Episode 39 – Roth IRA Conversion Strategies from the Horse’s Mouth with guest Elaine Floyd, CFP

Episode: 39
Originally Aired: October 20, 2010
Topic: Roth IRA Conversion Strategies from the Horse’s Mouth with guest Elaine Floyd, 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Please note: *This podcast episode aired in the past and some of the information contained within may be out of date and no longer accurate.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. 

Roth IRA Conversion Strategies from the Horse’s Mouth
James Lange, CPA/Attorney
Guest: Elaine Floyd, CFP, Director of Retirement and Life Planning, Horsesmouth, LLC
Episode 39

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  1. Introduction of Special Guest, Elaine Floyd, CFP
  2. Two Perspectives on Roth IRA Conversions
  3. Key Dates for Roth IRA Conversions
  4. Recharacterizing Roth IRA Conversions
  5. Social Security Strategies and Roth IRA Conversions
  6. The Roth Mastery Study Group  

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Nicole: Hello, and welcome to The Lange Money Hour, Where Smart Money Talks.  I’m your host, Nicole DeMartino, and, of course, I am here with James Lange, CPA/Attorney and best-selling author of Retire Secure!  And first things are first tonight: I want to tell you that Jim’s new book, I’ve been talking about it for several weeks now, is available. The Roth Revolution: Pay Taxes Once and Never Again is now available for order on www.amazon.com, so if you jump on Amazon, you type in “The Roth Revolution” and it’ll pop right up.  It’s the first thing that comes up.  $19.95 and it’ll ship to you in just a few days, and if you do purchase the book, what I will do, if you e-mail me your receipt, I’m going to forward right back to you immediately something that we’re calling the lost chapters.  Jim actually even wrote more of this book, and it’s not actually in the published version, but if you do buy it, I’m Nicole.  I’m the marketing director, Nicole@paytaxeslater.com, send me your receipt and I’ll send you those lost chapters right out.  Well, tonight, we have an excellent show planned and it’s live, so remember, tonight’s a great night to call in because, of course, we have Jim here, but we’re also fortunate to have Elaine Floyd here on the show here tonight.  Elaine, are you there?

Elaine: I am.

1. Introduction of Special Guest, Elaine Floyd, CFP

Nicole: Okay, well, great.  Welcome.  Elaine is currently the Director of Retirement and Life Planning for Horsesmouth, LLC.  Now, for those of you who might not know about Horsesmouth, and I’m sure advisors listening probably do, but Horsesmouth is a New York-based training and professional development company specifically for financial advisors.  Elaine is a thirty-year veteran of the financial services industry.  She’s earned her CFP designations, Certified Financial Planner.  She’s written four books and hundreds of articles on retirement, taxes and financial planning.  In addition, I know, Elaine, we want to give you some time to talk a little bit more about this yourself, but she’s created something called the Roth Mastery Study Group for financial advisors, CPAs and attorneys.  So, we certainly have a busy lady here, and we’re thrilled to have you, so thanks for joining us.

Elaine: Thank you.  I’m happy to be here.

Nicole: Great!  Now, I already mentioned that the show is live tonight.  I want to give you that number: 412-333-9385.  You can call in and talk with Jim and Elaine.

Jim: And before we get started with the substance, and Elaine, I don’t even know if you remember this, but I actually met Elaine about three years ago, or four years ago, in New York City.  There was a conference, and the idea was to determine the ideal distribution pattern for retirees, and it was a conference of mainly academics, and then there were a couple of people in practice, of which I was one, and Elaine was there also, and I think it was actually breakfast that I just happened to be sitting next to Elaine and we started chatting, and I thought, “Wow!  She really gets it!  She’s really smart!”  I don’t know if you remember that discussion, Elaine.  We were talking about immediate deferred annuities, and I thought, “Man, she’s really smart.”  So then, later on when I heard about this Roth mastery group, I thought, “Well, if Elaine’s doing it, it has to be good,” and it certainly is.  So, we’re really pleased to have you on the show.  Thank you so much, Elaine.

Elaine: Well, thank you.  I’m really happy to be here, and I have long had admiration for your work.  I’ve read your books, and I have followed your work for many years, so this is a mutual admiration society here, I think.

Jim: Well, good, thank you.  And one of the interesting things about Roth IRA conversions and some of the related material, and I think that there are a number of people who, in my opinion, think about these topics correctly, and in the way that, frankly, I do, and one of those guys is Bob Keebler, and I think his materials are excellent, and before, you know, just recently, I didn’t know that Elaine was this strong in Roth IRA conversion information, but the information from Horsesmouth Roth IRA Mastery is just excellent, so I just wanted to congratulate you on that.

