The Potentially Dire Consequences to Your Legacy with the “Death of the Stretch” IRA

Posted on May 22, 2019 by James Lange in Beneficiary Designations, Current Events, Economy, Estate Planning, Estate Tax, Financial Scandals, Government Programs, Inherited IRAs, Roth IRA, Stretch IRA and tagged Beneficiaries, inherited ira, James Lange, PA, Pittsburgh, Roth IRA, stretch ira.

The Death of the Stretch IRA is rearing its ugly head again.

As I have written about, this is personal to me. I was hoping that distributions from my Roth IRA and IRA would be “stretched” over the life of my daughter and maybe grandchildren. It could make a difference of well over a million dollars to my family.

If you have a million dollar or more IRA or retirement plan, this threatened (but as yet not totally defined) legislation could be just as devastating to you and your family. Once the two houses reconcile their differences (see the above post for the details of the different proposals), established estate plans will likely need to be reevaluated. This threat increases the merits of Lange’s Cascading Beneficiary Plan or a similar flexible estate plan. It also creates an even greater incentive for IRA owners considering significant Roth IRA conversions.

I wrote two books on this topic based on the proposal that advanced through the Senate Finance Committee beginning in 2016. While the changes to IRA and retirement plan distribution rules weren’t included in the last set of tax changes (much to our surprise), clearly the idea still has a huge bipartisan appeal.

The action points in both books was to reconsider and revisit the idea of converting more of your IRAs to Roth IRAs. This is consistent with my most recent recommendations encouraging higher conversions because of the low income-tax rates we are currently enjoying. The threat of losing the ability to stretch distributions from IRAs and retirement plans for generations only makes looking into Roth IRA conversions more compelling. If you have an IRA and/or other retirement plan and were hoping to leave it to your heirs with a favorable tax treatment and want to be kept up to date with this information, please call our offices at 412-521-2732.

The Essence of Lange’s Cascading Beneficiary Plan

Posted on November 14, 2017 by James Lange in Beneficiary Designations, Inherited IRAs, IRAs, Lange’s Cascading Beneficiary Plan, Roth IRA, Stretch IRA and tagged Families, Lange's Cascading Beneficiary Plan, Leave it to Beaver, stretch ira.

Learn how Lange’s Cascading Beneficiary Plan can help ease your worries for your family’s financial future.

Somewhat tongue-in-cheek, I refer to “Leave it to Beaver” families as the perfect candidates for the Lange Cascading Beneficiary Plan (LCPB). Just to be clear about what I mean by that, I am showing you a basic version of the family tree for that type of family. Blended families with children from different unions sometimes need to have estate planning with more complicated beneficiary designations. It is not that the LCBP cannot work, but it is not as straightforward. With that in mind, let’s look at the essence of Lange’s Cascading Beneficiary Plan.

Lange Cascading Beneficiary Plan example photo

It is important to think long-term with financial planning using the Lange Cascading Beneficiary Plan.

In previous content of the Lange Cascading Beneficiary Plan series, I have discussed the tax and long-term estate planning benefits of leaving your IRA and retirement accounts, when possible, to the youngest members of your extended family to get the longest stretch possible. Remember, keeping money in the tax-deferred environment (traditional IRAs and retirement plans) or the tax-free environment (Roth IRA etc.) for as long as possible works to your heirs’ advantage.

But, let’s be realistic. Even if you understand that the tax benefits are greater when you leave your IRA to your grandchildren, most couples want to ensure that their surviving spouse will be financially sound with enough discretionary money to lead a happy and fulfilling life. So, if we take that attitude, it might seem that the simplest and safest route is to simply leave all your money to your surviving spouse.

Or, you make some calculations and decide your surviving spouse will probably be fine with most of your IRA but some of it could go to the kids upon the first death. Maybe your plan works out perfectly, but maybe it doesn’t. Let’s look at an example. You have a two-million-dollar IRA, and you think, based on future calculations that your spouse will only need about $1,500,000.

You could make your children the beneficiaries of $500,000 at your death. Conducting your estate planning in this manner could provide your children with some inheritance after the death of the first parent. It might be very useful to them, especially if they have children of their own that will be needing money for school or facing other monetary challenges associated with raising a family.

The financial market is in constant flux, keep that in mind when making plans.

That sounds like a great plan but what happens if the market takes a big dive? The two million you thought was going to be there has dropped to 1.5 million, and you have designated $500,000 of that to go to the children. Now, your surviving spouse has less money to live on, and you fail to meet your objective of providing for your spouse. That would be horrible. Divvying up an estate appropriately is one of the biggest hurdles of estate planning.

So, you go back to square one, and leave everything to your surviving spouse outright. Down the road, your family will likely have to give up more in taxes. Furthermore, if changes in the tax code modify the advantages of the stretch IRA, you could potentially forfeit the tax advantages that might be offered to compensate a bit for the loss. There was talk, for instance, of allowing $450,000 of an Inherited IRA to be stretched over a lifetime, and this exemption allowance would be available to both spouses.

If your estate planning leaves everything to your spouse, you forfeit one $450,000 exemption. Whereas, if the first spouse to die leaves $450,000 to the kids (giving them the advantage of the stretch), then when the second spouse dies, the children can take advantage of the second exclusion and stretch another $450,000. That is a big difference.

