Originally Aired: 07/20/2011
Topic: ‘Go Roth!’ with Author Kaye Thomas
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Introduction of Kaye Thomas, Tax and Estate Attorney
- Matching Dollars from Employer Are Key to Roth Decisions
- Simplicity Is a Primary Advantage of Roth Conversions
- Roth Needs Time to Overcome the Loss of Upfront Deduction
- High-Income Earners With 401(k) Can Contribute to IRA, Too
- Don’t Convert to Roth if You’re Near Retirement and Expect Lower Tax Bracket
- Some People Can Convert to Roth and Pay Tax from Within the Account
- Step Conversions Over a Period of Years Can Be Beneficial
- What Happens to a Roth After Investor and Spouse Die?
- Earnings on Non-Deductible After-Tax Dollars in a 401(k) are Taxable
Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
Nicole DeMartino: Hello, we are talking smart money. Thanks so much for joining us today. We’re going to be focusing our attention on Jim’s favorite topic, of course that is the Roth. First, of course, let’s start with a few introductions. We’ll start with the president of the Lange Financial Group in Squirrel Hill, CPA/attorney and best-selling author Jim Lange. Also today, joining us on our show, we have attorney and author Kaye Thomas. Kaye is a 1980 graduate of Harvard Law School, where he was a member of the Harvard Law Review. He’s spent two decades as a tax lawyer with prominent firms in Rochester, New York and Chicago but left the full-time practice of law in 2000 to focus on writing, consulting and public speaking. Kaye is the founder of Fairmark Press and the author of four books. Today, we’ll specifically be talking about “Go Roth!” You’ll hear more about that book, and if you want to see all of his books, you can go to his website which is www.fairmark.com, and with that, we welcome Kaye to the show.
Kaye Thomas: Thank you so much, Nicole.
Nicole DeMartino: You’re welcome.
Kaye Thomas: It’s a pleasure to be here.
Nicole DeMartino: Thanks.
Jim Lange: And I will add that Kaye, your book is marvelous. If you go to Amazon and you type in “Roth IRA,” the first book that you get is John Bledsoe’s book, and his was probably the first Roth book out in a big way in 2010, and then the second book, and it’s been there for a long time, is Kaye Thomas’ book, and on Amazon, it says “Go Roth 2009,” and I thought, “Well, why should a book that says ‘Go Roth 2009’ be ahead of mine?” because I have two books in the three and four position, but after I read it, I got it! I think it’s excellent, Kaye, so my congratulations to you. I know that you have subsequent books to that that we probably won’t be talking about today, but I think that the way you write, and your understanding of the Roth IRA is really second to none. So, I congratulate you for both having the good ideas and so articulately being able to explain them.
Kaye Thomas: Thanks, Jim. I appreciate those comments, and by the way, you know, it says “2009” because every time I bring out a new edition, I have to prominently indicate which year it was so that people know about it, but the 2009 edition does include the 2010 changes. It was brought out in 2009 for people to prepare for the significant changes that took effect in 2010, and so those are all covered in the book.
Jim Lange: Well, frankly, I don’t think of the Roth as a short-term decision anyway and you cover all the bases. I mean, there’s a couple things that maybe in your next edition that you could change, but, for me, it is really a classic book, and anybody who is interested in Roth IRA conversions, I think that they should buy it and read it, and I mean that sincerely. One of the things that you do in your book that I really liked, and I thought it would provide a good format for today’s show, is you talk about the life cycle of the IRA, and I think that that’s a very good way to look at it. So, I think using that as the base, if we could talk about the life cycle from the creation … and I guess when I say Roth IRA, I should also include the Roth 401(k) and Roth 403(b). I know, in your book, you basically say they’re interchangeable for most conceptual purposes, and I would agree with that. That we start out with the beginning, and what I thought we would start with is the advice that we would give somebody who is still working, and let’s assume, for discussion’s sake, the majority of the people who are working and have access to a 401(k) plan, but let’s assume, at least to start, that they don’t have access to a Roth 401(k) plan because, at least in Pittsburgh, I would say more employers than not don’t offer a Roth 401(k).
