Joe Anderson
ABOUT Joseph

As CEO and President, Joe Anderson has created a unique, ambitious business model utilizing advanced service, training, sales, and marketing strategies to grow Pure Financial Advisors into the trustworthy, client-focused company it is today. Pure Financial, a Registered Investment Advisor (RIA), was ranked 15 out of 100 top ETF Power Users by RIA channel (2023), was [...]

Alan Clopine

Alan Clopine is the Executive Chairman of Pure Financial Advisors, LLC (Pure). He has been an executive leader of the Company for over a decade, including CFO, CEO, and Chairman. Alan joined the firm in 2008, about one year after it was established. In his tenure at Pure, the firm has grown from approximately $50 [...]

Published On
November 24, 2020

Should you borrow money to pay the tax on a Roth IRA conversion? Should you do a Roth conversion or capture non-qualified long term capital gains? How will Social Security benefits affect taxes after a backdoor Roth IRA conversion? Should a highly compensated employee use the mega backdoor Roth strategy? Are the tax savings on a conversion worth it? Plus, the fellas explain the pro-rata rule – again.

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Show Notes

  • (01:05) Roth IRA Conversion or Non-Qualified Long Term Capital Gains?
  • (07:20) Should You Borrow Money to Pay Tax on Roth Conversion?
  • (13:10) Roth Conversion Pro-Rata Rule
  • (20:53) Backdoor Roth Conversions and Social Security
  • (25:34) Mega Back Door Roth Strategy for Highly Compensated Employees
  • (31:16) Retirement Strategy: Are the Tax Savings Worth Doing Roth IRA Conversions?
  • (42:05) Comment: The Backdoor Roth Podcast is Awesome

Free resources:

Sign up for the YMYW newsletter to get access to The Ultimate Guide to Roth IRAs as soon as it’s available:

Backdoor Roth IRA Resources:

LISTEN | YMYW #297 The Barn Door, Garage Door, Mega Backdoor Roth IRA Conversion (Backdoor Roth conversion rules)

LISTEN | YMYW #295 All About the Backdoor Roth IRA Strategy (when to do a Backdoor Roth conversion, the pro-rata rule and when it isn’t worth it, and more)

LISTEN | YMYW #293 Backdoor Roth Conversions and Investing for Kids (taxation on a mega backdoor Roth conversion)

LISTEN | YMYW #289 Backdoor Roth IRA Conversions, Stimulus and Self-Employed Retirement (Is there a point when backdoor Roth doesn’t make sense?)



BLOG | Decision 2020: Your Vote & Your Money (6 part series)

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Listen to today’s podcast episode on YouTube:


After a short break from Roth conversion questions, the inbox is once again overflowing with them, so today on Your Money, Your Wealth®, Big Al and, reluctantly, Joe, return to answering them. Should Perry do a conversion or capture non-qualified long term capital gains? How will Social Security impact Mike’s taxes after a Roth conversion? The fellas explain the pro-rata rule for Dan. Santiago is a highly compensated employee, should he do an MBDR, mega backdoor Roth conversion? Tom’s wife wants to know if the tax savings are really worth it when doing a Roth conversion, and Ed wants to know if you should borrow money to pay the tax on that conversion. Great questions all, and the fellas have some thoughts and suggestions. Click the link in the description of today’s episode in your podcast app to go to the show notes to read the episode transcript, access free financial resources, and ask your money questions. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA

Roth IRA Conversion or Non-Qualified Long Term Capital Gains?

Joe: I guess welcome to the Roth IRA show. Where all we talk about is Roth.

Al: Here’s what’s happening Joe, the questions we’re getting are based upon Roths. So that’s what we’re talking about. Then everyone assumes to ask us the Roth question. So just have to have one-

Joe: We have. We’ve answered 100s of questions on other topics. I guess the answers are probably awful. They’re like these guys don’t know anything else but Roth IRA stuff.

Al: We need to do 2 or 3 episodes in a row where we don’t talk about Roth and then maybe we’ll reset.

Joe: Yeah, but I got 15 pages of Roth IRA questions.

Al: We’re gonna plead with our listeners, send us something that’s not Roth related.

Andi: I think Perry on page 8 has a question that does actually involve Roth, but I think it might be a little bit more interesting to you guys.

Joe: I was thinking – OK. Perry, let’s see what Perry has to say. Perry-

Andi: Don’t yell at me if I’m wrong.

Joe: Oh, look at- right off the bat. “I have $500 in a Roth.”

Andi: I said it talks about Roth, but I think it’ll be an interesting question.

Joe: OK Perry.

Al: $500,000.

Joe: Yeah. $500,000. $500,000 shimoles.

Al: Just so we’re clear on that.

Joe: “I have $500,000 each, in a Roth; in a traditional IRA; and also in an non-qualified brokerage. $1,500,000 total.”

Al: So he’s completely diversified. $500,000, $500,000, $500,000.