This is why the Lange Cascading Beneficiary Plan is right for you.

What we come back to time and again, is that we don’t have a crystal ball that allows us to plan for the future with any confidence that we are making decisions that will be appropriate for the circumstances at that time. That is precisely why the LCBP is so effective. You can draft the documents in such a way that your surviving spouse (with the help of an advisor and perhaps the grown children) can make good decisions about allocating the estate that are both tax-savvy and in the best interest of the family.

Picking up on our previous example where the stock market took a dive and there is less money overall for the surviving spouse. Under the terms of the LCBP, he or she could say, “Hey, I’d love to help the kids out, but I need all the money.” End of story, surviving spouse just keeps everything and we get a good result.

The essence of the LCBP will put you at ease.

Alternatively the surviving spouse has more than enough money for long-term security and a comfortable lifestyle, so he or she decides that money should go to the kids. So, with the cascade in place, divided among the children equally, and with disclaimers available, the surviving parent can look at each child’s situation and help them in the way that makes the most sense. Perhaps one child has a bright financial future, and it would make more sense to pass money onto their children (the grandchildren). In that instance, the first child could disclaim their portion directly to their children via well-drafted trusts.

Second child would love to do the same, but actually, he or she could use the money. So, he or she accepts the inheritance, and does not disclaim to his or her children. Flexibility works. And, a further advantage is that none of these decisions must be made quickly. The family has nine months after the first death to finalize all decisions. A little breathing room after a crisis can be very welcome.

With documents that offer flexibility, you don’t have to predict the future to provide for your family in a way that makes sense for the time. Lange’s Cascading Beneficiary Plan allows for terrific post-mortem planning that can make an enormous difference for the family.

Next week, we will examine estate planning with the potential $450,000 exclusion in more detail.

See you soon!

P.S. If you want to do a little advanced study on this topic before the next post and video, go to https://paytaxeslater.com/estate-planning/.

Why Flexible Estate Planning Matters, Especially for IRA and Retirement Plan Owners

Posted on October 12, 2017 by James Lange in Estate Planning, IRAs, Lange’s Cascading Beneficiary Plan, Retirement Plan Options, Roth IRA and tagged Estate Planning, IRA, James Lange, Lange's Cascading Beneficiary Plan, Retirement, Roth IRA, stretch ira.

Why Do We Need Flexible Estate Planning?

Welcome back, Friends! This is the second post in my new video series on Lange’s Cascading Beneficiary Plan—the best estate plan for traditionally married couples, or what I like to call “leave it to beaver couples,” in contrast to blended families where more variables come into play for estate planning.

Why do we need flexible estate planning? Why is it so valuable for IRA and retirement plan owners? Well, to get there we must think about the unique tax features of IRAs and what happens to an IRA when you die…

Most contributions to IRAs and retirement plans are tax deferred. We will ignore Roths for now. Their status as tax-deferred investments is valuable to you and to your heirs. Under the current law, you can take advantage of a great estate planning tool referred to as “the stretch IRA.” Stretching the IRA means keeping as much money as possible in the tax-deferred environment for as long as possible. We want to allow as much of the principal in an inherited IRA to grow tax-deferred for as long as possible—currently a child or even a grandchild can stretch distributions from an inherited IRA over his or her lifetime. But, we are looking at a possible change in the laws regulating retirement plans that could really ruin that opportunity. Having flexibility in your estate planning allows you to roll with the changes, and make good decisions under the new rules. But let’s take a little closer look at how the stretch works.

Bob Smith is a married 69-year-old retiree with a million dollars in his IRA. On April 1 of the year after he turns 70 ½, Bob must begin taking annual required minimum distributions (RMDs) from his retirement plan. You see, the government has been letting Bob defer income taxes on his IRA contributions for many years. But eventually, they want their share! RMDs are calculated using numbers found in IRS Publication 590. Publication 590 gives us a divisor that is based on the joint life expectancy of Bob and someone who is 10 years younger than Bob. We see that at age 69, Publication 590 says that Bob’s divisor is 27.4 (very nearly 4%). So, when you do the math, this first year Bob must take out close to $38,000. So, for the rest of his life Publication 590 is used to determine how much of a distribution Bob is required to take annually.

Now, when Bob dies, the ownership of that IRA is transferred to his wife, Jane Smith. Conveniently in this example, she is the same age as Bob so she begins taking her required minimum distributions exactly as Bob did. As time goes on, her life expectancy decreases, and the distributions get larger. When Jane dies, however, what’s left in the IRA will go to their children as an Inherited IRA. This is when things can get interesting.

Let’s assume for discussions sake that their child, Sally, is now in her sixties. Sally will be required to take minimum distributions as well. The difference is that her distributions will be calculated based on her life expectancy. Which, obviously, is much longer than her mother’s was at the end. So, the dollar value of the distributions drops, and the bulk of the account continues to grow tax deferred for a long time—and Sally benefits from the power of compounding.