So, Kaye, if you could give advice on what you think somebody … and let’s also assume that there is sufficient money to fund their retirement plan to the maximum that is allowed. What advice you would give somebody who is still working who has access to a 401(k) plan at work, does not have access to a Roth 401(k), and let’s say we’ll take both circumstances, either falls within the income limitations of the Roth, and then people who make too much money? So, that’s a pretty broad question, but basically, what should working folks with access to a Roth, but not a Roth 401(k), do? What should they do?
Kaye Thomas: Yeah, it is indeed a broad question, and my point of view on this, which is really pretty much in the mainstream, although there are people who disagree on points of emphasis, when you compare a 401(k) with any kind of an IRA, one of the key features that you need to keep in mind is the potential for receiving a matching contribution, and I know that in the economic downturn, a lot of employers suspended matching contributions, and so there are a lot of people out there who participate in 401(k) plans that don’t have that feature available right now, although many employers are also reinstating previously terminated matching contributions. This is so important because really, when you come right down to it and you’re trying to crunch the numbers about where you’re going to come out with one strategy or another, if you have available to you the opportunity to get matching numbers, you know, it doesn’t have to be for one match or even a 50 percent match, as little as a 25 percent match can make a huge difference in the total amount of wealth that you’re able to accumulate through your retirement savings, assuming that you do qualify for that match that it becomes vested and that you don’t squander it when leaving your employment, that you either roll it into a new employer or roll it into an IRA. So, those matching dollars, really, for most people, are the single most important consideration in where your first dollars go for retirement savings.
Jim Lange: And I would agree with that 100 percent, by the way: Always, always, always take advantage of the employer match. You, in effect, get 100 percent on your money, sometimes more, immediately. So, I’d even incur credit card debt to take advantage of the employer match.
Kaye Thomas: It is free money. So, that is ordinarily going to be the very first place that you’re going to put your dollars. Now, one you run out of that match, employers are not required to match every dollar that you put in, if you’ve maxed out to the full amount that you can contribute to a 401(k), at most employers, you’ll receive a match only on a portion of that. And so, once you’ve run out of that match, you have other issues to be considering, and one of the most important ones is the Roth versus a traditional type of account, the Roth being the one where you don’t pay tax on your earnings, although you don’t receive the contribution, and in this case, I think for the vast majority of people, and this is not going to be true for absolutely everyone in every situation, but the vast majority of people, it makes sense to get a Roth going and put some money into a Roth, and there are a number of reasons for that.
One is that the Roth is such a flexible account that even if you’re thinking that through some kind of careful tax analysis, you may come out better with a current deduction than you do by making your earnings tax free, the flexibility of the Roth is the only account that’s going to make it possible for you to take your money back out if you do have an emergency where you have to take money out of a retirement account, something you always want to avoid if possible, but the Roth is the one possibility to do that without paying a penalty before age 59½ and without qualifying for one of the exceptions. Beyond that, getting the Roth started starts that five-year period running that you need to accomplish in order to ultimately have earnings be tax-free. So, even if you’re thinking, “Oh, I’m not ready to pump a lot of money into a Roth right now,” just getting one started and having it begin that five-year period helps you move forward in terms of qualifying eventually when you do think you want to have your Roth seriously funded, to be able to qualify for satisfying all the requirements to have tax-free earnings withdrawn from that account. So, that’s another reason to get it started, but simplicity is a big part of the argument for a Roth.
Jim Lange: And I think, frankly, you are being overly generous. I mean, I would agree with you 100 percent, and probably the way I would look at it is I agree with you, but maybe not for the same exact reasons. I agree with all your reasons, but I just like the math of the Roth more than the traditional, and as you pointed out in your book, in effect, and I don’t want to get into the technical discussion that you have in Chapter One about parity, which we talked a little bit about yesterday, but, in effect, you’re able to contribute more money into a Roth account and more money into a Roth 401(k) if you are allowed. So, you’re, in effect, buying out the government with a Roth. So, I think that that makes a lot of sense. So, I think that we are on the same wavelength that we want to, subject to exception, 1) put in the maximum that an employer’s willing to put in, then 2) maximize Roth possibilities, whether it be Roth IRAs or Roth 401(k)s or Roth 403(b)s, and then, if there’s still money left over and we don’t have a Roth 401(k) or a Roth 403(b), to put money in the traditional 401(k) or traditional 403(b). Is that more or less the same conclusion that you have?