Joe: Look at me.

Al: He’s fishing for a compliment. I guarantee it.

Joe: For sure. ‘What do you guys think?’

Al: He didn’t write that, but that was implied.

Joe: “So far in 2020, I’ve limited my normal taxable income to $45,000, single standard deduction would bring my initial federal taxable income down to $32,600. Note I’m also trying to keep my adjusted gross income below $87,000 to avoid that Medicare surcharge IRMA and preserve a local property tax freeze.” All right. So he sounds pretty sharp. “I would like to know your thoughts regarding a $50,000 Roth conversion or capturing $50,000 of a non-qualified brokerage capital gains by the end of 2020. As I fear the tax reaper is coming. My guess is that capital gain changes may be more of a future tax burden than changes in marginal tax rates. So I’m ready to pull the trigger and trade some non-qualified mutual funds that show unrealized multiple term gains. And I have held these mutual funds for a very long time so I think they’re mainly long term. Any clean thoughts? Your obedient servant.” Okay Perry. So what do you think? So he’s asking- I got- well he’s single. And then he’s keeping his taxable income to $32,000 so he’s got some room in the 12% tax bracket to sell some capital gains at tax-free. So he’s got about $8000?

Al: Correct. Yep.

Joe: So Perry, if you stay in the 12% tax bracket just call it $40,000 of taxable income. There would be no capital gains of that $8000. So just understand that. So should he do capital gains or conversions? Is his thought. He’s got $500,000, $500,000, $500,000 and he is 62 years old- did he give us his age?

Al: Well he must be 65 because he’s- or close to 65, because he’s talking about the Medicare IRMAA at $87,000.

Joe: So let’s see, 65, he’s got $500,000, that thing turns to $1,000,000. He’s got then- call it $40,000 of RMDs. And let’s see here- but he’s keeping his adjusted gross income below $87,000.

Al: Yeah I think that’s what he said basically he wants to do something, either the Roth conversion of $50,000 or capital gains of $50,000 to keep it below $87,000.

Joe: Got it. Because his taxable income is $32,000, he wants to keep it at $87,000- you know what? I don’t know. This is a tough question for me because I would want to look at what the allocation looks like. It looks like he’s bought these mutual funds a long time ago. What is the basis of the funds? And how much capital gain does he have? What’s going to hurt him more is probably ordinary income versus cap gains because he’s going to be in the 15% cap gain and 0% cap gains. But he’s also in that 10% or 12% ordinary income tax bracket. So does it make sense maybe to go to the top of the 22% tax bracket to convert some money out? Maybe you do that for one or two years? He doesn’t have to convert a lot because it’s not like he’s got millions. And he doesn’t seem like he needs it. But he’s single, so I don’t know. I like the conversion better than cap gains but that’s just- I’m just assuming investments are equal.

Al: And we don’t know enough information. And actually first I would look at the allocation and if you need to rebalance then I would do that first. Because poor investments are going to trump tax planning and plus you’re pretty balanced already. But if you need to rebalance I would start with that. I would do the capital gains. I would do the Roth conversions after that. However, if you’re already very well balanced for what your goals are then I probably would go over to the Roth.

Joe: With the whole IRMAA thing, with the increase in Medicare, just count that as a tax. Just add that increase into the overall equation of what you’re doing when you do the conversions just to see what makes sense when you’re doing your planning.

Al: If he goes above that, his premium goes from $144 a month to $202 a month. So $60 a month, it’s not gonna break the bank and then he could go up to $109,000. So you just have to sort of look at that as an extra cost.

Joe: Hopefully that helps Perry, your obedient servant. I like that.

Should You Borrow Money to Pay Tax on Roth Conversion?

Joe: Let’s see. Ed from Cincinnati writes in. He goes “Would you borrow money to pay the taxes on a Roth conversion?” That was in the subject line of this email.

Al: Got it.

Joe: “Hello. I’m a new listener and enjoy the Roth conversation PODCAST!”

Andi: There’s the new name.

Joe: Oh you mother-

Andi: Oh Joe.

Al: Podcast in all caps- exclamation point.

Joe: Oh, it’s the Roth conversion podcast. I’m telling you folks, this is it. I’m done. I’m retiring.

Al: I was just going to say, you can tell people- when they send us a Roth conversion- you can- Andi can say ‘just go to episode 276 and it’ll answer that question.’

Joe: So Ed’s a new listener, he’s like wow this is a great Roth podcast. “My total IRA balance is $2,700,000 but only 3%, $80,000, is in a Roth IRA. My wife and I are 66 years old and we’ll be getting a total of about $60,000 per year from Social Security starting at age 70. Our lifestyle would normally keep us easily in the 12% tax bracket so only a small portion of the RMD fund at age 72 will be needed. We only have a small balance in after-tax monies to pay the taxes on a large Roth conversion. Would you recommend that I borrow $200,000 at a current rate of 3% over the next 6 years to pay the taxes on converting half of my traditional IRA balance? Thanks. FYI, your advice in a previous podcast was very helpful to me. I was assuming that I would be stuck in the 22% tax bracket for the rest of my life. However, as you pointed out earlier, what happened when that $2,700,000 balance doubles to $5,400,000 say at age 80, the RMD now causes Medicare premiums to get scary and other non-earned income tax penalties. Yikes.”

