Originally Aired: May 3, 2017
Topic: Invaluable Advice from One of the Top IRA Experts in the Country, Ed Slott
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Introduction of Ed Slott, Tax Advisor, Author, PBS Host
- Convert to Roth IRA While Tax Rates Are Lower
- Convert Your Funds If Your Employer Offers a Roth 401(k)
- Avoid Required Minimum Distributions With a Roth IRA Conversion
- “Backdoor” Roth IRA Could Be Eliminated in Tax Reform
- Once Your Retirement Account Is Built, Focus on Tax Planning
- Lower Rates Are “Like Buying Taxes on Sale”
- Stretch IRA Will Die Because Beneficiaries Don’t Lobby Congress
- Life Insurance Offers Enormous, Unlimited Tax Advantages
- Qualified Charitable Distribution From IRA
- You Might Not Recover From a Tax Mistake in Retirement
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.
1. Introduction of Ed Slott, Tax Advisor, Author, PBS Host
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg, along with CPA and attorney Jim Lange. This week, we’re welcoming America’s top IRA expert, Ed Slott, back to the program. Ed’s been called the best source for IRA advice by The Wall Street Journal. He runs the popular website, www.irahelp.com, and has authored many best-selling books, including his latest, Ed Slott’s 2017 Retirement Decisions Guide. Ed has been frequently quoted in The New York Times, Forbes, Money magazine and many other publications. His latest PBS program, Ed Slott’s Retirement Roadmap 2017, is now running in Pittsburgh and all over the country.
Now tonight, Jim and Ed will be covering a number of topics, including the possibility of lower tax rates ahead and what planning can be done based on future tax changes; IRA mistakes Ed has seen in this year’s taxes; strategies for Baby Boomers who are now having to deal with required minimum distributions; and how much should you react or not react to market fluctuations as you plan for your retirement? So, with that introduction, let’s get started by saying hello to Jim Lange and welcome back to Ed Slott.
Jim Lange: Welcome to the show, Ed.
Ed Slott: It’s great to be back here in Pittsburgh via radio.
Jim Lange: Well, and I know you’re going to be here in person tomorrow …
Ed Slott: That’s right!
Jim Lange: But anyway, it is always an honor to have you, and when Dan says “top IRA expert in the country,” that is actually accurate, and it’s hard to measure expertise, but certainly one objective way is the number of books sold and public exposure and how much you command in speaking fees, and I think by all those measures …
Ed Slott: And how many people repeat it!
Jim Lange: And how many people repeat it, you are the top guy. I sometimes like to say, there’s about 15 in the country. All 15 have been on my radio show, but it’s great to hear information from the brightest and the best.
So, one of the things that I wanted to talk about, and I want to start with a few basics because, you know, we’ve now passed the April 15th deadline and in, let’s say, a new environment, in terms of potential lower taxes, at least temporarily, and, let’s say, a little bit of a feeling of uncertainty in the air, I know you have always been a fan of tax-free, even better than tax-deferred, and I wanted to talk for a minute about Roth 401(k)s and, let’s call it a “backdoor” Roth IRA. Can you tell our audience a little bit about a Roth 401(k) and why, if their company offers it, they should at least consider it and who should consider it?
2. Convert to Roth IRA While Tax Rates Are Lower
Ed Slott: Yeah. First of all, you’re right. I love anything tax-free, and if you’re like me and you’re heading to retirement, which I am not, but if you are heading to retirement, the last thing you want to worry about in retirement is taxes, and you used a word “uncertainty.” That’s not a word you want to use in retirement, and I’m talking about uncertainty about what future, I believe, higher tax rates, and it’s interesting when you set up the question, you talked about the possibility of lower tax rates, but that only leads to higher tax rates somewhere in the future. It balances out. Somewhere, you can only put so much on a credit card until the bill has to be paid.
So the key is to take advantage of today’s low rates and avoid future higher rates in retirement. So that’s where a Roth IRA comes in. A Roth IRA, what makes it different from an IRA is you pay taxes upfront, but then never again, like a book I’ve heard of! And I believe in that because who wants to bother with it? So you pay it once. It’s kind of like, let’s say you go into a parking garage. You take a ticket, and let’s say you stayed there an hour, two hours, 10 hours, five days. At the end, they charge you for how long you were there. What if they did the reverse? What if you could pay a certain amount just to get in the lot, and you could stay as long as you want? That’s kind of the Roth IRA, if you follow my thinking there. Well, you pay upfront, but never again, so you don’t have to worry about it. Now, it’s the paying upfront that some people have a problem with, but that’s short-term thinking. Remember, it’s not a question of if, but when. You will pay later, and possibly on a higher balance at a higher rate. So my feeling is, bite the bullet now, especially while tax rates are low, and may even get lower. So now is the time to strike. So that’s the concept of a Roth IRA. You don’t get a tax deduction, and when I say you pay tax upfront, you pay tax by not getting a deduction. So, you won’t get a deduction, but that Roth builds tax-free for your retirement.