Kaye Thomas: That’s exactly where I come out for the vast majority of people. You know, if I can kind of just without getting into the parity discussion, which is a little complicated and hard to deal with if you don’t have it down on paper in front of you. The key point here is exactly what you mentioned, which is that the Roth account is effectively bigger, and you can do the math and come out to where a $3,000 Roth account is exactly equivalent to a $4,000 traditional IRA, and if that’s true, then a $4,000 Roth account is effectively bigger than a $4,000 traditional IRA. So, when you’re maxing out accounts, you’re sheltering more dollars, in effect, by putting those dollars into a Roth than if you’d put those dollars into a traditional account.
Jim Lange: All right. I’m afraid we’re going to have to take a break now. When we come back though, we can maybe talk about the exception because you said for most people, but I think there is an important exception that I think that you and I would both agree with, and then we’ll go on to Roth conversions and continue our life cycle of the Roth discussion.
Nicole DeMartino: All righty, we are going to take a quick break. You’re listening to The Lange Money Hour, with Jim Lange and Kaye Thomas. We’ll be right back.
Nicole DeMartino: All righty, welcome back to The Lange Money Hour. You’re here with Jim Lange and Kaye Thomas. We’re talking about the Roth.
Jim Lange: Kaye, you mentioned that that was your general advice. That is, first match, second Roth, third traditional. Now, let’s assume that you have the choice, but there are some exceptions, and one of the things that I liked about your book, that obviously shows yes, you have a complete understanding of this and you’re not afraid to put it out there, even if it’s a tiny bit analytical, if you will, is you distinguish between different tax brackets. So, let’s say that we have somebody who is maybe at the height of their earning power, maybe they’re in their 60s, and there’s going to be a period of time between their retirement and when they are age 70. So, let’s say maybe somebody in their mid-60s who is working, about to retire, is making a lot of money now. Would you recommend the traditional or the Roth for that person?
Kaye Thomas: Well, it does depend very much on tax brackets, although I think that many advisors have a notion that saving in a Roth is unwise if your tax bracket is going to be lower in retirement than it is when you’re saving. That’s not 100 percent true or even, I would say, broadly true for younger people, but for people who are getting close to retirement, it takes some time for the Roth to overcome the disadvantage of not getting that upfront deduction at a higher rate versus providing the tax exemption that’s going to come into effect when you’re taking money out of the retirement account when you’re in a lower tax bracket. And so, people who are closer to retirement and who are in a significantly higher tax bracket prior to retirement than they expect to be after retirement, for those people, the mathematics for the Roth really are not going to work out for them, typically. And so, for those people, instead of necessarily going from taking those matching dollars to moving to a Roth to moving back to the 401(k), typically for those people, it’s going to be taking those matching dollars and then possibly your next dollars going into a traditional IRA, if you like the investment opportunities better, and then continuing your traditional 401(k) account. The key difference here really is that break between the 25 percent tax bracket and the 15 percent. So, people are still going to be in the tax bracket of 25 percent or higher in retirement. For those people, even though their retirement tax bracket may be lower, the advantages of the Roth can still overcome that differential, but it’s very hard to make the math work for Roth contribution at a tax rate when your deduction would be at a tax rate of 25 percent or higher, but your retirement income is going to be coming out in the 15 percent tax bracket.
Jim Lange: I would agree with that analysis. The thing that you might consider doing though is maxing out the traditional when you’re in your high bracket, and then, and this might be a lead-in to the next area of conversation which is the Roth IRA conversion, my favorite years for Roth IRA conversions are after you retire, so in the situation that I brought up where somebody is in their 60s and will have a number of years after retirement but before age 70, that will most likely be their lowest income tax bracket for the rest of their lives, and that is almost always the best years to make a Roth IRA conversion because you don’t have the income from your job or wages. You don’t have income from your minimum required distributions. Assuming you can fund your retirement from outside sources, that might be a great time to do a Roth conversion. So, that type of person is still maybe a great candidate for a Roth conversion, but not in the year that they’re in the high tax bracket. Is that fair?