Al: Good emphasis.

Joe: Thank you.  But first of all Ed from Cincinnati, we do not give advice on this program. Secondly, I have no idea what Ed drives and how he listens to this new podcast. So- it’s very important because you gotta put yourself in the shoes of the listener.

Al: Got it.

Joe: To see where their vibe is, to see where their mind is. You know what I’m sayin’?

Al: Yeah. And that’s all you want to know? What they’re- if they have a pet?

Joe: I don’t know where the whole pet thing came about, I don’t really care about pets but-

Andi: It was because of Maverick. Somebody wrote in and said that they had their dog Maverick in the passenger seat with them. And so you were like, well what kind of dog is it? And I mean really, that does tell you a lot about a person.

Al: And someone- I think someone was like walking their dog when they listened to our podcast.

Joe: So what I do is when I read this, I close my eyes and I try to envision Ed from Cincinnati and then- or I try to think of our supply chain manager from Cookerville. So- Marcus from the South. I just try to put myself with them like I’m sitting across the desk. That’s how committed- it’s called commitment Alan. It’s called commitment to the craft.

Al: Right.

Joe: OK. Totally forgot his question.

Andi: “Should you borrow money to pay taxes on your Roth conversion?”

Joe: Okay. All right. So yes, I would. For sure. He’s got $2,500,000, he’s only spending a couple of bucks. Me personally- this is not advice. If I was in Ed’s shoes- he’s got $60,000 of Social Security. So here’s what- here’s how I would pay off the note though. So I would take a home equity line or whatever, $200,000. You borrow that at 2%. Because what happens with RMDs that kick in, it’s already going to be forced out of the retirement account. So let’s say he’s spending $70,000 a year so he’s taking $10,000 from the portfolio. $10,000 into $2,700,000 is minuscule. So the $2,700,000 is going to continue to compound over time. And so when he takes his RMD, let’s just call it at $3,000,000 at age 72. That’s $120,000 plus the $60,000 that he has in Social Security. So he has $180,000 of income. And let’s just assume he’s only spending $70,000, $80,000. He’s got an additional $80,000 that needs to come from the retirement account. That additional dollars that comes from the RMD is then used to pay off the note.

Al: I completely agree Joe. And typically we don’t- we really don’t want people to borrow money to pay their taxes on a Roth conversion. However, in a case where you don’t have any assets outside of retirement and you’re in a low tax bracket and you have a very large IRA or 401(k) then it makes total sense because your RMD- that forced out of those funds is going to be plenty to pay off that debt rather quickly.

Joe: He’s got the money. So you’re borrowing at 3%. The taxes are going to be a lot more than 3%. So it’s like, can I get leverage from the overall net worth of my house to make sure that I can be a little bit more tax sensitive long term and pass more- ? I mean you have to run the numbers of course and you probably want to sit down with a qualified person versus writing into a podcast.

Al: And I just want to add and probably in most cases, we probably would not tell people to borrow for conversions.

Joe: I would say 99% of the time.

Al: Right. But in this case it does make sense because you’ve got the large IRA. Maybe not a lot of other funds outside of retirement and you’re going to be in a low bracket when you retire. So there you go.

Roth Conversion Pro-Rata Rule

Joe: So we got the Dan but it’s not his real name. So what you’re doing some kind of sleuth stuff again, Andi?

Andi: No. He asks at the bottom of it to please use a different name.

Joe: So he wants to be called Dan or did you pick Dan for him?

Andi: No he chose to be Dan. That is his chosen name.

Joe: OK. Dan from Nashville, Tennessee. Like there’s no- let’s say his real name is Ed.

Al: Yeah maybe.

Joe: It could be.

Al: Because it says in the back, it said “I would not like to use my real name as it is recognizable. “So yeah. It’s someone in the Nashville music scene, probably that we know, huh?

Joe: Yeah, I hope so. I’m a big country music fan. “Hi Andi, Joe and Big Al. Thank you so much for the value you bring to your listeners and doing so in such a fun and easy to understand manner. I have become an avid listener since discovering the podcast last year. Since listening, I have successfully asked my company add the Roth provision of the 401(k), added a SEP IRA to a separate, not overlapping business, and waiting to hear from the pension committee if they will allow us to take a CRD, currently not allowed in the 401(k), but I pitched it for tax savings purposes.” Geez, look at this guy.

Al: That’s great.

Joe: He’s just taken every nugget that we give and just-

Al: – take a break from this music and start thinking about this stuff.