3. Convert Your Funds If Your Employer Offers a Roth 401(k)
Now, there’s a company version of that called the Roth 401(k). I think the biggest misunderstanding … well, there’s a few things with the Roth 401(k). It’s not even that relatively new anymore. It’s over 10 years old already, but it’s not really that well-known or understood. So, it’s basically a version of the Roth IRA, but as part, a component — and that’s important to know, that’s where people make mistakes — of an already existing 401(k). So, the 401(k) is like the IRA, where you get a deduction for money going in, but then it builds tax-deferred, which means you’re going to owe money when you take it out. But the Roth 401 component of that, if your company has that, that’s probably the better place to go. You can put in a lot more money. There’s no income limits, by the way, as there are for Roth IRAs, and the money grows tax-free.
But I think the big misunderstanding — I don’t know if you find this also, Jim — people go to the company, “I want a Roth 401(k).” You can have it without a 401(k). It’s an add-on, like an accessory. It’s a component of an already existing 401(k). So first, your plan has to have a 401(k) to begin with, and then have elected to add-on the Roth 401(k). But if you put money in there, what’s the downside? And when I say ‘in there,’ the Roth 401(k). You might not get the big tax refund that you’re used to getting, because more of your income will be taxable, but you’re building tax-free in that Roth 401(k), which, one day, when you leave the company, may be rolled into your Roth IRA, and all that money will be totally tax-free in retirement, removing that word that you said earlier on, the uncertainty of what future, I believe, higher tax rates can do to your retirement savings. The last thing you need to worry about is, “Will taxes go back up to 50 percent, 60 percent when I’m ready to get mine?” That’s a likely possibility because you can only lower rates for so long before they have to bounce back and face reality. So, that’s why I’m a fan of the Roth IRA, the Roth 401(k), and anything that gives you tax-free money in retirement without having to worry if rates will rocket back up.
Jim Lange: Well, I think that’s a great answer, and I love the analogy of going into the parking lot and paying upfront and staying as long as you want, and the other thing that I will add to that, though, it’s not just tax-free for you; it’s also tax-free for your heirs and there’s no minimum required distribution.
4. Avoid Required Minimum Distributions With a Roth IRA Conversion
Ed Slott: Yeah, that is one of the big advantages. I know the people, most of the Baby Boomers, now the first ones turned age 70½ last year in 2016, and the biggest complaint we get is required minimum distributions that start at 70½. Most people take them not because they want to or they need to, but because they have to, and it really irks many people to be forced to pay taxes on money that they don’t need. But that’s the deal you made when you went into a tax-deferred, say, a 401(k) or an IRA. Now, with the Roth IRA … now, remember, many of the people that have these 401(k)s and IRAs that are turning 70½ didn’t really have much time for the Roth option, but people do now. The Roth has been around … January 2018 will be 20 years. So more people should be taking advantage of it.
Jim Lange: And I’m also a big fan, and I know you are also. My favorite book of yours is still The Retirement Savings Time Bomb (and How to Defuse It). I think you did update it. That’s still my favorite book.
Ed Slott: I updated it in 2012, and other than updated amounts, it’s essentially accurate. But the whole point is there will be a reckoning day, a day of reckoning, where that tax hits, and it’s probably going to be at the worst possible time, when you’re the most vulnerable, when the paychecks stop in retirement when you need every dollar.
Jim Lange: Actually, we were talking about trying to tell people about your great offer on public television. We couldn’t find a great website for it, but if there was one thing that somebody could do right now, and even though the book is slightly dated, like you said, all of the concepts are right on, that book, I think, is … with all due respect, Ed, I know you’ve written a lot of books and you’ve spoken all over the place and you’ve done wonderful, very thorough analysis even for advisors, but that book would be the best. So could you also repeat the name of it?
Ed Slott: Oh, you can get it on my website or Amazon or something, and it is a 2012 edition, so there have been changes, but it’s called The Retirement Savings Time Bomb (and How to Defuse It), and if you just type my name into Amazon, it’ll come right up, or my website. My website is www.irahelp.com.
Jim Lange: Well, I’ve always loved that book, and I think, by the way, it has stood the test of time, literally, meaning that all the advice in it, I think, is excellent. And I know that you’re a big fan of Roth conversions, and we could probably do a …
Ed Slott: Well, I’m also a big fan of long-term planning, none of these short-term Band-Aids or quick fixes, and that’s why I like to talk about things that will hold up over time. That’s why I believe if you go into retirement tax-free, it may cost something now, but long-term, you’ll be way better off.