Kaye Thomas: I agree, yes.
Jim Lange: All right. There’s one other point that I wanted to cover before we go to the conversions, because it’s something that I think a lot of people miss, and you bring it up in your book, and I bring it up in my book, and I don’t see a lot of people doing it. Let’s assume, for discussion’s sake, that your income is so great that you are not allowed to make a Roth IRA contribution. Can we talk for a moment about a non-deductible IRA?
At first, we’ll just keep it simple. Let’s assume that you have no other IRAs at all, and the conversion of the non-deductible IRA to a Roth IRA, because I think a lot of people don’t know that … let’s even assume that you’re making a couple hundred thousand dollars or you’re somewhere over the limit between you and your spouse, if you’re married, and they don’t know that you could put in $5,000, or $6,000 if you’re 50 or older, for both you, and then $5,000 or $6,000 for your spouse into a non-deductible IRA, and then the next day, convert that to a Roth IRA for no tax cost. So, maybe if you could talk a little bit about the non-deductible IRA and whether that’s something that you recommend to some of your high-income clients and readers?
Kaye Thomas: Yeah, well, that certainly does make sense, and we do have to specify, as you know, it makes a big difference if you have an existing IRA because of this rule that requires you to treat multiple IRAs of the same type as a single IRA. But someone who does not already have an IRA can make that non-deductible contribution to the IRA, and without regard to their income level, the only requirement is that you have to have earned income during that year and you have to be under 70½. If you meet those requirements, you can put that money in and then do the conversion the next day, and as you say, there’s no tax cost in doing that.
Jim Lange: By the way, I don’t know if a lot of listeners understand the power of how much money they are allowed to contribute tax-free. So, let’s say that you and your spouse are both working, and let’s assume that you’re both making more than $25,000, and let’s also assume for the moment that you’re 50 or older. If your employer offers a Roth 401(k) or a Roth 403(b), you could put $22,000 each in those accounts and you could put $6,000 into a non-deductible IRA, the next day convert it to a Roth, so between the two of you, you can put in $22,000 plus $22,000, that’s $44,000, plus $6,000 and $6,000. So, you have the opportunity to put away $56,000, and a lot of times, the limitation on how much you should be putting away is not necessarily what the tax laws will allow, but what you could afford. So, as you pointed out, this is kind of like a tax mecca, if you will, the ability to put away so much money income-tax free.
Kaye Thomas: That’s absolutely true. That’s a powerful way of expressing it, and this is a good place to mention, Jim, certainly you and I know this, but it’s one of those things that is a very common misconception that should be cleared up. Many people have the notion that if they have a high income and they participate in a 401(k) plan, that they cannot contribute to an IRA. That’s just something that’s out there as kind of an urban legend, I guess, but I keep running into this over and over with people having that misconception, and the rule is that if you have a high income and you participate in a 401(k) at work, you may be denied the deduction, but you are not denied the right to make that contribution, and so you can make that contribution non-deductible, convert it to a Roth IRA and increase the amount of dollars that you’re sheltering.
Jim Lange: Right, and later on, if we have time, I’d love to discuss the Roth conversion from the non-deductible IRA into a Roth, but there’s so many other important things that I’d like to get to first, and I guess now’s probably a good a time as any to talk about … actually, before we leave the subject of Roth 401(k) and Roth 403(b), a lot of people also don’t know that if many companies have recently implemented a Roth 401(k) or a Roth 403(b), and a lot of people don’t know that they might have opportunities to contribute to that account, or to even do a Roth 401(k) conversion or a traditional 401(k) or 403(b) conversion, and so all that is probably important in the context of the Roth conversion, but I will just say that the Roth conversion might be appropriate for some people who don’t even have a traditional IRA. They might just have a traditional 401(k) and 403(b). And actually, it looks like we are at a breaking point. I want to get into the Roth conversion and I don’t want to break that up, so …
Nicole DeMartino: OK, why don’t we break now and then we’ll go fresh into that? You are listening to The Lange Money Hour, with Jim Lange and author Kaye Thomas. We’ll be right back.