Joe: That’s right. “I also did the free assessment and went on to do some financial planning on a limited engagement. I asked my dad to do the assessment, if he ever finds his statements. My question is, in regards to Roth conversion and the pro-rata rule, I’m 41, married, filing jointly, and in the 32% marginal tax bracket for ordinary income, 15% for capital gains; 23% effective tax rate. Based off my assessment, years to retirement and projection of higher future taxes, I’m converting all of my tax-deferred accounts to a Roth. I understand it’ll be a hefty tax and my goal is to pass savings down to my children or use it later in retirement.” Dan’s 41. And he’s talking about passing his retirement accounts his kids.

Al: I know. Well, where my head went was, it not Willie Nelson. He’s a little older than 41.

Joe: Got it. “I have a $47,000 my traditional IRA; a total $22,500 total deposits were all non-deductible IRA contributions. The rest is growth. $44,000 in my SEP IRA; $51,000 recently closed cash balance that can be transferred to either my 401(k) or IRA in the upcoming weeks. Additionally, I have $160,000 in unmatched 401(k) plan that I will convert to a Roth IRA this year and $1,000,000 in brokerage taxable accounts.” Way to go Dan from Nashville. “My question is, with the pro-rata rule, will there be any savings on the $47,000 if I transfer my SEP IRA and the cash balance to my 401(k) plan? So all I have left in the IRA total is $47,000 or since I’m converting it all anyway eventually I will not get any savings. I don’t fully understand the pro-rata rule. I thought I would be saving taxes on the $47,000 when it’s converted to Roth because the other SEP and cash balance will go into my 401(k) and not be taken to go into effect. And then I can convert the SEP, cash balance, rollover, and 401(k) to a Roth later this year. Thank you again for all your time and energy in the podcast. I appreciate you all. P.S. If this goes on the podcast, I would not like you to use my real name as its recognizable.” He doesn’t know that we got like 8 listeners on this show. We got Ed from Cincinnati that just tuned in.

Andi: But if it is Willie Nelson or somebody like that, I can understand why he wouldn’t want them to know that he listens to this show.

Joe: That’s kind of cool then that someone recognizable-

Al: That someone that we might actually know.

Joe: “Also for the past month or so, Joe’s mic has noticeably seemed muffled.” That’s just how I talk.

Al: You need to take off your mask.

Joe: “Andi and Big Al seem fine. FYI, for what it’s worth. Thanks again.” I sound muffled?

Andi: That was because of Zoom. That’s why we’re not using Zoom anymore.

Al: So it’s better now?

Andi: Yep.

Joe: I don’t know. Maybe Dan, the music business Dan man-

Al: He’s sensitive on sound so-

Joe: Yes. Yes. His ears are just like-  So does he have basis?

Al: He doesn’t say.

Joe: All right. If you move- So here’s how the pro-rata rule again works, for the millionth time. If you put your profit-sharing plan or your SEP-IRA and all of that stuff, if you move it into your 401(k) plan and you convert the $47,000, what’s going to be taxed is $47,000, if it’s all pre-tax. But I believe you have basis in it because you had some non- or if you have after tax dollars. So you’re not going to be taxed on the after-tax dollars. But if- that’s the whole basis of a Backdoor Roth IRA anyway. So if you have basis and you isolate the basis, you can do so by moving everything else into the 401(k) plan, converting the IRA that has the basis in it you will not be taxed on the basis and you’ll only be taxed on the growth. So I don’t want to reread this whole thing- but was there-? Did you hear basis anywhere, Al?

Al: No.

Joe: But you were dreaming about Willie Nelson the whole time.

Al: I was. I was thinking about On The Road Again and Whiskey River. I think that’s right. I think if you- unless you’re doing a Backdoor Roth, the pro-rata rule doesn’t come into play if there’s no basis in your IRA. It just doesn’t matter.

Joe: So if you’re going to convert the $47,000 in your IRA, convert it, you’re going to pay tax on whatever is pre-tax and growth. If you do have basis or after tax contributions, those will not be taxed. So let’s say you had $7000 of basis, and the balance is $47,000 and you have these other IRAs and SEPs, you moved all that into your 401(k) plan and you converted the $47,000, only $40,000 would show up on tax. The $7000 of basis would be tax-free. It’s just return of basis that you would move into the Roth IRA. So hopefully that helps, Dan. Appreciate you calling in or writing in and hopefully we didn’t give away too much.

Due to popular demand from the Your Money, Your Wealth® audience, we will be publishing our Ultimate Guide to Roth IRAs very soon. It’ll explain in depth what a Roth IRA is and the benefits of it, how a Roth IRA differs from a traditional IRA and from a Roth 401(k), the rules for Roth contributions, conversions, withdrawals, and more. When you have a question about Roth conversions in the future, you can simply consult the Ultimate Guide to Roth IRAs! Click the link in the description of today’s episode in your podcast app to go to the show notes and subscribe to the YMYW newsletter to ensure that you’ll be able to access this comprehensive resource about Joe and Big Al’s favorite topic as soon as it’s available.  Then help us spread the financial fun and knowledge by forwarding the newsletter to your friends.