Elaine:  Well, thank you, and I just want to say that I give a lot of credit to those industry professionals like Bob Keebler that you mentioned, and Ed Slott and Natalie Choate, and I give them acknowledgement in my course because everything that I teach in the course came from somewhere, and all of these industry experts really took the time to break down the Internal Revenue Code, because the information on Roth IRAs is not readily available.  If you turn to IRS publication 590 on Individual Retirement Accounts, you’re not going to  get the nitty-gritty details about Roth IRAs and Roth conversions, so I really give a lot of credit to all of the industry professionals who have put a lot of effort into really breaking down the code and making it understandable to all of us.

2. Two Perspectives on Roth IRA Conversions

Jim: And you’ve mentioned a bunch of really strong IRA experts, all, by the way, have been on my radio show.  One of the things that I like to do is to, rather than speak in code, is to talk about some of the strategies that our listeners can use to take advantage of the Roth IRA conversions, and it’s hard to start because there are so many issues, but one of the issues that I’m often asked about is in terms of “Well, gee Jim, I really don’t want to make a Roth IRA conversion because I’m going to have to pay so much taxes.  You know, I have $200,000, or sometimes even more than $1,000,000 in my IRA, and if I convert that entire amount, that’s going to be a huge tax bill.”  And then, I want to talk about making a partial Roth IRA conversion and the impact of tax brackets.  In fact, I think you actually wrote an article specifically on that, Elaine.  So, I was going to ask you what some of your advice, in terms of making a partial Roth IRA conversion, might be to some of our listeners?

Elaine: Well, yeah, we can jump in right there, or if I could back up just a little bit.  A lot of people, when they first face this Roth conversion question, it is so complex, and there are so many moving parts, that they just say, “I’m not going to do it.”  And they look at the amount of taxes, as you mentioned, that they’re going to owe on the conversion, and they just fall on the floor, and they just say, “How could this possibly be worth it?”  But, people need to remember that not paying taxes on their IRA is not an option.  They’re going to pay taxes.  The question is, is it going to be now or is it going to be later?  And that’s really the question that we’re trying to answer with the Roth conversion analysis.  So, we approach it from two perspectives, and we call it the conundrum.  The first approach is that you enter all of the variables into a calculator, and you let the calculator tell you if a conversion makes sense or not.  Now, the problem with that is that you have to use a lot of assumptions that you’re not sure if they’re going to work out.  I mean, you have to make assumptions for your life expectancy, for your tax bracket, for your rate of return, and many of these assumptions are literally unknowable.  You just can’t know them, and now, you can run the calculator many, many times and change your variables each time, and you can get a better sense of which variables are more important than others, but you can’t know for sure.  So, the second approach we talk about is just do it.  Just assume that doing either a full or a partial Roth IRA conversion is a good thing, and we can’t exactly quantify it right now, because we don’t know what your future tax rate is going to be.  We don’t know what some of these future things are going to be, but we’re going to just trust that you’re going to be glad that you did it.  So, we kind of start with those two approaches.  So, taking the second approach, just do it, that’s where you get into the strategies that you mentioned.  So, assuming that everybody is going to do some sort of Roth conversion, then the question is, how do you go about doing it?  And one strategy is to do a series of conversions, to do a tax analysis and figure out where your taxable income is going to be and where it lies on the tax bracket table, and convert just enough to bring your income up to the top of your current bracket.  And then next year, do it again.  So, that’s one strategy.  Do you have a comment on that, Jim?  Have you looked at that?

Jim: Well, we do, whether you call it running the numbers or financial calculations or whatever you want to call it, we actually do make those projections.  I actually have a problem with many of the calculators on the web because they tend to measure in total dollars instead of purchasing power, and I think because of that, even if all those assumptions came true, I’m not sure that you would get the optimal answer.

Elaine: True.  I agree with you totally, and another problem with many of the calculators out there is that they measure the results as of a specific date and time, and that bad date is often seventy-and-a-half when minimum required distributions have to come out of a traditional IRA.  They throw all the numbers in.  They say, “Okay, what’s the IRA going to be worth at seventy-and-a-half versus the Roth IRA if you convert?” and that tells you your answer.  Well, that misses a huge part of the Roth story, because Roth IRAs do not have RMD requirements at age seventy-and-a-half, as many of your listeners probably know.  But, what they may not realize is the impact of that.  When you can leave those assets inside a Roth IRA to grow tax-free, as opposed to taking them out of a traditional IRA, and even if you don’t need the income, even if you would be reinvesting your RMDs from the traditional IRA, it would be reinvested in a taxable account.  So, that would be, every year, reducing your return just a little bit in comparison to the Roth.  So, I just wanted to make that point about yes, I agree with you that calculators, I don’t think any of them are really perfect, but when you are looking for calculators, I would just say that you look at the purchasing power, as you suggested, and also look at the results throughout the entire distribution period, and if the IRA holder doesn’t plan to take distributions until, say, 80 or 85, maybe they’re going to draw from taxable accounts and tax-deferred accounts first and leave the Roth accounts for last, then that Roth grows more valuable day by day throughout the years, and if somebody is using it as an estate planning tool, if they have plenty of assets and don’t ever plan on taking distributions from the Roth, then a Roth conversion is practically a no-brainer.