You all know that I am a big fan of paying taxes later. So, if you have done flexible estate planning, like Lange’s Cascading Beneficiary Plan, and if you can afford it, here is an even more dramatic possibility. Since the flexible estate plan allows Sally to disclaim the Inherited IRA (she doesn’t need the money), she can pass it directly to her son, Phillip (her parents’ grandchild). Now, Phillip is in his thirties and his required minimum distribution is even lower. Think of how long that deferral can run!

And, if you REALLY want to think of something incredible, imagine that this retirement plan is a Roth rather than a traditional IRA. Now, all those distributions are tax free and we are really talking about building generational wealth. The video with this post goes into detail about how IRAs are treated after death, and provides examples using specialized software that show how family wealth can grow using inherited IRAs and Roth IRAs—with the caveat is that this is how things work under the current law.

Unfortunately, we still believe that the death of the stretch IRA will pass in 2017 or 2018. What is going to happen, subject to exception, is that the non-spouse beneficiary will no longer be permitted to stretch distributions of an Inherited IRAs over his or her lifetime. Any amount over $450,000 will be required to be disbursed within 5 years of the IRA owners’ death. Potentially devastating! There are some work-arounds that we have devised in anticipation of the law changing but this is precisely why flexible estate planning is so critical. Enjoy the video.

See you next week!

-Jim

P.S. If you want to do a little advanced study on this topic before the next post and video, go to https://paytaxeslater.com/estate-planning/.

Stop the Sneaky Tax!

Posted on September 6, 2017 by James Lange in Beneficiary Designations, Inherited IRAs, QTIP Trusts, Retirement Plan Options, Roth IRA Conversions, Stretch IRA and tagged death of the stretch ira, end of the stretch ira, inherited ira, James Lange, new ira laws, new ira rules, Retirement, Roth IRA, Roth IRA Conversion, Save Our Stretch IRA, Sneaky Tax, Stop the Sneaky Tax, stretch ira, stretch ira changes, stretch ira rules, stretch roth ira.

It’s Time to Stop the Sneaky Tax!

Those of you who follow my blog know that I have been somewhat obsessed with the legislation that I call the Death of the Stretch IRA. If you’re new to my blog, please read some of the preceding posts – they’ll tell you just how much this legislation will cost IRA owners. The worst part of the Death of the Stretch IRA is that most beneficiaries (your children and grandchildren) won’t have a clue about how much of their inheritance they have lost to taxes. When they inherit your IRA after you die, your beneficiaries will suddenly have more money than they had before. Our government is counting on them to be content with their higher bank balance, and is hoping that they never notice that an enormous chunk of their inheritance ended up in Uncle Sam’s pockets before the remainder found its way to them. That’s what makes this tax so nefarious and, well, sneaky!

Our government has a lot of expensive problems right now – they’re looking to come up with a viable heath care system, build a wall on our southern border and I can’t even begin to imagine how much it will cost to repair the damage done by Hurricane Harvey. The Treasury doesn’t even have enough money to pay for their day-to-day operations, much less all of this – they’re going to be raising the debt ceiling next month! I’d bet my own IRA on the fact that the government is planning to include the Death of the Stretch IRA – and the $1 Trillion in revenue that it will generate – as part of an appropriations or budget action that will be voted on before the end of 2017.

You Can Help Stop the Sneaky Tax

If you are a loyal reader, you know that we have been writing our clients and friends to warn them about the sneaky tax, and working on solutions to minimize the damage that this legislation will do. Now it’s time to send a shot across their bow and tell the government that they’d better find their revenue someplace else besides your IRA. We are asking your help to start a grass-roots protest against the Sneaky Tax which would kill the stretch IRA—an incredibly useful estate planning tool. This new law would be so absolutely devastating to so many families across the country, our clients included, that we can’t just sit by and watch it happen.

Write Your Congressman Now

Please help us get the message to our legislators that we will not stand for them picking the pockets of our children and grandchildren. Please consider going to www.stopthesneakytax.com to add your name to the list of people who are unhappy with this proposed new law and send an email to your Congressmen asking them to say NO to the sneaky tax. You can also keep up to date with what is going on with this law by joining our new private Facebook group: SOS Save Our Stretch! Stop the Sneaky Tax! You can join the group by going to www.saveourstretch.com. For a limited time, joining the Facebook group will entitle you to a free Advance Reader Copy of Jim’s newest book – The 5 Greatest Tax-Saving Strategies for Protecting Your Family from the New Tax Law.

Sign our Petition to STOP Washington’s Planned Trillion Dollar IRA Sneaky Tax at www.stopthesneakytax.com.

Join our Facebook Group for breaking news and updates at www.saveourstretch.com.

And please forward this to everyone you know who has an IRA!

-Jim

Action you can take:
Forward this petition to all of your friends’
Join our Facebook Group and for a limited time get a FREE advanced reader copy of my upcoming book dedicated to stopping the sneaky tax.

You can view my previous posts on the Death of the Stretch IRA by clicking the links below;

Recharacterizing Roth IRA Conversions? – Your Ace in the Hole When the Death of the Stretch IRA Passes?