Nicole DeMartino: Welcome back to The Lange Money Hour. We are here with Jim Lange and author and attorney Kaye Thomas, and we were talking a little bit about his book Go Roth! and I just want to mention, if you want to get any more information on Kaye or that book, go to www.fairmark.com.
Jim Lange: And I would add it’s a no-brainer. I would just buy the book. And if you don’t like it, you can come to me personally and I’ll refund your money because it has great information. Kaye, what I wanted to talk about next, and you cover it quite well in your book, is the issue of whether people with traditional IRAs and 401(k)s should make a Roth IRA conversion, and I think that your analysis of tax brackets is very good, but Roth conversions were much hotter last year in 2010, and you don’t hear a lot about it anywhere near as much in 2011. There might be some good reasons why you don’t hear about it as much, but would you say that the Roth conversion potential is just as good in 2011 and in future years as it has been in the past?
Kaye Thomas: It is, in some ways, potentially even better, but 2010 was a special year of course because it was the first year of eliminating the $100,000 income limitation on being able to do a Roth conversion, and perhaps the first thing we should mention is that it was only the first year for which that limit was eliminated. It was eliminated permanently, and so that opportunity is still there for people with incomes above $100,000. The only thing that has gone away is this opportunity to defer the tax. There was a special tax-deferral rule that people who converted in 2010 could report the income instead of reporting it on their 2010 return, split it between the 2011 and 2012 returns. So, there was a little bit of an added bit of juice in terms of doing conversions in 2010, but other than that, the opportunities are still there, and certainly something for people to be looking at with the possibility of tax increases in the future. So, the opportunity hasn’t gone away and it really has not significantly even been reduced other than that very small technical detail about which year you report the income.
Jim Lange: Yeah, OK. One of the problems with this show is that I just agree with just about everything that you’re saying, and I can’t be controversial. A lot of people got very excited about the fact that you could defer the taxes over two years, in effect. So, you do the conversion in 2010 and you pay the tax on half the income in ’11 and half in ’12, when I think you and I both agree that that’s really, let’s call it, a detail and not the important thing, which is many years of tax-free growth, and that the Roth conversion … and the other thing that you mentioned that a lot of people don’t really understand is, a lot of times, people think that 2010 was a one-year window for people who had incomes of more than $100,000, when, in fact, as you mentioned, that is a permanent change, meaning that the Roth IRA conversion is still open and available to anybody that has an IRA. So, why don’t we talk about who are some of the good candidates to make a Roth IRA conversion and when are some of the times that it might make sense for an IRA or a 401(k) owner to consider a Roth conversion?
Kaye Thomas: Well, the first thing to say is that the overall consideration for when you want to be looking at conversion are pretty much the same, or similar to, the considerations about whether you contribute to a Roth as opposed to contributing to a traditional retirement account. So, those are somewhat parallel, and that means that if you are in that period of time where you’re close to retirement and anticipating a lower tax bracket in retirement, significantly lower especially, chances are you don’t want to be doing a conversion now. You want to be looking at the magical window that you mentioned between the time that you retire and move into a lower tax bracket and the time when your tax bracket may be going up because you’re faced with required minimum distributions from whatever retirement savings and traditional IRA accounts. And so, those are the people who are most unsuitable for a conversion.
The other problem in doing a conversion is people who are below age 59½ and do not have the money available to pay the tax from outside sources, and so if you’re going to be drawing money from the retirement account and using that money to pay the tax on that conversion below the age of 59½, there’s no special exemption for that, and so you would pay the 10 percent penalty for an early withdrawal from your retirement account in addition to any tax that’s imposed on that conversion. And so, the combination of those two things can make it very difficult to make the math work for conversion in that situation. It is possible. Some people have translated that into a general rule of thumb to say, “OK, you should never do a conversion if you have to pay tax using the dollars in your account.” That’s not quite true, though. People can benefit from a conversion even when they’re using money from inside the account provided that they’re not paying that 10 percent penalty. So, this would be people who are in a low tax bracket already, perhaps after retirement and after age 59½, and who want to think about a conversion as a way, even though they’re going to have to pay tax from inside the account, doing this conversion is going to allow them to put this money outside that required minimum distribution requirement permanently, and if you look at all the math on that, it is still possible to come out ahead with the conversion while paying at least a portion of the tax from inside the account.