Jim: Well, I think I agree with you, and I think that calculators, while they might have some value, frankly, they scare me because sometimes, when you put some variables in and you get an answer, if you don’t know any better, you think, “Oh, that’s the answer,” and then you don’t take anything further.  We call it running numbers, and we have a number of software programs that we use that help us, but I actually find, in practice, that it’s a much more manual procedure than you might expect.  So, instead of entering a bunch of variables and hitting optimize, it’s a little bit more like interpolating, like “Well, let’s try this amount for these years,” and it’s a little bit of an art and a science, and we have several Roth IRA conversion software programs that we like, but the other software that we use is actually plain old 1040 software.  So, in our case, it’s a Prosystem FX, and for some of the listeners at home, it might be Tax Cut or Turbo Cut or Turbo Tax or something like that, but we actually test different levels of Roth IRA conversions, and then see what the actual tax is, because you had mentioned, Elaine, that you like to sometimes go to the top of the income tax bracket, and I agree with that.  I think that that’s a really smart idea.

On the other hand, sometimes you get surprises, and I’ll give you an example.  Let’s say that you are a senior and you’re receiving Social Security and you’re in the 15% bracket, and your plan is to make a Roth IRA conversion that will take you to the top of the 15% bracket.  Well, one of the things that you have to be careful of is that the additional income on a Roth IRA conversion will increase your taxability for Social Security, and also for Medicare Part B.  Another thing it might do, it might increase the taxability of your dividends or your capital gains.  To my knowledge, there’s no formula that covers all that extensively, and the best way to do it is actually get out 1040 software, test different amounts of conversions and then see what tends to be the optimal amount.

Elaine: That’s a great idea.  I’d just like to make the point on the Social Security and the Medicare Part B premium, is that, like you say, the conversion income can make a worst case scenario in those two things.  You can be taxed on up to 85% of your Social Security benefits or you can pay many hundreds of dollars in Part B premiums because you would be in such a high income range.  However, it would just be for the year of the conversion, of course.  Does your software also calculate if we take this hit up front, it’s going to actually reduce those things later on.

Jim: Well, sure, and that’s why, to me, I don’t know a better way of getting the optimal number.  Now, I’d like to think that I could just look at a situation, and off the top of my head say, “Oh yes, you should convert X amount,” but frankly, I’m not that good.  I don’t know anybody that really is, and the other thing is, we’re talking on the lower end of the taxable income stream, it can go at a similar manner as the upper end.  So, for example, if you add income on a Roth IRA conversion, you might end up reducing your exemption amounts.  You might end up reducing some of your itemized deductions.  So, I would say you have a lot of great rules of thumb in your quick reference guide, and we’ll maybe get to that, but I would say for somebody who’s really actually going to be writing a check to the IRS for Roth IRA conversions, that you really want to have somebody who knows what they’re doing to make these calculations or, if you’re very brave, to get the appropriate materials, certainly at the risk of sounding self-serving, I think that my book might be an excellent start.

Elaine: Shameless self-promotion there?

Jim: There you go.  See, I’ve been living with my new book for months and months, and it’s actually just now on Amazon, so I’m actually pretty excited about it.

Elaine: That’s great.

Jim: But, I do like the idea of actually somebody who is looking at some of these things and getting the true impact, and I think that sometimes it’s not immediately obvious and it’s not clear to me that the calculators have that.

Elaine: Yeah, I agree.  I would definitely agree with that, because you’re looking at many, many variables.  The tax variables that you just talked about, the exemption phase outs which are going to be coming back and all of the different deductions and how they’re impacted by the extra income the year the conversion is reported, and then contrast that against how these things are going to be more favorable down the road when you don’t have to take taxable minimum required distributions when you’re taking tax-free income out of your Roth IRA, and how much more favorable it’s going to be at that time.  Of course you know, those things we can’t predict with any certainty, but everything sort of has to be lumped in to the question and analysis.