5. “Backdoor” Roth IRA Could Be Eliminated in Tax Reform
Jim Lange: Can I ask a specific question? Because there’s a little bit of controversy on this. So let’s say that your income is too high to make a contribution to a Roth IRA. There is something called a “backdoor” Roth IRA. Could you explain what that is and how that works and whether you think it’s completely kosher?
Ed Slott: Right. Well, basically, you make a contribution to a non-deductible IRA, for which there’s no income limit. You know, that’s a fact that even advisors sometime misunderstand. I always hear people, and even advisors, say, “Oh, I make too much to contribute to an IRA.” That’s not the case. There are no income limits for traditional IRAs. The only time income comes into play is if you’re active in a company plan, and even so, all that means is maybe you won’t get a deduction. So there’s no income limit to contribute to a traditional IRA. So you do that and do a non-deductible, and then, at some point, if you wish, part of it, all of it you can convert to a Roth IRA, and that’s how you can kind of override those limitations.
But some of the current tax proposals are taking aim at that. In fact, we just talked about the Roth 401(k), which I’m a big fan of. I don’t know if you saw the piece in the Wall Street Journal just a few days ago about a proposal to do away with 401(k)s completely, going to more of a Roth-centered proposal where there are no more tax deductions, and everybody puts in after-tax money. Now, that would be a huge shock to the system, so I can’t really see it happening. You know, you just can’t turn off the spigot cold turkey, but, you know, long-term, you may be better off having money growing tax-free.
Jim Lange: Well, I think so. On the other hand, I guess, theoretically, if you’re near the end of your career, you’re in a very high tax bracket, then you might want a traditional, and then you do a conversion after you’re retired and you’re in a lower tax bracket. That might be one of the exceptions.
Well, speaking of being in a lower tax bracket, so right now, both President Trump and the Republican Congress is interested in revising taxes. You know, President Trump is in the news now for wanting to lower the corporate taxes, and we just had a tax-policy expert saying that both President Trump’s version and the Republican version, but all the versions have lower taxes, which, presumably, at least according to this nonpartisan group, will significantly increase the deficit, and, like you said, well, you have to pay the bill sometime.
Ed Slott: We’ll just pay for it later under a new administration.
Jim Lange: All right, so let’s say that that is a realistic possibility. How can people profit from that information?
Ed Slott: That’s not only a realistic possibility, that’s math!
Jim Lange: OK, fair enough! I like your certainty. Let’s say that it is math. Let’s say that something is going to pass, either later this year or maybe early next year, that lowers the top-income rate and maybe even the middle-income rate, and let’s assume that you are right, and as a matter of math, at some point in time, whether it’s the next administration or two administrations from now, or even the current administration after they’re in a little bit of trouble, the tax rates are raised. Let’s say that we know that that’s going to happen. What are some things that people can strategically do to take advantage of that?
6. Once Your Retirement Account Is Built, Focus on Tax Planning
Ed Slott: Well, building a retirement account, believe it or not, is not so much about investments. Obviously, investments are an important part. But once you have the money, the key to building a retirement planning is around tax planning, not the investments. I like to say you manage your investments on the way in, but you manage the taxes on the way out, and one core foundational principle of good tax planning is to always, and this is an always rule. You know how in financial-advisory articles and things, they always say, “Well, it depends on the facts and circumstances, and if this and if that?” This is an always rule. This is non-negotiable. Always pay taxes at the lowest rates. That’s a core of good tax planning. So if we think the lowest rates are now, and I agree, somebody out there might be saying, “That sounds great,” here’s another good rule: Always buy low and sell high. You know, obviously, when is the right time? But I think that’s now. I just can’t see rates going much lower. They may dip a little lower from this new legislation, but at some point, it’s going to hit rock bottom. That’s when you strike. That’s when you move money from an IRA to a Roth IRA, and that’s when you start getting rid of the tax liability built up in your 401(k)s and IRA, because you’re getting it at the lowest rates. Always pay taxes at the lowest rates. You got deductions probably at much higher rates. So if you can get that money back, it’s almost like tax-rate arbitrage, playing the tax rate. You’ll come out ahead.
Jim Lange: And I agree with that, and I’m going to add if you take into consideration your own personal circumstances, and a lot of people don’t understand that at age 70, they’re likely to get clobbered for taxes because if they’re following some of my advice for Social Security, they’re probably holding up on Social Security, which, by the way, has the added advantage of keeping your tax rate lower to do more Roth conversions between retirement and 70. But still, in most of the numbers we run, we hardly ever convert everything. It’s usually a series of partials, but you’re still going to have a substantial minimum required distribution at 70, and you’re going to have at least … well, I call it “one-and-a-half Social Securities,” that is, the husband, and even if the wife didn’t work, and I don’t mean to be sexist, so I’ll just say the primary earner and the secondary earner.