Posted on August 24, 2017 by James Lange in IRAs, QTIP Trusts, Roth 401(k), Roth IRA, Roth IRA Conversions, Stretch IRA and tagged death of the stretch ira, end of the stretch ira, Finance, Financial Advisor, inherited ira, James Lange, new ira laws, Retirement, risk, Roth IRA, Roth IRA Conversions, roth ira recharcterization, stretch ira, stretch ira 2017, stretch ira rules, stretch roth ira.

What Are The Risk of Roth IRA ReCharacterizations?

This post is the last in a series about how you might be able to use Roth IRA conversions as a defense against the Death of the Stretch IRA.

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.

How does a Roth IRA Conversion Work?

Suppose you have an IRA worth exactly $1 million, and that it happens to be invested equally in ten different mutual funds of $100,000 each. Then suppose we run the numbers for you and figure out that $100,000 is the optimal amount for you to convert to a Roth IRA. How does a Roth IRA Conversion work?

Well, one idea would be to start by ranking your funds according to how much you expect them to fluctuate in value. Maybe you are holding a portion of your IRA in Certificates of Deposit at your bank. Most people would expect that money to be “safer” because it generally doesn’t fluctuate in value. Then suppose you have a portion of your IRA invested in large cap stocks. You’ve noticed the value changing as the stock market moves up and down but, in your case, we’ll say this fund fluctuates an “average” amount compared to your other holdings. Then suppose that you also a portion of your IRA invested in small cap stocks, and that fund has been known to lose 20 percent of its value overnight. We’ll call that one the “riskiest.”

So which part of your IRA should you convert? You could convert the CDs or the ones that you consider to be the safest. Or you could convert the small cap stocks – the one you consider to be the riskiest. Maybe you’d like to convert part of each fund that you own. Let’s look at the possible outcomes.

You can certainly convert your CDs but, in my opinion, going through all that paperwork to avoid paying taxes on the one or two percent you’ve probably earned on them doesn’t seem worth the time or trouble. What about converting a little bit from each fund you own? I’d prefer that to converting the CDs, but it still seems like more work than necessary. What about your “riskiest” fund – the one that has the value that fluctuates wildly? Let’s assume that you converted $100,000 of that fund. What position might you be in a year down the road?

Well, suppose that fund doubles in value. You now have a Roth IRA worth $200,000 but you only had to pay tax on a $100,000 conversion. Good for you! But suppose the fund went down in value, and now you have a Roth IRA worth $50,000. Worse yet, you’ve paid $25,000 in income taxes, and now you’re really mad at me.

Recharacterize Your Roth IRA Conversion

Remember, as long as you act by the October tax deadline, you can recharacterize, or undo, your conversion. This flexibility can give you enormous peace of mind while you’re waiting for the details of the Death of the Stretch IRA to be finalized. A recharacterization will NOT get back the money your investment may have lost – you will need to wait for the market to come back up for that. What the recharacterization can do is get back the money you paid in income taxes, if the account goes down in value.

A Risk of Roth IRA Conversions

As beneficial as Roth IRA conversions and recharacterizations can be, there is always one risk I make clients aware of when discussing them. It has to do with the IRS itself. Have you ever known anyone who has gotten tied up in an endless and stupid loop of government red tape? Let me tell you about a married couple I know, who have always filed jointly. The wife, whose name has always been listed second on the tax return, started a consulting business and, as she was required to, made an estimated tax payment for the income she earned. The couple filed a joint return and waited for their refund to arrive. They finally received a letter from the IRS and opened it, only to find that there was no refund enclosed. Worse yet, there was a letter saying that no refund would be coming because they had overstated the amount of tax they had paid – a transgression that not only caused the IRS to completely wipe out their refund but add a significant amount of penalties and interest to their tax bill.

Armed with copies of canceled checks, the wife went down to the local IRS office and demanded they retract their letter – which they eventually did. But do you want to know why it happened in the first place? When the wife made the estimated tax payment for her business, she paid it using her own Social Security number because that was the number shown on the 1099s she’d received for her consulting work. Unfortunately, when they received her check, the IRS didn’t recognize her as a taxpayer. Even though she’s always filed jointly with her husband, her name and Social Security number were listed on the second line of the return, not the first. And because hers was not the first name – even though it was a joint tax return – the IRS could find no record of her, and her tax payment just went into a big black hole!

Unfortunately, we have found that the IRS sometimes has trouble putting two and two together. If both your conversion and recharacterization forms aren’t filled out exactly right, you could risk getting a nasty letter in your mailbox. We fight those battles with the IRS on behalf of our clients, but if you’re a do-it-yourselfer, you need to know that it’s not unheard of for them to have a record of just one form or the other – but not both. If it happens to you, you need to stick to your guns and get it sorted out. A Roth IRA conversion can be your best defense against the Death of the Stretch IRA, and you can change your mind as long as you recharacterize by the deadline!

Thanks for reading, and stop back soon!

-Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

Roth IRA Recharacterizations and the Death of the Stretch IRA

Posted on August 17, 2017 by James Lange in Inherited IRAs, IRAs, Roth IRA, Roth IRA Conversions, Stretch IRA and tagged death of the stretch ira, end of the stretch ira, inherited ira, James Lange, new ira laws, Retirement, Roth IRA, Roth IRA Conversions, stretch ira, stretch ira 2017, stretch ira rules, stretch roth ira.