Backdoor Roth Conversions and Social Security (Mike, San Diego)

Joe: We got one from Mike in San Diego. He goes, “both my wife and I still working in our early 60s with over $1M in taxable 401ks. We want to try to get more of this in Roths but earn to much too much (over 32% bracket) to bit the bullet on the tax right now but do the (not to be spoken) backdoor Roth every year.

Andi: Not to be spoken because he knows you hate them.

Al: He still brought it up. ‘Cause that’s his question.

Joe. Yeah. I appreciate the effort. (Derail) “However, I would like to try it during retirement in a few years to convert some to Roth. I expect my income from our pensions alone will cause 85% of my social security benefit to be taxed in retirement. I was thinking of converting some of my taxable 401K to Roth but uncertain how my social security benefit will impact the tax rate I would pay if I did this conversion after I started receiving Social Security. How is the taxable portion of Social Security benefit impact tax brackets? By the way, I do enjoy Joe’s humor and Al playing the straight guy. Keep it up.

Joe: All right. Thanks Mike. Need that little boost. Confidence boost. So alright, so he’s curious about Social Security taxation. He’s already saying his pension is going to make his Social Security taxable. So how it works is this. Is he married? Yeah. So under $34,000 then 50% of it is going to be taxed. $34,000 to $44,000 is kind of the threshold if you have income under $34,000, your Social Security will not be subject to income tax. So it would be tax-free to you. From $34,000 to $44,000 then 50% of the overall benefit it’s going to be subject to income tax. For example, if your Social Security benefit is $20,000 and $10,000 of that would show up on the tax return. Now once he gets over $44,000 of provisional income, then 85% of his income is going to be subject to tax. And how the calculation on provisional income works is that you have to take half of your Social Security. So whatever that dollar figure is and then you use your adjusted gross income. So interest, dividends, 401(k) distributions, conversions, even municipal bond interest, everything like that. So if it’s over $44,000, 85% of the Social Security benefit, it’s going to be subject to income tax. So it sounds to me his pension is already going to be there. Then he has Social Security so he’s already in the 80- you know 85% of it’s going to be subject to tax. The overall Roth conversion is not going to affect the taxation of his Social Security. It will probably affect his Medicare premium.

Al: I agree with all that and it sounds like when he retires, he’ll probably be in a lower bracket. So even though he’s getting Social Security it still would be a good time to do conversions. Because it’s before the required minimum distributions. So I’m all for that. I think that makes sense. In some cases, we like people that try to delay their Social Security for two reasons; one to get a-

Joe: No dollars of Social Security to become income taxed. Because then every $1 that you add, you add $1.85 to income and that’s- there’s a small threshold where we wouldn’t recommend- if someone had a small IRA and they had Social Security, doing conversions doesn’t make sense because the tax rate is too high. But it sounds like his pension and Social Security’s already pushing that Social Security limit into the 85% level. And he has over what, $1,000,000 in retirement accounts. Or did I just give him that balance there?

Al: No, that’s in the first sentence.

Joe: Of course. I love it. I got $5,000,000 in my retirement account.

Al: I love it when they lead with that.

Joe: Yes.

Andi: I’m not bragging.

Al: I mean I got $3,000,000 in my account. My wife doesn’t really have any anything. We’re going to talk about me.

Joe: I got $10,000,000 in my retirement account. Hello Joe, Al, and Andi. I have a question for you.

Mega Back Door Roth Strategy for Highly Compensated Employees

Joe: Let’s see…

Al: What are ya’ feelin’ like, Joe?

Joe: Let’s go with Santiago from Columbia City, Indiana. So what’s he gotta to say? “Hello Andi, Big Al and Joe. Love the show like so many listeners. Could use more episodes.” Not even close there, Santiago. We’re lucky we can tape this one. “Thanks in advance for the conversation, not advice. Santiago- Oh, you don’t have to give you age, but I like it- 53, from Columbia City, Indiana. You ever been at Columbia City, Indiana?

Al: Never been. Have you?

Joe: No. So Santiago, he listens to us on his way to work while driving his 2012 Chevrolet Cruze. Chevrolet Cruze. Interesting. “I contribute to my company’s 401(k) plan. I maxed out my annual contributions and then get money returned because I am a high earner. I haven’t heard you talk about this problem before.” Santiago’s- he’s got like big problems here. He’s highly compensated. “Last year, a little over $4000 was returned to me as a result of the calculation that 16% of my contribution that was returned. Thanks to your show, I did some research to see if our plan allowed and it does. And recently started taking advantage of the Mega Backdoor Roth-” now we have an acronym for it. The MBDR.”

Al: I never heard of that but Santiago is helping us out.