Jim Lange: Well, again, I would agree with you. Actually, for listeners who are really interested in this point, if they go into the archives, if you go to www.paytaxeslater.com and you go to the show with Barry Picker, Barry and I talked about that quite a bit, so I won’t repeat that discussion here. But I also wanted to talk a little bit about whether it makes sense and whether you usually typically recommend huge whopper conversions, when I say a whopper conversion, I’m talking maybe a couple hundred thousand dollars, or, in some cases, a million dollars or more, or whether it is more common for you to recommend a series of Roth IRA conversions up to a certain amount or up to a certain tax bracket amount ever year for a series of years?
Kaye Thomas: And the answer is the whopper conversions make sense for the people with whopper income and wealth who don’t anticipate being in a lower tax bracket, or at least not significantly lower, even after retirement because they have so much investment income. People fortunate enough to be in that situation, they can go ahead and convert as much as they want, provided that they do have the money from outside the Roth to pay the tax on that conversion because they’re going to achieve a very significant overall benefit, and that was the rich opportunity that was afforded by this dropping of the $100,000 limitation.
But for the rest of us, those of us who do expect to be in lower tax brackets in retirement, conversion planning, to keep it within a reasonable tax bracket for the amount of tax that you’re going to incur on the conversion can make a lot of sense, and converting over a period of years can be beneficial. There is always this asterisk on that, but you can lose some opportunity if the market happens to take off and your investments appreciate a lot before you get that next step of your conversion done. Then you’ve missed the chance to have that money be tax-free, but overall, the step conversion makes a lot of sense for people who are moving money from one bracket to another.
Jim Lange: And I would agree with that. One of the things that our office does is we help people determine how much and when to convert, and I would say, as you mentioned, we have literally recommended multi-million dollars Roth IRA conversions for people who were always going to be in the top tax bracket, and more likely for most people, it will be a series of conversions every year. The only thing that’s kind of tricky about it is, to me, I don’t see how you could really give specific advice without actually running the numbers, and we not only use actually a variety of Roth conversion software, but when Steve Kohman, who is our Roth IRA number cruncher, does it, he actually uses 1040 software and he actually plugs in an individual client’s 1040 and sees the effect of different amounts on different years, and sometimes what happens is issues like total taxation of Social Security, issues like Medicare Part B, qualifying dividend, differential capital gains, alternative minimum taxes, some of these things sometime have an impact on how much and when to convert. I don’t know if you have found that yourself also?
Kaye Thomas: Well, I’ll say that I am not myself much into the number crunching business because I come from a lawyer’s background and not a CPA and I don’t do tax returns, but I can tell you this that from viewing this kind of analysis if it’s been done by others, that is exactly the right way to go, and the right way to do it is to get your hands on those numbers and see what actually comes out of those calculations because it just happens so often that something unanticipated … you think it through conceptually and you say, “This makes sense,” and then you actually work through the numbers and realize there’s just something there that maybe changes the analysis that couldn’t be anticipated until you did the work.
Jim Lange: Well, I think that that’s a great point, and I fear I sometimes have the reputation of being the Roth guy, and I love Roth IRAs, and how I try to defend myself is no, I am a numbers guy and I like to recommend the course that gives people the most purchasing power over time, and it just so happens that a series of Roth IRA conversions over a number of years is usually the recommended course. So, it’s not like I’m so in love with the Roth that I’m willing to overlook reason and what makes sense. It’s just that that very often is the best course, and I, and people in my office, are number crunchers and we’ve gone to the AICPA to get our numbers peer reviewed. I’m getting that look again! When we come back, I’ll tell you what I’d love to talk about is Roth IRA conversions and estate planning, and I’d also, if we have time, love to at least touch on the subject of the conversion of after-tax dollars inside an IRA or 401(k) to a Roth without having to pay the tax.
Nicole DeMartino: Well, you heard it. We’ll be right back with that. You’re listening to The Lange Money Hour, with Jim Lange and Kaye Thomas. We’ll be right back.