Jim: Well actually, you’re right.  The uncertainty is a huge part of it, and there’s so much uncertainty, we don’t even know what the tax rates are going to be next year.  We don’t know if there’s going to be a tax increase or not.  What I would say with that is that while we don’t know what’s going to happen next year, or even two years from now, I think it’s relatively clear over the next 5,10, 20 or 30 years, the taxes in general will go up, meaning that Roth IRA conversions, while taxes are still low, are even more favorable.  And we know we have the healthcare surtax coming in 2013 for upper-income tax payers.  One of the issues with uncertainty, and I’m curious as to what your advice on this is, is if you make a Roth IRA conversion in the year 2010, so you make the Roth IRA conversion in calendar year 2010.  And this is the only year, unless they make a change in the code, where you actually have a choice.  You could recognize that income in calendar year 2010, and presumably file it with your taxes in April 2011, or you can say, “I’m going to recognize half of the income, not half the tax, by the way, but half the income in 2011 and half in 2012.  When we thought that the tax rates were almost certainly going to go up or next year, we were saying, “Hey, you might be better off paying the taxes in 2010,” because if you defer it to 11 and 12 when rates go up, you’re going to end up paying more taxes.  Now, it looks like, particularly for middle income taxpayers, that taxes may not go up, and I was curious what advice you were giving some of your readers and some of your financial advisors on that issue.

Elaine: My advice is to wait, because you don’t really have to make a decision.  I mean, you really have until October of next year to make your final decision but really, by April 15th of 2011, is when, you know, if you’re going to report the conversion for 2010, you have to decide by April 15th, 2011 and I think by then, don’t you think Congress will have done something?  Don’t you think we’ll know what tax rates will be by then?  Also, it’s not just the tax rates, it’s also people’s individual tax situation.  So that is a huge part of it too, so if people have steady income year to year to year, then it depends more on what the tax rates are going to be, but if their income varies, for example, if somebody is in the process of doing some maneuvers to really reduce their 2011 income, then those people would be wise to report it in 2011 and 2012.

Jim: Well, I think that’s great advice, and just to clarify what Elaine was saying, she didn’t mean wait until 2011 and 2012 to recognize the income.  She meant wait until later 2011 in order to make the decision.

Elaine: Yes, thank you for clarifying that.

Jim: The other thing, the strategy that we can talk about that plays into this, and it just so happens that that has an ulterior motive for somebody with a tax preparation firm like myself, is that we might not have all the decisions that we want to make by April 5th, 2011 so, for example, we’ll hopefully get into the issue of Roth IRA conversions and recharacterizations, and sometimes, having the additional time, instead of April 15th being our normal deadline, that if we file an extension with our returns, then October 15th becomes, in effect, our deadline, and if I interpret what you’re saying right is, if people get extensions on their 1040s until October 15th, 2011, they can actually decide as late as, well, cut your tax preparer a break.  Don’t say October 14th.  But let’s say late September, 2011, they can decide then a couple of things.  One, whether they want to recognize the conversion in 2010 or half in 2011 and 2012, and they can also decide if they want to recharacterize their Roth IRA conversion that they made in 2010, or recharacterize one of multiple IRA conversions.

Elaine: Yeah.  The thing also to keep in mind, though, is if you do end up recognizing the income in 2010, the taxes are due on April 15th, so I mean, yes, you can file an extension, but if you think you’re going to end up recognizing it on your 2010 return, be aware that you should pay by April 15th or face those penalties and interest.

Jim: Well, I think, Elaine, you’re absolutely right, and the extension to file is not an extension to pay, so what we recommend is take your best guess, and make an estimated payment along with your extension, so that if your best guess is true, then your taxes are paid in.

Elaine: Exactly, and you get the money back, you know, when you file in late September, or whenever your tax preparer is able to get it done, then if you end up not reporting it for 2010, then, of course, you would get that tax money back.

Jim: Right, and that additional flexibility, I think, is really important, and I’m a big believer in if you can, put off the decision until more information is known, and we’ll have a lot more information, for example, we’ll know a lot more about your individual tax circumstances, we’ll know more about tax rates.  The other thing that we’ll know is we will know the performance of  the investment that you chose to make a Roth IRA between the time that you made it and, instead of just April 15th, actually up until, well, again, I’m not going to use the deadline which is actually October 17th, I’m going to say late September.

Elaine: Labor Day.

Jim: Yeah, that’s probably better.  And I will admit that there is a slight ulterior motive here that I don’t mind spreading out the tax season to help some of our hard working CPAs who put in many nights and many weekends during tax season.

Elaine: Sure.  Let me just reiterate one very important point, which may be obvious, but I just want to make sure it’s clear, and that is, even though we’re deferring a lot of these decisions until next year, you must do the Roth conversion by December 31st of this year in order to have those options available to you.  If you miss it, if you wait until January or later to do the conversion, then you, number one, miss out on what we think will turn out to be very low tax rates for this year, and number two, you miss out on that opportunity to defer the reporting of the two years.  So, I just want to stress that point that this is the year.  This is the time right now between now and December 31st, although give your financial advisor a break and try to do this by December 1st and get those Roth conversions done, and just keeping in mind too, you can recharacterize next year.  So, I know that a lot of CPAs and a lot of proponents of Roth conversions are out there saying “Don’t ask questions, just do it, because you can always undo it.”  I don’t know if I’d go that far myself.  I mean, there are certain situations where I’ve seen that Roth conversions are not always the right thing to do, and when that’s the case, then you don’t want to do it and you don’t want to put the client through that, but in very, very many cases, Roth conversions are the right thing, and I think clients are going to come back and thank their financial advisors for recommending them, and the people who do them and the people who are listening here who do them are going to end up being very happy that they made that decision.

