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ABOUT Andi

Andi Last brings over 30 years of broadcasting, media, and marketing experience to Pure Financial Advisors. She is the producer of the Your Money, Your Wealth® podcast, radio show, and TV show and manages the firm's YouTube channels. Prior to joining Pure, Andi was Media Operations Manager for a San Diego-based financial services firm with [...]

Published On
November 14, 2023

How can Steve & Sharon in Minnesota get more money into their Roth IRA without paying more tax? That’s just one of our topics, today on Your Money, Your Wealth® podcast 455. Also, should Fred in western New York do Roth conversions before required minimum distributions (RMDs) kick in? If Mike in Utah saves on healthcare premiums now, will that mean large RMDs and tax bills later? Should Mark in Maryland do a backdoor Roth after maxing out his 401(k)? And should Joseph in Kansas contribute to his new employer’s Traditional or Roth 401(k)? 

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Show Notes

  • (00:49) Should We Do Roth Conversions Before RMDs Kick In? (Fred, western NY)
  • (10:22) Will Saving on Healthcare Premiums Now Mean Large RMDs and Tax Bills Later? (Mike, UT)
  • (19:36) Where to Invest After Maxing Out 401(k)? Backdoor Roth? (Mark, MD)
  • (28:04) How to Get More into Roth Without Paying More Tax? (Steve & Sharon, Roseville, MN)
  • (39:24) Roth 401(k) or Traditional 401(k) With New Employer? (Joseph from Wichita, KS)
  • (47:08) The Derails

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Transcription

Andi: Steve & Sharon in Minnesota are high earners – can they get more money into their Roth IRA without paying more tax? That’s today on Your Money, Your Wealth® podcast 455. Also, should Fred in western New York do Roth conversions before required minimum distributions kick in? If Mike in Utah saves on healthcare premiums now, will that mean large RMDs and tax bills for him later? Should Mark in Maryland do a backdoor Roth after maxing out his 401(k)? And should Joseph in Kansas contribute to his new employer’s traditional or Roth 401(k)? If you’ve got money questions or to get a full retirement spitball analysis of your own, go to YourMoneyYourWealth.com, click Ask Joe & Al On Air, and send us your details. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

Should We Do Roth Conversions Before RMDs Kick In? (Fred, western NY)

Joe: Got Fred on the line here. He goes, “Hey Al, Joe, Andi, My name’s Fred. I’ve been enjoying your podcast for a little over a year now and find it both informative and entertaining much more on both fronts than other financial podcasts I’ve tried in the past. I’ve turned a couple of my friends onto the podcast and they joined too.” Well, thanks, Fred. “Keep up the good work. I’m hoping you can provide a spitball for me.” Okay, here we go. “He retired a couple months ago, turning 65 here in a few months. I’m divorced, live in New York and have two grown children. They are completely launched and off the payroll.” Well, congratulations. “I drive a 2019 Subaru cross check.

Andi: Crosstrek.

Joe: Ooh, Crosstrek. Subaru Crosstrek. I would think someone that drives a Subaru Crosstrek would be from Portland.

Al: Or Colorado, right?

Joe: Or Colorado.

Al: Need that four-wheel drive to get to the mountains? I don’t know. Maybe the snow, right?

Joe: I suppose. Okay. “Drink of choice is either a nice stout while watching my Buffalo Bills or a little Tito’s Gimlet on the rocks.” Lil Gimlet. It’s the first Gimlet we’ve had in a while. “Since retiring, I’ve worked as an engineering consultant, making approximately $20,000 per year. Going forward, I’d like to replace working with a little bit more volunteering and traveling. While tracking my spending, I find I spend roughly $6,000 a month inclusive of state and federal taxes. Fortunately, my low income since retiring has allowed me to be covered by New York state’s essential healthcare plan.” So he’s got no monthly premium and a $2,000 max out-of-pocket per year. It’s pretty good. “This obviously will change as I go into Medicare next year. Currently, I live with my three-year-old English Springer Spang Spaniel. He’s got a house valued at $500,000. There’s $160,000 outstanding balance at 2.75 % on a 20-year mortgage. No prepayments for me. To cover monthly expenses, I’ve used a combination of my consulting income and a little bit of cash. I currently have approximately $85,000 in cash and a high-yield interest money market account paying 5%. Beginning next month, I’ll start drawing $2,000 a month from two annuities I’ve held for years. Next April, I’ll also start drawing $1,000 per month from a pension. Again, I plan to make up any monthly shortfalls from my cash reserves. I don’t plan to take Social Security until my full retirement age of 66 in 10 months. Social Security will provide me another $3,600 per month. Bearing any big changes now and then, my monthly net should be covered by the combination of the annuities, my pension, and the Social Security. My retirement nest egg is being professionally managed at Fidelity. My holdings include the following. He’s got $300,000 in qualified money, another $184,000, or call it $200,000 in a rollover IRA, $22,000 in an inherited IRA, $35,000 in a Roth, and $500,000 in a brokerage account. Given the high national debt, It’s my expectation that current tax rates will have to increase after the current sunset. So my question, do you think it’d be advantageous to start converting my qualified accounts to Roth once I turn 65? Limiting conversions to take me to the top of the 22% tax bracket. I pay any taxes due using funds from my inherited IRA or the funds in my brokerage account. The advantages I see for this approach are twofold. One, lessen my future tax burden, assuming tax rates go up. And two, reduce taxes due to my beneficiaries for any money I don’t consume before passing. An advisor I used in the past told me they didn’t see much benefit in my case. I feel there is. Thanks in advance for your spitball.”