Ed Slott: If you want to be correct on this, always use the phrase I use when I talk about this, “where the wife didn’t work outside the home.”
Jim Lange: OK. All right, where the wife didn’t work outside the home, we’re looking at what I’ll call one-and-a-half Social Securities. So a lot of times, people are in this high or higher tax bracket, even forgetting the national changes, after retirement. So the impact of doing a Roth IRA conversion at a lower rate is even more powerful for people who are not yet 70.
7. Lower Rates Are “Like Buying Taxes on Sale”
Ed Slott: Oh yeah, doing a series of smaller conversions, taking advantage of low brackets, but I might even push it a little. If you can afford it, you know, you don’t want to go broke converting, but if you can afford it, take advantage of these lower rates. It’s like buying taxes on sale. Everyone loves a sale. The difference with a sale on clothing is you don’t have to buy those items; with taxes, you do have to buy them. It’s just a matter of when. So, if you have to buy them anyway, buy them on sale, which is now.
Jim Lange: Well, and I’ll be even more specific. So, what some people do is they say, “OK, I’m going to go to the top of the 15 percent bracket, or the top of my existing bracket,” which is top of the 25 percent bracket, and the numbers that we’ve run, because we like to … well, we always say everybody’s a snowflake and you have to run individual numbers, because we’re not as firm as you. We’re more like a “It depends on your situation,’ blah blah blah.” But anyway, what we have found that surprises people is that we sometimes go to the next bracket. So, for example, it’s very common for us to take a 25 percent tax bracket payer and make a Roth IRA recommendation that will take them into the 28 percent bracket, and even though they don’t break even on day one, over a period of years, they end up way ahead.
Ed Slott: Yeah, I actually go further. When people are interested in doing a Roth conversion, I have them convert as much as possible, usually everything. Now, you’re probably saying, “Wait, what if they don’t have the money to pay the taxes?” That’s the beauty of the Roth. See, to me, the planning is not how much you convert, but how much of that conversion you keep, because with the recharacterization principle, or ability, the do over, the second look at it, if you convert today in 2017, you have until October 15th, 2018, over a year away, to change your mind. So, I’d rather convert everything and then bring back, once I know the numbers, which you’ll definitely know by that time, then undo the portion to get you to exactly where you want to be.
Jim Lange: By the way, I love that strategy. The only thing that I would add to that is that I would then do separate accounts. In other words, I wouldn’t have one big Roth conversion. I might, let’s say, divide it into five different accounts, and then you recharacterize. It’s kind of like betting on a horse race after the race is already over.
Ed Slott: Yeah, yeah, I like that saying. I had this with a few people, and unfortunately, when they had bad scenarios, like there was a big hurricane here years ago and people had huge losses, and in those cases, I had already had them convert large amounts to a Roth IRA, unknowing they would have this huge loss to write off! And the conversions went through almost untaxed in many cases, or they had business losses that were deductible. You never know when those things are going to happen, but if you already had done the conversion and then they happen, the conversion can be very low-cost. In other words, make lemonade out of lemons.
Jim Lange: Yeah, I love that idea, and I’m going to make one more point. I also like the idea that when you know you’re going to be in a low tax bracket for one reason or another, and the example I use is people going into a retirement community or a retirement home, where a certain, or even a substantial portion is for medical expenses, that is a beautiful time to make a Roth conversion.
Ed Slott: Right, right. Although, in that case, you’re really doing it more for your beneficiaries than for you.
Jim Lange: I would agree with that also.
We were talking about the impact of lower taxes, and Ed said the best time to pay taxes is when the rates are lowest, and one of the things that we are facing, or, I should say, our heirs are facing, is that the Senate Finance Committee voted 26 to 0 to, in effect, kill the stretch IRA, which would mean, subject to a $450,000 exclusion, that they are saying that after we die and we leave the money to a non-spouse, which is presumably our kids or our grandkids, they’re going to have to pay income tax on the entire amount, subject to the $450,000 exclusion on the IRA, which might push them into the highest bracket. Ed, I think you have been warning about this for years and years.