Nicole: Elaine, I’m going to pop in for a second.  We need to take a quick break, and I think in the last couple of minutes, we’ve thrown a lot of dates out there, so maybe when we come back, we’ll cover those four key dates, December 31st and then we’ll talk about the ones in 2011.  I’m here with Jim Lange and Elaine Floyd of Horsesmouth, LLC, Director of Retirement and Life Planning, and we’ll be right back.  You’re listening to The Lange Money Hour, Where Smart Money Talks.


Nicole: Well, welcome back to The Lange Money Hour.  I’m here with James Lange, CPA/Attorney and best-selling author of Retire Secure! and just came out with his new book The Roth Revolution: Pay Taxes Once and Never Again, and you can get on www.amazon.com and get that book for yourself.  It’s been acclaimed by many, many people, and I think you’ll really enjoy it.  Again, this show is live, and if you want to ask Jim and Elaine a question, feel free to give us a call.  That number is 412-333-9385.

3. Key Dates for Roth IRA Conversions

Now, before we went to the break, I heard the two of you, you were saying so many dates, and I think these dates are so important, and Elaine, I’m actually looking at the Roth IRA Quick Reference Guide that I received from Horsesmouth, and there are four key dates at the top of this sheet, And the first one is December 31st, 2010 and you just were talking about that.  Could you just review one more time what’s significant about the last day of this year?

Elaine: In order to report the conversion on your 2010 tax return and pay taxes on the conversion income at 2010 tax rates, the conversion has to be accomplished by December 31st of 2010.  The alternative reporting option, rather than report it on your 2010 tax return, you have the option of spreading it over two years and reporting it on 2011 and 2012, and that is only applicable on conversions accomplished in 2010.  Not to confuse people, but I should mention that if there is a gap in time from the time that you take the money out of a traditional IRA and the time that you put it in the Roth IRA, because essentially a Roth conversion is a rollover, and you can do it by taking receipt of the assets, and then putting it back into the Roth account within sixty days.  The effective date is the date that the money comes out of the traditional IRA.  So, if you take money out on December 15th and you don’t get it back into the Roth by January 15th, it still would qualify as a 2010 conversion.

Nicole: Okay.

Elaine: But yeah, the main thing is, just get it done before December 31st.

Nicole: Get it done, right?

Jim: And I hate to say this, but what you said just scares the be-jeevers out of me, because I picture oh, I can take the money out.  Then I can play with it and do whatever I want, and then I can restore it sixty days later.  In fact, I’ve actually seen cash-type people borrow money on their IRAs with the intent of restoring it in sixty days, and for some reason or another, sometimes that restoration doesn’t always happen, and then they end up with taxes and a 10% penalty and a real mess.  So, I would normally prefer, rather than taking physical possession, is basically doing a direct transfer that would typically be characterized as a trustee-to-trustee transfer.  The other thing that I’ll mention is you do not have to have a separate investment.  So some people say, “Oh, okay, well I’ll convert to a Roth IRA, but what investment should I have?”  Maybe there are some very slight, subtle differences between the investment strategies of a Roth IRA versus a traditional IRA, but I think in general it’s normally if you’re happy with your portfolio, you can keep the same stocks and bonds or whatever is in your portfolio and just convert that to a Roth.

Elaine: Sure.  And the easiest way, really, to do the conversion, is to stay with the same custodian and just have the account retitled and keep everything the same.  It’s just that the account title is different.  So yeah, I’m glad you mentioned that, Jim, because that is kind of scary when people take the money intending to put it back.

Jim: Yeah, and I’ll tell you one situation where somebody took it out and they put it in a losing investment, and the amount of the investment was much smaller, and it was such a huge loss because they had taxes, they had penalties, and they didn’t have the money, in effect, to pay the taxes and the penalties because they lost so much money with the investment going down.  So, there are a lot of strategies out there that can work out pretty badly if you’re not careful with them.

Elaine: Right.

