing their Roth IRA conversions because they plan on moving to Florida, which does not have an income tax, and with the New York tax rates, we say that you’re better off waiting and doing the conversion later when you’re no longer in New York.

Jim:  Yeah, that is another not-well-known fact that people have to take into consideration.  If they were staying in the same state, and also, Pennsylvania, for example, you don’t have to pay the taxes on a Roth IRA conversion either, so maybe what people should do is make the Roth IRA conversion now in Pennsylvania, and then move to New York.

Barry:  Or I might come visit you someday.

Jim:  Okay, very good.

Nicole:  Alright, I think we are at the end of our hour already.  Barry, thank you so much for joining us.

Barry:  It’s been a pleasure.

Nicole:  Great having you.  Again, if you want Barry’s book, jump on his website, www.pwacpa.com.  Again, we thank you for joining us.  We’ll be back in a couple of weeks, and this is the Lange Money Hour, where smart money talks.

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.