Nicole DeMartino: Well, thank you for listening to The Lange Money Hour today. Our guest today is Kaye Thomas, author and attorney, and Jim’s been talking about her book today, Go Roth! If you want to take a look at that book or if you want more information on it, you can go to his website, which is www.fairmark.com. Easy enough.
Jim Lange: And Kaye, you know, you just mentioned earlier, “Well, I am an estate attorney,” and that’s certainly what you have been doing for the majority of your career. So, I wanted to talk about the impact of Roth IRA conversions for estate planning because, for whatever it’s worth, at least the kind of clients I tend to attract, and of course there’s all kinds of different people, but a lot of times, the types of clients that I get are people who were married many years ago when neither of them had any money. It’s not like today where people go job hopping, and frankly, the jobs don’t stay around for many years, they often work for many years for one or two companies, tended to contribute money to their IRA or 401(k) or, in later years, Roth IRAs, but money was always a little bit tight, salaries were never necessarily spectacular, and they paid the mortgage and they paid the car payments and they paid for their kid’s teeth and braces and then, later on, college, and it was very hard for them to accumulate money, and now they’re often in a situation where they have a substantial amount of money in their IRA and retirement plan, but many of my clients have a little bit of that, what I’ll call, depression era mentality or reluctance to spend money.
So, it has been my experience, even though you have an excellent discussion of withdrawals of the Roth IRA in your book, that a lot of times, people are going to make Roth IRA conversions and end up dying with Roth IRAs, and I was hoping that we could talk a little bit about what happens in the event that you make a Roth IRA conversion or you contribute to a Roth IRA, it continues growing income tax-free for your entire life, there’s no minimum required distribution for you, no minimum required distribution for your spouse with that Roth IRA. But if we could talk a little bit about what happens to the Roth IRA after both spouses are gone, I think that that would help our listeners really appreciate the value of Roth IRA conversions even more.
Kaye Thomas: Yeah, and the short answer is that although required distributions do take effect after the death of the original owner and the spouse if it went to the spouse, the distribution can be made over the lifetime of a beneficiary, particularly if that beneficiary is in a much younger generation. That money can remain sheltered for decades and decades, and this has brought about the use of the term “stretch IRA” that appears in many articles, and the use of this technique, it’s something that you simply don’t get that benefit from a traditional IRA because of those minimum required distributions that have to come out at age 70½. So, it’s a wonderful way to not only maximize the amount of money that you have sheltered but extend for many, many years the number of years that that money is sheltered as well.
Jim Lange: Yeah, it’s just so wonderful, particularly for clients who are not great spenders, but they want something that increases their wealth. So, unlike, say, life insurance, and we can talk about life insurance, and it might be a wonderful thing for your kids, but normally for, let’s say, either a term or even a permanent policy that is more for the next generation or two generations, it’s still money out of your pocket that will benefit future generations. The Roth is going to put money in your pocket in terms of purchasing power, and then also be a phenomenal benefit through what Kaye and the literature calls a stretch Roth IRA. Now, Kaye, what I do for a lot of estate planning clients that I have that have both traditional IRAs and Roth IRAs is I encourage the use of flexible estate planning. So, if we forget the analysis of the B Trust (because that’s beyond the scope of this conversation), with a traditional family, when I say, traditional family,, I call it the “Leave it to Beaver” family, original husband, original wife, same kids, I might have money go to the spouse first, kids equally second, and then a well-drafted trust for the benefit of the grandchildren third, and then the real decision of who gets what comes not today when we actually draft the wills and beneficiary designations of the IRAs and Roth IRAs, but we make the decision after either the husband or the wife die, or after both deaths, then that’s the time when we often decide between child and a well-drafted trust for the grandchild. And I don’t know if that is consistent with anything that you have recommended or done, but I love the Roth IRA going for the benefit of the grandchild because we might get 50, 60, 70 years or more of income tax-free growth.
Kaye Thomas: All of this makes perfectly good sense to me. I had the misfortune during my decades of working in law firms to always work with excellent estate lawyers who therefore prevented me from developing quite the same expertise in the use of trusts as I might otherwise have, but this just sounds like excellent planning and makes a great deal of sense.