Joe: Santiago. “- the MBDR within the plan. I was maxing out the pre-tax dollars which could be in the 24% tax bracket knowing that I’ll be making less in retirement. Currently, rates would place my retirement earnings in the 12% tax bracket. Should I bother with a pre-tax contribution when a good portion of that money will be returned? I do reinvest the refund into the brokerage account. Or am I better off putting all my contributions into the MBDR option? The Mega Backdoor Roth- I- ” see where this show has gone to Alan?

Al: Yeah I know. It’s every single question.

Joe: “My current savings rate is 30%. My goal is to reach the annual planning contribution limit. I hope I have provided enough information. Thank you all.” All right. Santiago, so he’s highly compensated. So what that means is that he’s got a top-heavy retirement 401(k) plan. So for highly compensated employees, what the 401(k) plan does not like is that here are the big shots are sheltering all their money from tax, while the rank and file are not saving any money into the 401(k) plan. So they do these testing on these 401(k)s to make sure that it’s kind of equally throughout. You could set up 401(k) plans that it doesn’t matter because then that’s based on the match. So it’s a Safe Harbor 401(k) plan. So Santiago, maybe ask your employer to set up a Safe Harbor 401(k). But if he sets up a Safe Harbor 401(k) I’m guessing that Safe Harbor 401(k) will not allow the MBDR.

Al:  I would agree with that.

Joe: Because there’s testing for you to do after-tax contributions. So my advice to Santiago is that I want go pre-tax as much as you can and then everything else go after tax to the plan limit. Find out kind of- get a gauge of what your contributions were last year and then make sure- just switch your contributions to after-tax; still go into the plan. And then from there, those are after-tax contributions and then convert those. Or maybe you could tell them because I’m highly compensated, if I get blasted out of the plan- but I don’t think they run those calculations until later. And so instead of sending me a refund, can you just classify those as after-tax? Maybe you could do that. It sounds probably like a smaller company, who knows? So I would talk to H.R. first and kind of see what you can do. But I would fully take advantage of the after-tax components of that plan and then convert the after-tax components to the Roth. What do you think, Al?

Al: I agree. I think you do the after-tax first, you max that out and then you put as much of the post-tax in as you possibly can. Because that’s what you use for the Mega Backdoor Roth. So I’m in complete agreement with you.

Joe: Yeah. Al meant to say do the pre-tax as much as you can and then go post-tax.

Al: I always mix that up, don’t I?

We have indeed discussed backdoor Roth conversions many times before on this show, and in the podcast show notes you will find previous episodes where the fellas explain the rules for doing a backdoor Roth conversion, the pro-rata rule and times when a Backdoor Roth doesn’t make sense, when to do a backdoor Roth conversion, paying tax on your mega backdoor Roth conversion and much more. I’ve also linked to our post election tax planning resources, our 2-day retirement classes,  and our free retirement workshops in the podcast show notes so that you can take an even deeper dive on the Roth strategy and arm yourself with more knowledge when it comes to planning for your retirement. If you’re not the DIY type and want a professional to take a look at where you stand as you head into retirement, you can sign up for a free financial assessment with Joe and Big Al’s team too. It’s all in the podcast show notes, and, say it with me now, you can get there by clicking the link in the description of today’s episode in your podcast app.

Retirement Strategy: Are the Tax Savings Worth Doing Roth IRA Conversions?

Joe: Tom writes in from ChiTown, Chicago area. “Andi, Tom here. My first question for the 3 of you. So I drive a 2014 blue Honda Civic.” What do you think Al? Do you like Honda Civics?

Al: Yeah, they’re super reliable. Those are cars that you never wear out.

Joe: He doesn’t have a dog yet. He’s looking forward to getting a golden retriever as a retirement gift; has 3 children, graduated from college and they are self-sufficient. “I’m 60 years old my wife is 58. Currently living in a modest suburb in the far north Chicago area. We hope to retire somewhere a bit warmer in the winter but we don’t know where yet. I’m late into tax planning; otherwise we would have a lot more money in Roths and less in pre-tax. I recently started running to lose my COVID lockdown weight and I discovered your podcast.” So he’s out there jogging, Al.

Al: Yeah, he sure is, in ChiTown. Getting a little chilly now.

Joe: He’s getting slim. He’s gonna look real nice for his retirement.

Al: Yes. Right.

Joe: “I absolutely love your show. Amazing how Andi is able to keep you boys on track. And I’m burning through about 4 of your episodes per week.” Wow. 4 episodes a week.

Al: That’s a lot.

Joe: That’s way too much Tom. You ought to be burning some calories not burning those episodes.

Al: Well hopefully he’s doing both at the same time on his jogs.