8. Stretch IRA Will Die Because Beneficiaries Don’t Lobby Congress
Ed Slott: Oh yeah, but nothing ever happened, but it’s on the block, and, you know, this is not even a Democrat or a Republican issue. It was in Obama’s budget. It’s up again. I can even count the number of times it’s been in and it never went anywhere. But as soon as some tax legislation goes through, it’ll be in there, and the reason it’s going to go in there is because nobody is protesting against it. There’s no lobby for beneficiaries. Beneficiaries don’t have a lobby. First of all, for beneficiaries, that would be work! Who’s going to get in for that? So there’s nobody, you know, holding a benefit for beneficiaries, and Congress always saw the retirement account as your retirement account. It was never meant to be an estate-planning vehicle. When IRAs began, they began because people had no money in their retirement account. Their corporate pensions had disappeared, companies were going bankrupt and not paying out the pensions that were earned, and this is back in the early ’70s, and they created the IRA as a holding tank so you wouldn’t run out of money. Well, over the years, many people accumulated large sums in IRAs that Congress never expected, so large that they couldn’t even spend it during their lifetime. So that started all of this benefit of the retirement accounts going to beneficiaries, and Congress was never thrilled with that. So it’d be an easy one to kill. Nobody would even notice, other than people like you and I and our colleagues that study these things. It wouldn’t even get noticed really in the media. You know, the stretch IRA is dead. The first thing people would say is, “What was that?”
Jim Lange: Well, I’m actually pretty concerned because if there is such a thing as a typical client …
Ed Slott: Oh, I’m not saying I’m not concerned, but you asked if it’s likely to happen. I believe yes, because there’s not a lot of pushback on it. Who’s pushing back on it? Like I said, there’s no lobby group.
Jim Lange: And the other reason why I think it’s very likely to occur is because if you’re going to lower rates for both corporations and individuals, and you’re going to have some attempt to get some revenue in somehow, here we have something that the Senate Finance Committee, on a bipartisan basis, voted for 26 to 0. So, I do think it is coming, and the numbers we’ve run, even though the Roth IRA conversion won’t be quite as good for your heirs, it will still be very helpful because they won’t get clobbered with … so, let’s say that I have a lot of clients and a lot of readers and listeners, and Pittsburgh’s a working town, and a lot of the readers and listeners got married relatively young and they worked through, let’s say, locally, Westinghouse or PPG or the university, and the salaries were never great, and, you know, it was hard saving money because they had to pay for their kids’ braces and they paid the mortgage and they paid the car payment, and then they paid for their kids’ college. So it’s really hard to save money, but they’re pretty conservative and they tended to max out their retirement plans. So now, they’re in their 60s and 70s and they have, sometimes, you know, one, two, three, four million dollars in their retirement plans, often not great spenders, and they’re going to leave money behind. So this death of the stretch becomes a very important part of, let’s say, their planning. Have you also found that Roth IRA conversions can, let’s say, reduce the impact of the death of the stretch, again, going back to your theme, getting into the tax-free at the lower rates?
9. Life Insurance Offers Enormous, Unlimited Tax Advantages
Ed Slott: Well, if that was the case, I would encourage a client maybe not to do a Roth at a later age, say, after age 70, because when you pay out tax money upfront, you have to look at the costs versus the long-term benefit, and the big benefit of the Roth has always been longevity, the amount of years, the snowball effect to the exponential compounding of tax-free money, but if that time period gets cut down to 10 or 20 years, then you have to look is the cost of paying taxes upfront worth the benefit if it all has to come out in 10 or 20 years. So you may want to look to other tax-free vehicles. That’s why I’m a big fan of, say, life insurance, where you could simulate the stretch through trusts if you want, or even charitable planning, and you could simulate it. You know, all that’s going to happen if this happens. First of all, as you said, the current proposal is a $450,000 cap on that or a coverage. So many people under that won’t be affected. They’ll be OK. But if you have bigger money, then it’ll ignite you to do probably better planning anyway. So, all that’s going to happen is it’ll awaken the giant to do the better planning they probably should’ve been doing all along, like emptying out these IRAs and putting it into, say, permanent life insurance policies, where the family will end up with actually more money and more of it tax-free, and more flexibility to leave it to a trust, or simulate a stretch IRA and protect it for beneficiaries.
Jim Lange: Well, by the way, that was what you had talked about in The Retirement Savings Time Bomb (and How to Defuse It), which, by the way, is my favorite book of yours, and you have confirmed what I thought, which is even though the book isn’t new, all the concepts still apply, and what you had said in that book was to take a small percentage, even maybe 1 or 2 percent or maybe more, of your traditional IRA, pay taxes on it now, use that money to buy a life insurance policy that is permanent. I happen to be a cheapskate, so I like low premium guaranteed-type policies. The downside of that is they’re never paid up. You just have to keep paying. But whatever type of policy might be the most interesting to you, and I have run all kinds of numbers and the book that I have written specifically regarding the death of the stretch IRA basically shows, under the existing law, that strategy of taking some money out of the IRA, paying tax, and buying insurance is good, but if the proposed law passes, then the benefit of that strategy is just enormous.