Are Roth IRA Conversions legal? How can you change your mind after making a Roth IRA conversion?

This is one in a series of posts about Roth IRA conversions and the Death of the Stretch IRA. If you have not visited my blog before, it might be helpful to back up and read a few of the preceding posts.

Roth IRA Conversions – a Legal Way to Beat the Death of the Stretch IRA?

As you might know, I do a lot of presentations for legal and financial professionals, as well as plain old normal people, about Roth IRA conversions and the Death of the Stretch IRA. One question that comes up a lot in my presentations involves the legality of Roth IRA conversions. People look at the numbers I show them and say, “It doesn’t seem right that you can do this because your family is so much better off. It seems too good to be true. Is it legal to do this?”

In order to answer that question, I’d like to refer you to this quote from Judge Learned Hand said “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”

I definitely do not advocate doing anything illegal – in fact, I applaud you if you were one of the people who asked the question – but, like Judge Learned Hand, I certainly believe that you should take advantage of every tax break that you’re allowed to. Would you worry about taking a tax deduction for a Traditional IRA contribution that you made, or for a donation to a charity? Of course not! Roth IRA conversions are no different. They’re definitely legal – they’re permitted by the US Tax Code, and the IRS even has a specific form that your CPA has to use when you do one. The problem is that they’re very complicated, and most people don’t like the idea of having to deal with even the most basic tax maneuvers – much less the complicated ones. So yes, Roth IRA conversions are definitely legal, and you don’t have to worry about bringing the IRS down on your head if you do one. But I still want to talk to you about how you can possibly get hurt when you go through the process.

Roth IRA Recharacterizations – Your Safety Net

Suppose you’ve read my books and my blog, and you’re rightly concerned about the Death of the Stretch IRA. You convert $100,000 of your Traditional IRA, and, because you’re in the 25% tax bracket, you paid $25,000 from your after-tax money. You now have a Roth IRA worth $100,000 and your savings account is $25,000 lighter. Then the market crashes, and suddenly your Roth IRA is worth only $60,000. You paid all those taxes for nothing! Or did you?

At the risk of making a complicated topic even more complicated, you need to know about Roth IRA recharacterizations. If you make a Roth IRA conversion, the IRS gives you until October 15th of the year following the year that you made the conversion, to change your mind. So if you make a Roth IRA conversion in 2017, and the value of your account goes immediately down, you have a fairly long time where you can wait it out and see if the market recovers. But suppose it doesn’t recover? Well, as long as you act by October 15^th of 2018, you can recharacterize, or “undo”, your conversion. I like to give my clients as much time as possible to decide whether or not the Roth conversion was a good idea, so I generally suggest that they ask for an extension on their tax return so that they don’t file it before that October 15^th date. In most cases, a drop in the stock market that happens right after a Roth conversion and causes so much chagrin will work itself out within a year, and my client is happy that they made the change after all. But if there is a long-term drop in the stock market, like there was in 2008, it is good to know that you can change your mind. There is one thing I do want to point out, though. If you recharacterize your Roth conversion, you’ll get back the money you paid in taxes. You won’t get back the money you lost in the market – at least not because of the recharacterization. You might get your money back eventually, but you’ll have to wait until the market comes back up.

Like Judge Learned Hand said, you are not obligated to pay more tax than the law requires. Roth IRA conversions can provide you with a hedge against the Death of the Stretch IRA, and save your family an enormous amount of money in taxes over the long term. And the ability to recharacterize, or “undo” your conversion should give you the peace of mind in knowing that you do not pay a nickel more in tax than you have to.

Stop back soon for more Roth IRA Conversion talk!

-Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

Part II: How Roth IRA Conversions Can Help Protect You Against the Death of the Stretch IRA

Posted on August 10, 2017 by James Lange in Inherited IRAs, IRAs, Roth IRA, Roth IRA Conversions, Stretch IRA and tagged death of the stretch ira, end of the stretch ira, inherited ira, James Lange, new ira laws, new ira rules, Retirement, Roth IRA, Roth IRA Conversions, stretch ira, stretch ira changes, stretch ira rules, stretch roth ira.

Roth IRA Conversions and the Death of the Stretch IRA

This post is part of a series about using Roth IRA conversions as a defense against the legislation that I call the Death of the Stretch IRA. If you are new to my blog, you might find it beneficial to back up and read my earlier posts.

The Best Time to Convert a Traditional IRA to Roth

One of the reasons that people can be reluctant to convert a traditional IRA to a Roth is because they have to pay tax on the transaction. Nobody wants to give the IRS one more cent than they’re entitled to, right? And it’s true – any amount that you convert from a traditional IRA to a Roth is taxed, just like a normal withdrawal. But here’s the bigger problem. Not only do Roth conversions increase the amount of tax you owe at the end of the year, it can also increase the rate at which you pay tax. Managing the tax implications of Roth IRA conversions can be a huge problem for people who are looking to protect themselves against the Death of the Stretch IRA, so I want to tell you about the sweet spot that you should look for if you are considering a conversion.