Jim: Well, why don’t we finish the dates, because I know Nicole wanted to go through each one of those dates, and then I have a few other strategies that I want to go through.  So, the next date on your Quick Reference Guide, and by the way, what I’m talking about, and this note is more for financial advisors than our consumer listeners, is with the Roth master, you get all types of things.  They have some really good information.  They have some sample workshops and they have a number of articles.  I just saw this today, Elaine.  I was embarrassed that I didn’t know this.  A number of articles by you that can be distributed to their list as part of the bonus, but the other thing that they get is this Quick Reference Guide, which I really like, and the second date on the key date of the Roth IRA Quick Reference Guide is April 15, 2011, and the way, what is written on the card is last day to contribute to a Roth IRA, assuming you’re eligible, but I would say why don’t we concentrate on the second point, and I’ll let you do that, and I’ll just tell you what it is if you don’t have that in front of you, which is the last day to file an extension for filing the 2010 tax return.

Elaine: Which you have to do if you want to recharacterize.

Jim: Yeah.

Elaine: We’ve been talking about the option to recharacterize, which is basically, you know, the “oops” option where it allows you to undo it, to make it as if the conversion never happened, and you have until the third date on our list, which is October 17th, to do that.  However, the importance of that April 15th date is that in order to have the right to do that recharacterization, you have to do one of two things.  You either have to file your tax return by April 15th of 2011, or you have to file an extension by that date.  If you just don’t do anything, assuming that you get the automatic extension until October 15th to file, you have lost the right to recharacterize.  So that is just really critically important that people have to do one of those two things by April 15th in order to have that right to recharacterize.

Jim: Alright, and I’d like to cover one more date, and then I actually want to talk a little bit more about recharacterizing because I think it’s a really valuable strategy or technique that a lot of people aren’t taking advantage of.  But, the other key date is January 2nd, 2012, and the Quick Reference Guide says the first day to reconvert if 2010 conversion was recharacterized in 2011, and maybe we’ll talk about that a little bit after we talk about generally the recharacterization.  So, Elaine, when would you typically recommend that somebody make a conversion and then recharacterize, and by the way, the way I think of it, you know, it’s interesting hearing your analysis as kind of an “oops” analysis, and I look at it as an undo for people who use Word and other Microsoft products, and you put something in and then you want to take that out, there’s typically an undo.  Well, that’s kind of what a Roth IRA recharacterization is like, and it puts you in the same position as if you had never made a conversion in the first place.  So let’s say, for discussion’s sake, that you make a $100,000 Roth IRA conversion in 2010, and let’s say you get an extension and it’s now late September of 2011 and that $100,000 investment is only worth $60,000.  Well, you’re pretty unhappy because you don’t want to pay tax on $100,000 when the Roth is only $60,000, so you might consider undoing, or recharacterizing, and I thought if you could tell us some of the techniques that I read about that frankly, it’s the same kind of thing that I’ve been recommending for years, but maybe people can hear it from you about some of the proactive ways you can take advantage of the ability to recharacterize.

4. Recharacterizing Roth IRA Conversions

Elaine: Well, first of all, you definitely want to monitor the account and compare at any given time.  Now, there are two key times to review the value of your converted Roth IRA, and let’s say that you do the conversion right now.  You want to reevaluate that account at the end of this year, because if you recharacterize before the year is over, then you can reconvert.  The rule is, it has to be at least thirty days or in the next tax year, so if you recharacterize before this tax year is over, then you have all of next year to do that reconversion, if you want.  But there’s not a lot of time between now and the end of the year, so the accounts may not move very much in value.  The next critical time, of course, is before that October 15th or October 17th reconversion deadline date, and so, you might want to set a date.  Jim, you’re a tax preparer, what date do you want to set?  Maybe August 1st of next year for everybody to look at their account and just get a sense at that time of where the market has been, what the accounts are worth, and sort of gear up for recharacterization.  If the market goes straight up between now and then, then nobody has anything to worry about and there probably won’t be any recharacterization unless somebody just for some other reason regrets having done a conversion, but otherwise, you want to monitor those accounts and just be ready to recharacterize if they fall in value.

Jim: Yeah, I agree with you.  The one thing that I was going to add is we’ve been doing a little bit of an interesting, I don’t know if you want to call it a trick or a strategy or something like that.  So let’s say, for discussion’s sake, that you make a Roth IRA, or you’ve already made a Roth IRA conversion in 2010, and now it’s November or early December of 2010 and the investment is way down and you want to recharacterize it, but let’s assume, for discussion’s sake, that other investments are down.  One way to get around that thirty day rule, which basically says you’re not allowed to make a Roth IRA conversion, recharacterize and then convert the same IRA again, is you convert a different IRA.  So let’s say, for discussion’s sake, that you have two accounts.  Let’s call it IRA One and IRA Two, and you convert $100,000 of IRA One in 2010, and now it’s getting towards the end of 2010 and let’s say both of them are under water.  So now, you had two $100,000 IRAs.  You converted One to a Roth and it’s worth only $80,000, and IRA Two is only worth $80,000.  What you could do is recharacterize, or undo, the Roth IRA conversion number One, and then make a Roth IRA conversion of IRA number Two, and you only have to pay tax on $80,000 compared to if you just make a Roth IRA conversion of IRA One and then don’t do anything.  So, you literally save taxes on $20,000 by using that little technique.