Ed Slott: Oh, of course, because you’re getting the leverage of life insurance and the tax-free benefit, and remember, it’s a much better asset to leave to a trust. Let’s say you do have a large account. Like you said, remember, the people like the $450,000 and under, they’re not going to have to worry about this, but if you have a million dollars in an IRA, you have to worry about if your kids have to take taxable distributions for the rest of their lives; if you want to control it, it has to go through a more complex scenario involving a trust. Life insurance removes all of those barriers. There’s no required minimum distributions when the kids inherit life insurance, it can remain in the trust tax-free, it can be doled out based on the discretion if you want to put that kind of discretion in a trust, and you don’t have to worry about the taxes when the big chunk of money from the life insurance comes in.
Jim Lange: And the other advantage is is that you can put in whatever provisions you want into the trust. So if, for example, you have a spendthrift child or a child with special needs, which I actually think is a great way to provide for a child who would not be able to work. That way, there is a certainty that that child will be provided for. Usually, I tend to be a cheapskate again. I don’t like to hire lawyers or banks, but I tend to prefer family members as trustees, who is going to watch over what’s going on with the, probably by now, adult child, and dole it out, and not have the minimum required distribution rules and the five specific conditions that the trust must meet to meet a qualified designation of a IRA. All right, so I think we are all in agreement on that. You know, again, people don’t necessarily love the idea of it, but if you’re looking to long-term protect your estate and protect your family, life insurance is wonderful leverage.
Ed Slott: Right, I’m a big believer, and I don’t sell life insurance. You may think because you hear me talking, I’m a CPA. I’m a tax guy. But from a tax perspective, the tax exemption from life insurance is the single biggest benefit in the code. It’s an unlimited benefit.
Jim Lange: And I think, specifically, what you’re referring to is, let’s say, for discussion’s sake, that you’re paying $10,000 or $20,000 a year in premiums, and maybe, over a lifetime, you pay maybe $200,000 in premiums, and the death benefit is, let’s say, a million dollars, and I think what you’re referring to is that $800,000 gain is not subject to taxes, not income taxes, not capital-gains taxes, not even inheritance taxes or estate taxes. So it really is a huge, literally, tax-free bonus that we can thank the life-insurance lobby for and that many of us can take advantage of.
Ed Slott: It may even be better than the real-estate lobby, but it’s close.
Jim Lange: Well, they’re both pretty favorable. We’ll see how they hold up with, let’s say, potential changes. But I’m still going to bet that it’s going to be a tax-free benefit, and it’s going to be even more favorable than under today’s law. But you also did mention IRA trusts, and you did mention some of the problems with them, and I’m the first one to acknowledge that. On the other hand, I do think if you do have a significant IRA, and it is appropriate to have the beneficiary be a trust, that you still want to do an IRA trust and get all the conditions right so that the beneficiaries can stretch it as long as they legally can.
Ed Slott: Right, and the key is getting all the provisions right, because IRAs are not like other assets that are left to a trust. They have their own internal rules inside the trust. Wherever they go, they have those rules. So you can’t write a trust, as you know, that just says “Do whatever you want” because there are constraints, and if you don’t follow them, the trust fails and the IRA could have to be paid out at high trust-tax rates costing you more.
Jim Lange: All right, I just want to mention that Ed is going to be, let’s say, relatively frequently on PBS. He has an offer associated with PBS that, frankly, is just out of this world. You get more stuff for $150, or 12-something a month, than you can imagine, and I don’t have a website for you, but please watch for that, and, in the meantime, you can get The Retirement Savings Time Bomb (and How to Defuse It), which is my favorite book of Ed’s. And it is always an honor to have Ed on the show, who, I think is universally acknowledged as the top IRA expert in the country, certainly measured by books sold, influence on both the professional and the consumer markets, speaking, et cetera. And one of the benefits, and I know many of our listeners are consumers, but I also know we have a national following, and many of the listeners are advisors. In fact, I know, just today, somebody mentioned that a bunch of advisors are listening to my webinar, but anyway, Ed, I get your newsletter, and I know that you like to say, “Oh, buy the e-copy because it’s a little cheaper.” I will admit: I’m an old-fashioned fuddy-duddy. I like the hard copy, and I get more great ideas …
Ed Slott: No, I think they’re the same price. You just get more with the online because you have access to the complete library of issues, going back over 10 years, or, I think, even 15 years or so.
Jim Lange: Oh, OK. I think my package has both. I get the hard copy and access.
Ed Slott: Oh, you may be on a special list, so don’t advertise that!
Jim Lange: Oh, sorry about that! But anyway, I love your newsletter. You have also generously given me permission to reprint some of the things that you had, and one I loved, which was talking about educating grandchildren, and you advocated using Roth IRAs instead of 529 plans. So you talk about a lot of good things, but you also talk about some of the mistakes people make. Can you tell us, let’s say, some of the doozies that you have run into in recent years?