First, I want to clarify that the examples that follow are based on the 2016 tax tables. The IRS has not published the 2017 tables as of this writing, so for purposes of illustration, we’re going to use the 2016 tax tables. But as an example: if you’re married and file a joint tax return with your spouse, you can earn up to $75,300 and stay within a 15% tax bracket. If you earn $1 more – $75,301 – you’ll shoot up to a 25% tax bracket. If you’re a high earner, you can earn up to $231,450 and pay 28% in taxes. If you earn $231,451, you’ll move up a tax bracket, to 33%.

The best way to convert a Traditional IRA to a Roth, therefore, is to first project how much income you’ll have during the year. Let’s say that you’re 64 and still working and, after adding up all of your income sources, you think you’ll end up with $131,450. And then let’s say that you have $1 million in a Traditional IRA. Should you convert all of that into a Roth? For most people, that would be a very bad move. But what you might be able to do is convert $100,000 because, when that amount is added to your other income, you’d still be in a 25% tax bracket. We generally recommend that our clients do series of small Roth IRA conversions that consider their other income sources so that they do not increase their tax bracket. For many people, the sweet spot for their conversion amount will be the difference between their normal income, and the top of their tax bracket.

I gave a workshop recently where someone was really having difficulty understanding why you’d want to pay taxes one moment before you had to. He asked, “Why does it matter when I pay the taxes if I’m going to be in the same tax bracket now or later?” And while he was (technically) correct about the amount that he was considering converting, what he’d forgotten about was the future gains. If he doesn’t convert, the gain earned inside his traditional IRA will be taxed when it is withdrawn. If that gain is earned inside a Roth IRA because he converted, the withdrawals will be tax-free. And when the Death of the Stretch IRA finally passes, having that pot of Roth IRA money that you can dip in to without having to worry about the tax consequences can give you enormous flexibility in retirement.

Future Income Sources Affect Roth Conversions

There’s one other point about taxes that I want to make. They frequently change after retirement! Let’s consider another example. Joe’s 65 years old and has just retired from his job. He also took my advice about Social Security and is waiting until age 70 to apply. From the IRS’s perspective, Joe doesn’t have a lot of income. Actually, he’s pretty comfortable because he’s just living on a savings account, but he has no wage income or Social Security income. These are the years when it might be a really good idea for Joe to consider a series of Roth IRA conversions and the best way for him to save some money in taxes! Why? Because when Joe is 70, he’s going to have income from Social Security that is higher because he waited, and he’s also going to have to take required minimum distributions from his retirement accounts. Taxes, taxes, taxes! If he is able to convert some of his traditional IRA to a Roth now, while he is in a low tax bracket, the required minimum distributions from his traditional IRA (if he has any left) will be less. And if he needs more income, he can always tap into his Roth.

Roth IRA conversions can be a great defense against changes in your personal tax situation, and against the Death of the Stretch IRA.

Thanks for reading, and stop back soon!

-Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

Roth IRA Conversions and the Death of the Stretch IRA

Posted on August 3, 2017 by James Lange in Inherited IRAs, IRAs, Roth IRA, Roth IRA Conversions, Stretch IRA and tagged death of the stretch ira, end of stretch ira, inherited ira, James Lange, new ira laws, new ira rules, Retirement, Roth IRA, Roth IRA Conversions, stretch ira, stretch ira 2017, stretch ira changes, stretch ira rules 2017, stretch roth ira.

How Roth IRA Conversions Can Help Protect You Against the Death of the Stretch IRA

Those of you who follow my blog know that I’ve spent a lot of time talking about the Death of Stretch IRA, and some ideas that you can take advantage of that could provide some defense for your own family. The next few posts will continue my discussion about Roth IRA conversions, and how they might benefit your heirs after the Stretch IRA is eliminated.

When Will the Stretch IRA Be Eliminated?

Some of my critics have said that I’m making a lot of noise about something that might never happen. They say that the Stretch IRA won’t be eliminated, and all of this discussion is for naught. I have two responses to that. First, I think it’s completely unrealistic to expect that our legislators will maintain the status quo. We have reached the point where our spending is no longer sustainable. Our national debt is estimated at about $20 trillion, but an even scarier statistic is how it relates to our gross domestic product (GDP). That number is about 106 percent – meaning that we owe more than what the entire country produces. At one point, President Trump suggested that we follow the lead of other countries and simply default on our debt. I would be surprised if he could get that proposal through Congress, but if he plans to return the country to solvency as he promised, he’ll need a lot of revenue to do it. With more than $25 trillion being held in tax-deferred retirement accounts, eliminating the Stretch IRA is a quick and relatively painless way to pump a lot of tax money into the government’s coffers. And that, my friends, is why I believe that the Death of the Stretch IRA will happen soon – possibly before the end of 2017. More than likely, the Death of the Stretch IRA will be included as part of a major tax reform – which, as you might recall, was part of President Trump’s campaign platform. Remember, he promised a simplification of the tax code – and there’s nothing simpler than grabbing all your money by eliminating the Stretch IRA!