Jim Lange: And one of the things that we have done sometimes is … let’s say that there is a fair amount of money, and at the first death, we sometimes have the surviving parent disclaim a portion of the IRA to the children, and then at the second death, that’s usually the time that we end up having to disclaim some money to well-drafted trusts for the benefit of grandchildren, because most clients want to take care of their children before their grandchildren, and most children obviously want to make sure that they’re OK before they pass money on. But boy, even a small amount of money going to a grandchild, growing income tax-free for 50, 60 years can just be a wonderful thing.
And finally, Kaye, probably the last topic that we’re going to have time to talk about, and you have genuine expertise … in fact, yesterday, I mentioned to Matt Schwartz, who is an estate attorney in our office, and I said, “Hey, Kaye Thomas is going to be on,” and Matt immediately said, “Oh yeah, he wrote that wonderful article on after-tax dollars inside a retirement plan or a 401(k).” And since we don’t have much time, and I don’t want to get too lost in the concept of the specifics, if we could just talk for a moment about some of the general ways to benefit from having after-tax or non-deductible IRAs in either an IRA or a 401(k), and getting that money to a Roth IRA without having to pay the tax. That’s something that we’ve done many times in our business, by the way, and by the way, we use … I think it’s your method four, which is the only one that you say is completely safe, and even then, it’s not 100 percent safe, but if we could talk about that for a little bit without maybe talking about the mechanics, just the concepts of, in effect, converting non-deductible IRAs and 401(k)s to Roth IRAs without having to pay the tax. It’s such an enormous benefit that is open to so many people that so few advisors or IRA or 401(k) planners know about.
Kaye Thomas: Well, I think, by way of background, although it’s less common nowadays, in the past, it was much more common for people to be making non-deductible contributions to have after-tax dollars in their 401(k) accounts. And so, there are a large number of people who do have substantial amounts of non-deductible after-tax dollars in their 401(k) accounts. Now, growth on that amount is going to be taxable. In other words, they could take those dollars, when they do come out, according to whatever rules are used, and in having them come out, those dollars will be tax-free, but earnings on those dollars, in the meantime, are building up inside an account where those earnings, when they eventually come out, will be taxable, and if we could get those after-tax dollars into a Roth account, then the earnings on those amounts would be completely tax-free in the future. And so, there’s a huge benefit to be gained if we can get those after-tax dollars out of a traditional account, whether it’s a 401(k) or a traditional IRA, and move those dollars into a Roth IRA. Now, the trick is, can you get those dollars out without getting the pre-tax dollars out, because taking the pre-tax dollars out means you’d have to pay tax on that conversion, and that’s the issue addressed in that article you’d mentioned.
Jim Lange: Yeah, and by the way, I addressed the issue in my book also and I think that that is a wonderful opportunity, particularly for people who are retired or about to retire. It’s really important to understand what their options are with the after-tax dollars or non-deductible IRAs, and also beyond the scope of today’s show, NUA, which is Net Unrealized Appreciation, and as much as I would like to talk much longer, because this is terrific, I’m afraid we are out of time.
Nicole DeMartino: I know you want to continue! We are out of time, unfortunately. We are out of time today. Kaye, thank you so much for being on our show.
Kaye Thomas: Jim, Nicole, it was a real pleasure. Thank you for having me.
Nicole DeMartino: Wonderful.
Jim Lange: All right, and Kaye’s book is Go Roth! You can read about it at www.fairmark.com, or, frankly, I wouldn’t read about it. I’d just go to Amazon and buy it.
Nicole DeMartino: Yeah, just go to Amazon and get it. If you want to see the other books that Kaye has written … actually, they’re on Amazon too, but you can go to www.fairmark.com, and if you have any questions for us, you can always call the Lange Financial Group at (412) 521-2732. As always, this show will be posted on www.paytaxeslater.com, and then the text document will follow. If you want to listen to it again, it’ll also replay Sunday at 9 a.m. We’re on every Sunday at 9 a.m., so certainly join us for that. You’ve been listening to The Lange Money Hour. Have a wonderful week. Bye-bye.