10. Qualified Charitable Distribution From IRA
Ed Slott: Well, I don’t know about doozies. Yeah, I have a lot of doozies, but there are certain things that apply to everybody, like this year’s tax time. I still run a tax practice. I still see a lot of things. I’m not as in the trenches as I used to be years ago, but I notice things. Any time I look at a return, and I’m focusing now on something that just became permanent in the last two years: qualified charitable distributions. Some people call these QCDs or charitable IRA rollovers.
Now, as soon as I say “charitable rollover,” some listeners might roll their eyes and say, “Well, you know, I gave enough!” But this is not about giving; it’s about getting more out of what you’re already giving. So when I see a tax return that has required minimum distribution income on it, and I see a Schedule A itemized deduction for large charitable contributions, I’m saying to myself, “Why wasn’t this person told to do a qualified charitable distribution?” In other words, they’re going to give, say, $10,000 in charity anyway, and if their required minimum distribution happened to make $10,000 — just to make a perfect example — you’re going to give the money anyway. Give it from your IRA under this special provision and you don’t have to include the $10,000 in income. Lowering your income increases things like medical deductions, itemized deductions, tax exemptions, credits, all good things on a tax return, and it always saves you money. I don’t think I’ve seen a case where you can’t do worse, so you can only do better. So as long as you’re already giving money, give it that way.
The reason most people don’t do it is, I think it’s still kind of new. It was only made permanent at the end of 2015. It was this on-again, off-again, so people weren’t sure. Congress kept reinstating it and then it died. But now it’s permanent, whatever that means in the tax code, but it’s here now, and I think, if you’re listening, and you have a required minimum distribution and you also give to charity — I’m not saying to give more, I’m just saying do better with the gifting you’re already doing — do it that way, and if you’re unsure how to do it, ask a financial advisor or go to your financial institution and say, “Look, I normally give a thousand or two thousand to a charity. I want to do this qualified charitable distribution where it comes right out of my IRA.” That will reduce your income. Now, on the other side, you don’t also get the charitable deduction because that would be double dipping, but you’re lowering your income, and in almost every case, you’ll pay less tax, and this is especially true for people who take — and this is many people — the standard deduction, which means they don’t get deduction for charity because they’re taking standard deduction. This is a way to get the benefit of this qualified charitable distribution, give to charity that way, and get the benefit of it plus the standard deduction. So whenever I see a return, if this is you, if you have required minimum distributions and you also give to charity, you should be using this provision. It will save you money on taxes.
Jim Lange: Well, I think that’s a great idea to get the most out of your charitable buck, and I’ll take it one step further, and this is even after you die. I see people leaving money to charity in their wills, and then they leave the IRAs to their kids, and I’m thinking, well, let’s say you want to leave $10,000 or $20,000 or $100,000 or whatever you want to leave to charity, I would rather see people do that through the beneficiary designation of their IRA, and then leave the kids the after-tax dollars, leave the kids the Roth dollars, and what I always think of that is by slicing the pie differently. So we’re going to give the charity the IRA piece, because the charity doesn’t care if it’s a Roth, if it’s an IRA, if it’s after-tax, but your kids do.
Ed Slott: Well, I wouldn’t do it with a Roth IRA. Let’s just get that out of the way.
Jim Lange: Right, right, exactly. Yeah, the Roth and the after-tax always go to the family, but the traditional IRA or 401(k) can go to the charity, and that way, basically, you get a bigger piece for the charity, a bigger piece for your family and a smaller piece for the IRS.
Ed Slott: I say that to advisors all the time. I say, “If you see a bequest in a will, tell them reverse the bequest. Give the tax-free money to the family and give the taxable money to the charity.”
Jim Lange: Yeah, and I rarely see that, by the way, unless we prepared the documents, in which case, we do it routinely.
Ed Slott: Well, they’d have to be told. That’s again where a good advisor can point these things out, just like I think every CPA doing tax returns should be looking for what I just said about QCDs. If you see somebody taking required minimum distributions and they donate to charity, then why are they not putting the two together and taking advantage of the qualified charitable-distribution provision?
Jim Lange: Well, it’s interesting that you say that because I’ve heard that the biggest complaint to both CPAs and advisors is that they are not getting proactive advice. That is, the CPA is saying, “Hey, by the way, instead of leaving money to charity by writing a check, why not just come directly from your IRA,” or let’s say the attorney’s saying, “Well, gee, instead of leaving money as a bequest, why don’t we leave it as either a percentage or an amount of the IRA?” And we are very proactive in our practice. We love to do those strategies, and, to me, that’s actually fun, and I know that that’s what you advocate.
Ed Slott: Not only that, I came across one case where doing the QCD actually lowered Medicare premiums by about almost $2,000.
Jim Lange: Oh, that one I hadn’t heard of, but that makes sense. That actually makes perfect sense because you’re lowering your adjusted gross income. I love that.