Andi: I just want to say nice job on the advantageous, Joe.

Joe: Ooh. Yes. Told you I’ve been practicing.

Andi: Yeah. It shows.

Joe: Practicing my craft. Reading email.

Al: It’s showing. On certain words.

Joe: Yeah. Okay. So Fred’s is in a good spot here.

Al: He’s in a great spot. I mean, just to summarize, I mean, counting the annuities, he’s got $1 million dollars, and then he’s got social security that’s going to pay him about $43,000 a year, right? Pension at $12,000. You just take those two alone without even thinking about the annuities, that’s $55,000. He wants to spend $72,000 or that’s what he’s currently spending. That shortfall is $17,000. It’s a 1.7 % distribution rate. If he takes the annuities or not, it still works. So this looks good from a retirement standpoint, being able to afford retirement, but the question is, should he go Roth or not? And he doesn’t have a lot he can convert, he’s got $184,000.

Joe: $500,000

Al: $500,000. Yeah. Counting the annuity. Correct.

Joe: He’s got different types of annuities Al. He’s got this fixed annuity of $290,000 and then he’s looking at drawing from an immediate annuity or something like that to get the $2,000 a month.

Al: Got it. Okay. That I didn’t get from this, but you’re smarter than I am.

Joe: Here’s his liquid assets. So he’s got, I don’t know, three, let’s call it $500,000 in retirement accounts. He doesn’t necessarily need any of these dollars. He needs a couple of bucks over the next couple of years, right. Until social security kicks in. He wants to wait until 66 in 10 months. So there’s a little bit of a gap, but he’s got plenty of money in a brokerage account and cash. The question is, does he convert? And so he’s 60, how old is he? 65.

Al: 65. Yep.

Joe: So he’s got 10 years. You call $500,000 in 10 years, so $1 million.

Al: Yeah, true. So then you take that $1 million and what’s your required minimum distribution? It’s about 4%. Right? So that’s about $40,000 of income. So then you add it to your other current income to figure out, all right, what tax bracket am I going to be in? And in Fred’s case, clearly 22% bracket, which was supposed to become 25% and just, you know, Three years, right?

Joe: So yeah, that makes a ton of sense. I think he’s right on track. He’s kind of forecasting a little bit. My monthly amount is going to be covered by my fixed income sources. I got $500,000 in qualified plans. Let’s say by the time he has to take money from the retirement accounts just assume as you know His money doubles in 10 years. It could be a lot more than that, it could be a lot less than that. But this is an assumption so it’s $1 million in retirement accounts. He has to take out $40,000 on top of his fixed income. Those RMDs are going to be at the 25% tax rate or could be higher depending on where tax rates go. He could convert now in the 22. So the question is would you rather pay tax at 22% and have those dollars compound 100% tax-free for you for the rest of your life and your heir’s life? Or do you want to continue to kick the can down the road and pay potentially higher taxes when your RMDs hit?

Al: Yeah, another way that I think about it is with Social Security and pension, $55,000, that’s equivalent to almost $1.5 million of assets. In other words, $1.5 million times 4%, actually $60,000, but that’s roughly, so that’s kind of almost like you have $1.5 million already in a retirement account, then you add the $500,000 to it. So it’s kind of almost like you have a couple of million. So if you think of it that way, because my RMD sits on top of all this fixed income. Sure. I actually kind of have a tax problem and you add the income up together. There’s no way Fred isn’t going to be in the 22% or future 25% bracket or whatever bracket it becomes. So yeah, 100% I think Roth conversions make a lot of sense, particularly with all the money in cash and the brokerage account.

Joe: Yeah, I would not take money out of the inherited IRA well, he has to take the money out of the inherited IRA anyway. That’s just gonna add to the tax, so you’re going to do less conversions if you’re using the inherited IRA to pay the tax. I would much rather have you take the money out of the inherited IRA to live off of. He’s got, what, nine more years to liquidate? Use cash or the brokerage account, I think, to pay the tax.

Al: Exactly. Yeah, because if you’re taking money out of the inherited IRA, now you’re just increasing your taxable income, which means you can do less Roth conversion.