Elaine: That is a great idea.  I hadn’t thought of that.  That’s a great idea.

Jim: Well, frankly, I mean, that’s one of the things that I’ve enjoyed so much about having people of your stature and Ed Slott and Natalie Choate and Bob Keebler and even John Bledsoe, who is kind of the wildest of them all.  He says convert no matter what, and you’re probably a little bit more conservative like I am.

Elaine: Right, right.  Yeah, but, you know, sort of piggybacking on your idea, another strategy we had talked about, you know, doing partial conversion to bring the amount up to the top of the tax bracket.  Another strategy is to do a series of conversions for the purpose of what we call time diversification, and it’s similar.  It’s basically the idea that you’re talking about, but let’s say that you have a $250,000 IRA.  You don’t want to convert it all right now.  You’re not sure where the market’s going to be going over the next year or so, so you convert $50,000 every few months, and it’s the same idea as dollar cost averaging.  You don’t know where things are going, so it’s like a way of diversifying.

Jim: And now, the money managers are probably going to scream bloody murder…

Elaine: Oh, I know!

Jim: But ideally, it would be in separate accounts.

Elaine: Exactly.

Jim: And that way, you can keep the winners and you can recharacterize the losers, which is something that some money managers will do and some will scream bloody murder and then do, and then some that won’t do at all.

Elaine: Right, right.

5. Social Security Strategies and Roth IRA Conversions

Jim: The other thing that I was kind of interested in talking about, and we haven’t talked about this at all, but at that same workshop that I met you, there was another participant there named Larry Kotlikoff, and Larry is an economist at the University of Boston, and Larry has some interesting strategies regarding either holding up taking your Social Security, or in the event that you have already taken Social Security, to actually give it back, which really goes against any gut instinct that people might have, and his analysis said, let’s say, for discussion’s sake, you started taking Social Security when you were 62 or 66, and let’s say you’ve collected $100,000 or $150,000 in Social Security, or even $60,000 or $50,000, his strategy says, “Hey, give it back,” and then, what happens is, you get a higher Social Security for the rest of your life, and he has a very convincing analysis of that, and one of the reasons why that caught my eye is because when you give your Social Security back, it’s very often a taxable deduction, and you can deduct that return of your Social Security.  My idea, let’s say, piggybacking on Larry’s idea, is to consider giving back your Social Security, making a Roth IRA conversion at the same year, taking advantage of the deduction of giving back the Social Security.  Now, this might really sound sick to people.  “Oh, this guy’s not only telling me to give back Social Security, he’s also telling me to pay some taxes on a Roth IRA conversion at the same time.”  But, I think a lot of cases, you’re actually going to be better off, and I’ve actually read that the Social Security Administration is thinking of closing that option of giving back your Social Security.  And I know frankly, in fact, I own it, you guys have some software on when to take Social Security, and I wonder if you have some thoughts on that issue?

Elaine: Oh, I definitely have thoughts on that issue!

Jim: Actually, I don’t wonder at all if you have thoughts on that issue!  I wonder what those thoughts are?

Elaine: Okay.  The first thought is we always recommend delaying if at all possible, and that’s especially true for the high earner in a marriage.  If you have, if you’re the husband, and sorry to be stereotypical, but…

Jim: Better to hear it from you than from me.

Elaine: If you have a high-earning spouse, it really makes sense for that spouse to wait until age seventy to take benefits initially because it generates maximum income while the two spouses are alive, and then it also raises the survivor benefits so it maximizes the widow’s income after the first spouse dies.  So that’s number one.  Number two, if anyone has taken Social Security early and then realized that it was a mistake, it very often is the right thing to do to repay those benefits.  I’ve seen many analyses on this.  You’re essentially buying an annuity from Social Security because if you have a lump sum to pay back those benefits, you can either put it into Social Security, or you can put it into something else, and the payoff, the payback for putting it into Social Security is higher and it’s essentially risk-free.  So that’s number two.  Number three, if somebody is thinking about applying at age 62 with the intention of undoing it at age 70, repaying those benefits and reapplying, I would not recommend it, and the reason is, like you say, word is they are thinking of taking that right away or shortening the period and maybe making it available for twelve months only for people who really do make an honest mistake, maybe they apply at 62 because they lost their job and then they start working again and don’t want the Social Security.  So, you have to provide for people who have legitimate reasons for wanting to do that, but for people who are trying to gain the system by taking it at 62, get that interest-free returns on that money from age 62 to 70 and then pay it back, they may be out of luck because that option may not be available to them, and then they’ll be stuck with that low benefit for life.  So, those are my opinions on that!