Roth IRA conversions – A Great Defense Against the Death of the Stretch IRA

Let’s suppose you die before the Stretch IRA is eliminated. Your family will be in a better financial position because they can withdraw your IRAs using the old rules – and stretch it over their lifetimes. But even if they are able to use the old rules, you could still be better off by doing a series of Roth IRA conversions. In my previous posts, I talked about the concept of purchasing power, and how you and your spouse can be better off during your lifetimes if you convert. We’ve proven this to hundreds of our clients by running the numbers for them, and collectively they’re better off by millions of dollars because they took our advice.

But what if the Death of the Stretch IRA happens during your lifetime? Do you believe, as I do, that the Stretch IRA will be eliminated so that the Congress can put one finger in to the country’s fiscal dyke that is already bursting at the seams? Well, when I give talks about possible solutions to the Death of the Stretch IRA, I tell people that Roth IRA conversions are a tool that can be beneficial in either situation. So it doesn’t matter if you die before or after the Stretch IRA is eliminated – Roth IRA conversions can still be beneficial to your family.

Waiting for the Death of the Stretch IRA

It was less than a year ago that the Senate Finance Committee voted 26-0 to eliminate the Stretch IRA. Congress never got a chance to vote on their proposal because they were consumed by one of the most bitter and contentious election processes in recent history. Well, we’ve been watching Congress’s actions all summer long, and have had ongoing discussions with some individuals who are in the know about the status of the Death of the Stretch IRA. If you subscribe to this blog, you’ll be among the first to know when it finally happens.

Stop back later for the latest updates on the Death of the Stretch IRA!

Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

The Best Time for Roth IRA conversions: Before or After the Death of the Stretch IRA?

Posted on July 25, 2017 by James Lange in Inherited IRAs, IRAs, Roth IRA, Roth IRA Conversions, Stretch IRA, Video Resources and tagged death of the stretch ira, end of stretch ira, inhertied iras, James Lange, new ira laws, new ira rules, Roth IRA Conversions, Roth IRAs, stretch ira, stretch ira 2017, stretch ira changes, stretch ira rules 2017, stretch roth ira.

For many individuals, a series of well-timed Roth IRA conversions can be the best defense against the Death of the Stretch IRA.

A lot of clients ask me if I manage my own finances the way I recommend they manage theirs, and the answer is definitely “yes”. I realized though, that I have not told you my own Roth IRA conversion story, and how my decision will affect my own family after the Death of the Stretch IRA.

Roth IRA Conversions – The Best Time is in Years of Low Income

Think back to 1998. It was long before we ever had to worry about the Death of the Stretch IRA, and it was the first year you were permitted to make Roth IRA conversions. Back then, if your Modified Adjusted Gross Income was more than $100,000 you were restricted from making Roth IRA conversions. Our family’s income was over $100,000, so I thought my income restricted me and never imagined I’d be eligible to do Roth IRA conversions myself. Then on February 16, 1998, our office was wiped out by a devastating fire that started in a pizza shop located directly below us. Can you imagine this happening to a CPA firm in the middle of tax season?

I learned some valuable lessons from this experience. First, never put your office above a pizza shop. Second, I learned more about the insurance process than I ever cared to know. We had extremely high expenses because everything needed fixed and, even though I was well insured, I didn’t get the check for the damage until 1999. That meant that 1998 was a very tough year for the business financially. I couldn’t take a salary, and for the first time our family’s income was far less than $100,000. Did I get upset? No. I said to my wonderful wife, “Cindy, I think we have an opportunity here”.

My wife and I had about $250,000 in Traditional IRAs between us. I told her that our normal income level would restrict us from making Roth IRA conversions, but our income in 1998 was far below normal – making that year the best time for us to do Roth IRA conversions. I told her that I thought we should convert the entire amount to Roth IRAs and voluntarily pay the tax due the $250,000 conversion amount. After she got over her initial shock, she looked at the mathematical calculations I had done and, being an extremely intelligent woman, she immediately understood that our family would be better off by hundreds of thousands of dollars in the long run. And so we did it – we converted every last dime of our IRAs to Roths. And those Roth IRAs are now worth quite a lot more than they were in 1998.

The law has since changed, and there are no longer any income restrictions on Roth IRA conversions. This means that you can do smaller Roth IRA conversions over a series of years rather than all at once like I did, and by doing so you can convert them at a lower tax rate than I was able to. The best time for many retired individuals is the period after you’ve stopped working, but before you are required to take minimum distributions from your IRAs and retirement plans. And with the Death of the Stretch IRA looming, there are probably even more reasons now for you to consider Roth IRA conversions than I had when my office caught fire in 1998.

Transferring my Roth IRA to My Child

Twenty years later, it is likely that Cindy and I will never spend those Roth IRAs. Some people will argue that, if that’s the case, there was no benefit to us converting our IRAs to Roths. Why pay tax when you didn’t have to, they ask? Well, I guess it’s because, in the long run, I was thinking of what would happen when I die and my Roth IRA is transferred to my child. My daughter Erica was only three years old when we did those Roth IRA conversions. If I die tomorrow and my Roth IRA is transferred to her, she’ll be hundreds of thousands of dollars better off because I did that conversion. And if I live for another twenty years, it’s not unreasonable to think that she’ll be more than a million dollars better off when I die.