Ed Slott: Right! You’re already getting the tax benefit plus an additional benefit because your income was lower. Medicare has these cliffs where you just go over by a dollar and the premiums soar.
Jim Lange: Well, I didn’t think of that additional benefit of the QCD, but I think that that does make sense, and I think many of the strategies that you have been talking about, we talked a little bit about the accumulation stage, but most of the strategies that we have been focusing on are, let’s say, later in life strategies, like what you had just said only applies to people who are older than 70. So, we’re really talking about people, I mean, hopefully, they’re all going to be around for many years, but you never know, of getting the planning right, not just in the accumulation stage, but in the distribution stage, and you sometimes tell a story about getting things right in the, let’s say, later part of your career, and then, before the show, we were talking about adding in Bill Mazeroski into that story to contrast, and I thought I would give you the stage and tell that because I think it’s just such a great way to end the show and to impress upon the listeners the importance of getting it right towards the end.
11. You Might Not Recover From a Tax Mistake in Retirement
Ed Slott: Well, when I do public television in Pittsburgh, which is quite often, they’re located right in walking distance, I don’t really know what the area’s called, but I always walk because it’s a childhood memory of mine, to that piece of Forbes Field. In fact, I have a picture of it I keep on my phone where Bill Mazeroski hit a home run in the 1960 World Series against my New York Yankees, and I always remember that as a kid. I was very young, but it was one of my first memories, and believe it or not, that has not been done ever since, a walk off Game 7 World Series-winning home run. Now, for the nitpickers, they say, “Oh no, no, Joe Carter did it!” No, he did it in Game 6. Nobody has done what Mazeroski did, and he had this great one event and he was in the Hall of Fame because at the right time, he stepped up and did it.
Now, there’s another guy, Bill Buckner, who had a one-time event if you’re a baseball fan. He dropped the ball against my New York Mets, and it allowed them to win the World Series. So the only thing they ever remember about these two famous baseball players, and they’re famous because of one event, but Bill Mazeroski’s famous because it was a good event, and Bill Buckner, who’s not in the Hall of Fame, is because his memorable event was a bad event, even though, if you look at his statistics, he has more hits than 70 percent of the players already in the Hall of Fame. Bill Buckner had 500 more hits than Joe DiMaggio, who was an MVP. He had over 2,000 hits. If you just looked at his stats, you would say, “Why isn’t this guy in the Hall of Fame?” Because when it counted, he made a mistake. So the analogy to retirement is when it counts in the second half of the game, like you were talking about, Jim, when you’re taking that money out, if you make a mistake, it’s over. It doesn’t matter how great you did your whole working, saving, building, investing for 40 years. If you make a mistake on the way out, that’s the one everybody will remember, especially your family!
Jim Lange: Well, I think that that’s just a great lesson because so many people have worked so hard, and like you said earlier, and I’m not going to discount the importance of getting the investments right, but getting the taxes right and getting the planning right is so critical, and, very frankly, so few people actually get the IRA part right. To me, it’s amazing. Even in Pittsburgh, you have a lot of attorneys with big names who work for big firms, and they might get some of the other parts right, but they don’t get the IRA planning right, and that really needs to be done. I don’t know if that has been your experience.
Ed Slott: You got to finish the game. It’s in the second half of the game. Nobody cares, you know? You could have made a fortune and had a huge IRA, but if you lose it all to a tax mistake at the end, what have you done? You built a savings account for the government. That’s all anybody will remember about you. Just like Bill Buckner! That’s all they remember about him. When it counted, he dropped the ball.
Jim Lange: And with the death of the stretch IRA, with that, let’s say, looming legislation, the odds of making a mistake and subjecting your kids to massive taxes that could’ve been avoided by planning earlier by a number of things, we mentioned life insurance, and then we mentioned Roth and a few other things, are really critical.
Ed, you have been a great source of information, and I’m going to refer people to what I think is the best deal that I know of, which is, if they do … and I wish I had a website that I could refer them to, but if they catch you on public TV in Pittsburgh or throughout the country, that you have this unbelievable offer. I think you have 20 CDs and DVDs for $150, and by the way, I’ve seen the equivalent go for a thousand dollars, two thousand dollars. So, I think that that is a great thing. Your newsletter I think is a great thing for advisors, and that can be found at www.irahelp.com, and then your book The Retirement Savings Time Bomb is still my favorite. I know your most recent is Ed Slott’s 2017 Retirement Decisions Guide, and that’s certainly the most current, but, to me, in terms of classic Ed Slott, it’s The Retirement Savings Time Bomb. So I wanted to thank you again for giving our listeners some great information, and I hope our listeners take advantage of some of the information that you offer.
Ed Slott: Thanks very much for having me on again, and I’ll see you when I’m in Pittsburgh.
Jim Lange: OK, I’ll see you then.