Joe: So he’s got some thoughts here Al, on his overall retirement strategy and I’ll just run down what Tom is doing for himself. He’s got a rollover IRA of about $1,000,000. He’s got his current 401(k) at $50,000; Roth IRAs of $200,000. He’s got company stock, fully vested of another $300,000. He’s got post-tax money that’s in cash of $250,000. He’s got an inherited IRA of $50,000; he’s taking RMDs from that; and then he also has a few other old IRAs of $300,000 he opened up back in the 90s with a couple of bucks. I think he puts money into Vanguard Health Care Fund in the prime cap. So his current income is $170,000 annually. He makes another $50,000 of bonus and another $50,000 in company stock. He doesn’t have any debt. So Tom is just living the dream in Chicago.

Al: Yeah he is. And I added these numbers up Joe. It’s about $2,000,000. He’s got about- almost $1,400,000’s in pre-tax retirement.

Joe: So his future savings- he’s going to contribute the maximum funds to the 401(k). “My wife has not earned much over the years and is not currently working due to COVID, so she’ll get half my Social Security. I don’t think a Backdoor Roth, garage or standard door will work well due to current IRA holdings.” That might not be true, Tom from Chicago. We’ll hold onto that for awhile.

Al: We’ll see.

Joe: When he retires he’s going to expect to do the following: He’s got Social Security income of $25,000 that he’ll collect at age 62; the Mrs. will get 50%  of that. He’s got a pension of $60,000 or $70,000, depending on when he takes that pension Alan and whatever survivor benefit, he’s saying minimum $60,000. So he’s looking to take the pension of $60,000, maybe take a little Social Security of $25,000. Then he’s going to plan to withdraw $40,000 a year from his rollover 401(k) using the 4% rule on that $1,000,000. He’s got an “additional $300,000 buffer from the IRAs for bad market years, thus not having to touch the $1,000,000 principal for several potential bad market years”. So what he’s doing here Alan is interesting. He’s segregating his accounts. And he’s like ‘this is the one I’m going to draw from; this is the one I’m going to keep for rainy days; and I’m going to use the 4% rule here and not there.’ And so interesting how people kind of look at their money-

Al: It is and-

Joe: I’ll finish and then we’ll-

Al: Ok.

Joe: Because here’s his questions- his questions are coming up. So he’s like “I thought about retiring in March 2023 after the payout of an annual stock cash bonus. Then not taking Social Security or pension until 2025 leaving 2024 a year open of no income. That would allow me to do some Roth conversions from my 401(k).” Let’s see- “My wife thinks I’m nuts and the tax savings is just not worth it. We have enough money in savings, money markets, accounts, to live at least one year without any income. Wondering what you guys think.” So his wife thinks he’s nuts.

Al: Right. That’s the premise. That’s why he’s writing us.

Joe: So he’s writing this like a full synopsis here and-

Al: He’s hoping we’ll agree with him.

Joe: Right. And then he’s like going to play it to his wife like what’s-his-name. Like what’s his- I forget his name. At the dinner table and then his wife at the belly laughs or some stuff?

Al: Oh yeah.

Joe: Andi, you’re usually pretty good at that but I guess you weren’t really paying attention.

Andi: I have no idea what his name was. Don’t remember.

Joe: Oh see, I guess he’s not a good fan because Andi only remembers the good fans. “Also, if we sell our house in 2024, would that count as income, thus making a mess of my plans? The house is paid off and I assume a capital gain of about $200,000. But I think that this is not taxable since we lived in the same house for 25 years. It’s never been a rental property. I thought it would be good to draw Social Security sooner than later as the pension and savings should be enough to live off of. We’re looking at about $100,000 a year with a buffer of about $450,000 post-tax savings current value for unforeseen expenses. All of this. So if our children inherit the Roth IRA, will they be able to make withdrawals tax-free? And do distributions need to be taken 10 years after they take ownership?” So he’s got a $2,000,000, $1,500,000 in retirement accounts; he’s got another $500,000 probably outside of retirement accounts; he’s going to have $100,000 of fixed income; and he wants to spend $100,000; and his wife thinks he’s nuts for thinking about doing a Roth IRA conversion.

Al: Right. Right. Well I like the concept, Joe. The concept is to think about delaying Social Security. Delaying pension? I don’t know enough about the pension to see what kind of benefits- if there are significant benefits to delay the pension in terms of extra payout. Then it might make sense. We know that’s true for Social Security. So I would say if the pension has significant benefits of waiting, I would probably wait a little bit because he’s got a lot of other resources. But on the other hand, if the pension- it’s a pension it’s not going to change that much. I probably start that, delay Social Security. He’ll still be in a low enough bracket to do Roth conversions and do that for a few years. You don’t have to do all or nothing. I think a lot of times people want to- they just want to shut stuff off and do everything- I think you can do it based upon what’s sensible in your situation. So I might- but I don’t know enough about the pension actually know whether that’s a great idea. That’s what I would think I would want to look into.