When my Roth IRA is transferred to her after my death, Erica will still be required to take minimum distributions from the account every year. If I die before the Death of the Stretch IRA legislation is passed, those minimum distributions can be stretched over her lifetime and the bulk of the IRA can continue to grow in a tax-free environment. If I die after the Death of the Stretch IRA legislation is passed, she’ll be required to withdraw the entire IRA within five years. Although the money will be forced from the tax shelter more quickly, at least the withdrawals will be tax-free to her. And I can’t think of a better present for my little girl.

Stop back soon for more Roth IRA talk!

-Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.

The Death of the Stretch IRA: Will the Rich Get Richer?

Posted on July 18, 2017 by James Lange in Inherited IRAs, IRAs, Roth IRA, Roth IRA Conversions, Stretch IRA, Video Resources and tagged death of the stretch ira, inherited iras, James Lange, new ira laws, new ira rules, Roth IRA Conversions, Roth IRAs, stretch ira.

Do Roth IRA Conversions Make the Rich even Richer? Will This Change After the Death of the Stretch IRA?

My most recent blog posts have been about Roth IRA conversions, and how they might benefit you under both existing law and the proposed law that would spell the Death of the Stretch IRA. This post continues this discussion, and outlines the benefits of transferring Roth IRAs to your children.

How Do the Rich Get Rich?

There’s been a lot of media coverage about rich people lately, have you noticed? The rich don’t pay taxes! The rich are getting richer! And so on. Well, I’m going to go out on a limb here and suggest that there are many rich people who don’t deserve all of the abuse they get about their wealth. Are there rich people who get their money from stealing and cheating? Certainly, and I hope the long arm of the law finds every one of them and brings them to justice. But I have many clients who are, by most people’s standards, rich – and not one of them ever failed to pay their taxes, or stole their money from someone else. Most of them had decent but not high-paying jobs, and the vast majority of them didn’t inherit their wealth either. So how do the rich get rich, and how do they continue to get richer?

In the late 1960’s, Stanford University conducted a study where the children who participated could receive a small reward (a marshmallow) immediately, or choose to receive a larger reward (two marshmallows) after waiting a short period of time. Some of the kids, of course, ate the marshmallow immediately. Others, though, waited for what probably felt like a lifetime, and were rewarded with the second marshmallow.

Most of my clients are two-marshmallow people. This means that during their lifetimes, every financial decision they made considered both the short-term and long-term benefits. Could they afford the monthly payment on a Cadillac? Probably, but they opted for Fords instead and banked the difference between the monthly payments. Could they use credit to buy new living room furniture? Yes, but they waited until they had enough money saved up to pay cash because they wanted to avoid paying interest on their purchase. Two-marshmallow people understand that sometimes it makes sense to do with less now, in exchange for a bigger payoff in the future. That’s how many of the rich get rich in the first place, and could be why the rich continue to get richer. And a similar mind set could be a lifesaver for you when the Death of the Stretch IRA legislation is passed, and you are scrambling to find ways to keep your hard-earned money out of the hands of the government.

Roth IRA Conversions: Not Just For Rich People Who Don’t Want to Pay Taxes

Many uninformed individuals think that strategies like Roth IRA conversions are simply tools designed to allow rich people to get richer, and to avoid paying taxes. That’s not exactly true. Roth IRA conversions can help anyone, not just rich people, get richer and avoid paying more taxes than necessary. In fact, I would argue that Roth IRA conversions can be of more benefit to someone who isn’t rich, because an additional $50,000 over the course of their lifetime would probably be far more important than it would be to someone who has more money than they can ever spend. But Roth IRA conversions can make a lot of sense if you are a two-marshmallow person, regardless of how much money you have. And it’s especially true if your money lasts longer than you do, and you end up transferring your IRAs and retirement plans to your children. Roth IRAs can make a significant difference for your heirs in light of the Death of the Stretch IRA.

Transferring Roth IRAs to Your Children

The video in this post compares two individuals – one makes a Roth IRA conversion of $100,000 and the other does not. The conversion provides a small benefit during the Roth IRA owner’s lifetime – so even though he pays taxes on the conversion amount, he still ends up with two marshmallows. But suppose he never spends the money and, at his death, the Roth IRA is transferred to his children? Over the course of their lifetimes, the children get ten marshmallows. And suppose his children don’t spend the Roth IRA, and instead transfer it to their own children (preferably by disclaiming it to a trust). Over the course of their lifetimes, the grandchildren get an entire bag of marshmallows!

So did the rich get richer? Yes. Did they do anything illegal, or anything that you can’t do yourself? No. Roth IRA conversions were the brainchild of the government – they want you to pay taxes sooner than you have to so that they have more money to spend. You may have change your way of thinking to that of a two-marshmallow person, and possibly do with less now in exchange for a greater payoff down the road. But doing so can enable you to create your own family dynasty that will benefit your heirs for generations to come, and help them offset the devastating effects of the Death of the Stretch IRA.

Stop back soon for more Roth IRA conversion talk!

-Jim

For more information on this topic, please visit our Death of the Stretch IRA resource.

P.S. Did you miss a video blog post? Here are the past video blog posts in this video series.