Jim: And I guarantee our listeners that that’s the condensed version.

Elaine: Definitely!

Jim: I’m just going to add one more little thing that, actually, this came right from Larry Kotlikoff.  You were right, and you referred to the person with the higher earning record.  Sometimes, it makes sense to apply and suspend your Social Security collection, and sometimes it makes sense for the spouse of the high earner to apply for and actually start collecting on his record, because it will not hurt him when he starts taking at seventy, and actually, you know, Larry was on this show and he spoke about this at length, and when I was writing this book, I wanted to talk about combining Roth IRA conversions and Social Security, so I thought well, I’m going to write it the best way I understand it, and then, rather than just sending it out there, I thought I would send it to Larry to have him review it, and Larry was pretty funny.  So, I sent him the chapter and he made a couple of edits.  One, one of the sentences I said is “If Larry is right,” and he just scratched that out.

Elaine: Of course.

Jim: And then the other thing, he added the part about applying and suspending and for the spouse, but the editor for my book is actually my mom, I have a professional editor also, but my mom is a retired journalism professor, and she is not shy with a red pen.  So, I gave her the material, and usually there was one or two corrections on more pages than there weren’t, and anyway, Larry actually contributed practically a page of his own analysis that I included in the book, and I didn’t tell my mother that somebody else wrote that particular part, and then, next to it, not only were there no red marks, but there was “Very good!” next to Larry’s section.  So, that part is in the book.  So, I think that we are in the same ballpark with that.

Nicole: Alrighty, we’re going to take a quick break.  We have a couple of minutes left, and when we come back, Elaine, I want to give you a few minutes to talk about your Roth Mastery Study Group, because we certainly have a lot of advisors that listen and I want to give you that chance.  We will be right back.  You’re listening to The Lange Money Hour, Where Smart Money Talks.


6. The Roth Mastery Study Group

Nicole: Welcome back to The Lange Money Hour.  I’m here with James Lange, CPA/Attorney, and Elaine Floyd of Horsesmouth, LLC.  We have a couple of minutes left, and Elaine, I wanted to just give you a minute to mention a little bit about your Roth Mastery Study Group, if you don’t mind?

Elaine: Thank you for the opportunity.

Nicole: Sure, go ahead.

Elaine: So, we did a survey at the beginning of this year because the media had done such a blitz on Roth IRAs because of the lifting of the $100,000 income limit at the beginning of this year.  So, we did a survey amongst our members and we asked them, you know, “What do you think about Roth conversions?  How much do you know about them?  Do you plan on doing them?”  Basically, in a nutshell, the response was, “Well, we don’t think very much of them, and we really don’t know very much about them.”

Jim: And I would agree with that.  I’m in front of a lot of financial advisors, and unfortunately, I would agree with you that most advisors are really not up to par on these strategies.

Elaine: Well, you know, in their defense, there is a lot to it.  What I had to go through to put this program together was review, I mean, hundreds of articles and academic books and, I mean, thank goodness I didn’t have to tackle the code itself, as I mentioned earlier, Ed Slott and Natalie Choate and some of those other people have done that, but what I did have to do was wade through a lot of material, and just kind of round it up and put it all in one place.  So, that’s really what I did.  The Roth Mastery Study Group itself is a series of four one-hour webinars given on Wednesdays.  We just started a new series last week, series one, which is “Fifteen Roth scenarios” where we show how our calculator works.  Sessions two and three are about the nuts and bolts of actually doing conversions, some of the very technical rules involved in them, and the recharacterizations and so on.  And then session four is about client education and marketing.  The study group includes a client seminar and script.  It also includes what we call a strategic alliances round table where financial advisors can meet with CPAs and attorneys like Jim, and put their heads together and use the Roth conversion as an opportunity to both do excellent work for their clients and also market to new clients.  So, it’s a whole package.  We’re very proud of it.  Everything that we’ve done is posted on our Roth Mastery website once you become a subscriber, so that if you can’t dial in at the appointed time for the webinar, you can always download them and listen to them at your convenience.  So, we’ve had a lot of good response, and people are out there doing a lot of, I like to call them Roth conversion conversations, because that’s really how it starts with clients and prospects.

Nicole: Well, great!

Jim: Well, Elaine, I want to thank you so much for joining us on the show, and I just love your material, and I think that you are a great resource for advisors and, frankly, have been for me.  So, I want to thank you again for being on the show.

Elaine: Thank you so much for the opportunity.

Nicole:  Thank you.  Well, everyone out there, have a great evening.  Thanks for listening.  You’re listening to 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.