Joe: All right Tom, here’s the deal. So you’re going to have enough fixed income from Social Security and your pensions to cover your living expenses. So stop segregating all this stuff. Just put it- look at it as one big pot. What do you want to segregate is, what do you have in retirement accounts versus non-retirement accounts? So you know what you can draw from in regards to pushing out either Social Security as Al suggesting maybe the age 70 or you claim it right away. But there’s a few things to think of. He’s 60 years old, he’s got $1,500,000 in retirement accounts and the draw rate from that retirement account is going to be very little because the fixed income is going to cover most of his living expenses. You agree with that Alan?

Al: I do.

Joe: Let’s say if he doesn’t touch the retirement accounts at all- and this is where he needs to put the wife on the podcast- because then the retirement account let’s say doubles in 12 years at 6% growth rate. He’s got now a $3,00,000 retirement account. His required distribution at age 72 is roughly going to be $120,000 plus his $100,000 of income. Call it $220,000 of income. What tax bracket do you think he’s going to be in? He’ll probably fall into alternative minimum tax and he’ll be in a 35% rate by that time. Who knows where taxes are going to be? So if he waits, that retirement account could be taxed probably anywhere higher- 25% and up. He could pay tax today at 24%. So I would ask the wife, would you rather pay 24% tax or anywhere from 25% to 35% in tax? I’m sure she would say 24%. So then you do the conversion, get the money out of there and then have it compound tax-free. It’s that simple.

Al: So I’m just going to add one quick thing Joe and I like that thinking. I think you push out Social Security. I’m not sure about the pension. You might want to take the pension just because otherwise you’re gonna go through your other resources pretty quickly and you can do this over 10 years. But you maybe want to fast track it for the next few years because we know taxes are going to be lower through 2025. So maybe a fast track a little bit; maybe a delay a little bit for the next couple of years; but then start taking your pension. So you still- you don’t go through all your savings but still keep converting until age 72. I think that makes sense.

Joe: Yeah. You take your pension at age 60-whatever- whatever the date that you’re gonna retire.

Al: He’s going to retire at 62, I think.

Joe: So take your pension at 62, look at pushing out Social Security to 70. Because you have enough other assets to cover the shortfall. Then you’re going to have a lot larger guaranteed income at age 70; but then that gives you a 12-year time frame to look at conversions, and then position your assets the way you want. You’re going to have lower tax rates at least until 2025 unless the president elect changes the tax law- whoever that ends up going to be.

Al: Oh okay, you going to go down that path? We don’t know, do we?

Joe: I’m not saying a word.

Al: Also Joe, there’s no taxes to pay on a capital gain on the house. A married couple gets a $500,000 exclusion as long as they’ve lived in the home 2 out of the last 5 years. And the kids will get the Roth IRA tax-free. But they do have to withdraw it over a 10-year period.

Joe: All right Tom, thanks a lot for your call or your e-mail.

Comment: The Backdoor Roth Podcast is Awesome

Joe: Jan wrote in. Jon?

Andi: Jon.

Joe: Oh sorry. My eyes are a little blurry. He writes in just recently, just a couple of days ago. He goes “The podcast keeps getting better. Tell Joe to keep his chin up, except on the tee box.” Yeah I like that. “-As it relates to the backdoor, barn yard, garage door, Roth IRA questions, he and Aloha Al are thought leaders, if not founding fathers in this space. Andi is the glue that keeps it all together. Awesome stuff.” Thanks Jon.

Al: Yeah, it’s very nice.

Joe: Because I’m on the verge of-

Al: – of quitting- founding father of-

Joe: Yes. Yes.

Al: – of the backdoor, barn door.

Joe: You might have a new host here of Your Money, Your Wealth® or the Roth IRA conversion podcast. It’s going to be Tax Chat with Al.

Al: I’m getting all geared up for that. You know it’s been about a ten- it’s been a decade of preparation, Joe.

Joe: Yes. Tax Chat.

Al: It’s gonna be- it’s what you listen to when you want to fall asleep at night I guarantee it.

Joe: It’d be great- intro music, Tax Chat. You’ll be like-

Al: I’m going to start the broadcast with ‘please take a deep breath, find a comfortable position.’

Joe: It’s like- I envision like a- like Donald Ross type.

Andi: Bob Ross?

Joe: Bob Ross. Well you know Donald is his son and it looks like Alan.

Andi: Got it.

Joe: Pretty trees. Pretty trees.

Al: I don’t know who that is.

Joe: The guy with the afro.

Andi: The painter guy. He painted landscapes and all that.

Joe: Beautiful little baby pretty trees.

Al: We’re getting- this is a bedtime show. This is to help you fall asleep. It’s in lieu of a sleeping pill.

Joe: Got it. Alright, folks, bring in the questions but please, enough with the Roth. I’m tired of it, to be honest with you.


Got a couple derails at the end of today’s episode, back where they belong. Visit the podcast show notes at YourMoneyYourWealth.com to read the episode transcript, access the free financial resources, and send in your money questions and comments, and we’ll see you next week on Tax Chat and the Roth Conversion Podcast.

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