Andi: There are several actions you can take to lower your 2023 tax bill, including a Roth conversion, but you’ve only got about 6 weeks left to do them! Register now to attend our live, free, End of Year Tax Planning webinar tomorrow at noon Pacific, 3pm Eastern with Pure Financial’s Tax Planning Manager Amanda Cook, CPA. Learn about the strategies that can help you reduce your tax liability, and which ones fit your specific needs and goals. Plus, get all your tax questions answered live and in person, tomorrow at noon Pacific, 3pm Eastern. Click the link in the description of today’s episode in your favorite podcast app now to go to the show notes and sign up – don’t forget to tell your friends. 

Will Saving on Healthcare Premiums Now Mean Large RMDs and Tax Bills Later? (Mike, UT)

Joe: Got Mike from Utah. He goes, “hello, I’ve been enjoying your podcast for the last couple of years, and this is one of my go to Podcasts while hiking in the mountains.”

Andi: Nice.

Joe: Well, Mike’s in a beautiful mountain in Utah.

Al: Yeah, that’ll, that’ll be prettier than ours, I can almost guarantee it.

Joe: “He’s 61 years old, he’s been retired for about three years. His wife, 62, retired two years ago. He drives a 2023 Chevy Bolt EV and a 2024 Corvette Stingray.”

Andi: Nice.

Al: Wow. That’s quite a gamut of cars, right?

Joe: Yeah. A little midlife. “We have a couple of drinks on the weekend, cheap rum and Diet Coke for me and my wife prefers a little Tito in Crystal Light.”

Andi: Another Tito’s.

Joe: “Our current expenses are $5,000 a month. We fund these expenses with cash we pulled from the market about three years ago. We have no outstanding debt, including the house. Our current plan is for my wife to start Social Security in five years at 67 with the benefit of $2,000 a month. I would wait nine years until 70 with the benefit of $4,500 a month. I will receive a small pension of $11,000 per year, not adjusted for inflation going forward at age 65. Our portfolio is as follows. Non-retirement accounts. Let’s see, he’s got 3, 4, 5, 6, 7 $650,000 in non-retirement accounts. Roth IRA, Big Al, $1.2 million.

Al: Yeah, that is amazing. Congrats, Mike.

Joe: I mean, very rare to see a Roth IRA that large.

Al: Yeah, I mean, when’s the last time you saw one over $1 million? I mean, it’s unusual.

Joe: Very unusual.

Andi: Mike’s been listening to this show for a few years.

Joe: Yeah.

Al: Yeah.

Joe: He’s got $800,000 in an IRA. He’s also got an annuity, $360,000, another HSA of $30,000. Okay. All right. “While we do not include any potential inheritance for our financial planning, it’s reasonable to expect to inherit about $1.2 million in current dollars within the next 10 years. We have been doing Roth conversions to the top of the 12% tax bracket and paying federal state taxes on cash on hand.” So, how old is Mike?

Al: 61.

Joe: Oh, 61. So, he’s been retired for how long? Two years? A couple years?

Al/Andi: Three years.

Joe: So he’s been converting to the top of the 12. And he’s got $1. 2 million in Roth. “As a result, we are able to get a high deductible health and dental insurance policy for about $245 a month through the healthcare marketplace. We’re planning to continue these Roth conversions until my wife’s Social Security starts in five years, then re-evaluate the impact of taxes on our Social Security income. We have hesitated on doing larger Roth conversions and moving it up to the 22% tax bracket as we do not see our taxable income increasing significantly in the coming years, or at least until RMD starts and then that will move us into the 22% tax bracket. The larger Roth conversions would likely result in the increase of… $12,000 for health care premiums for the next three years until my wife can start Medicare at 65. We are concerned that we are saving some money on health care premiums, staying in that 12% tax bracket at the expense of large RMDs in the future. Any spitball in our situation would be appreciated. Keep up the good work. Mike from Utah.” Alright, we get this question often.

Al: We do.

Joe: Here’s what happens. People save a ton of money, but we don’t see this where people save a ton of money and they already have $1.2 million in a Roth. They have a couple million dollars in a retirement account, and then they have some money in cash in a brokerage account. And so they might retire a little bit early, and so they qualify for the Affordable Care Act, or some credits, or just like the other caller had some credits from the state of New York. Mike has got a cheap healthcare plan with good benefits. He’s like, man, if I increase my adjusted gross income, that’s going to kick me out of these benefits where I’m going to have to pay higher for my health care. So, what should I do? Should I just kind of bite the bullet and maybe increase my income to get money into a Roth IRA to reduce my future tax liability, but then I’m also going to lose the benefit of the health care? So you have to do the math on both sides of the equation, I guess.

Al: Yeah, so in other words, if you have $12,000 more in health care, you just add that to the tax that you’re going to pay to figure out your effective rate. And I’m going to say without doing that calculation, this is what I would do. I would keep doing the small conversions till I hit 65.

And then once I go on Medicare, it doesn’t matter.

Joe: It does matter, you got IRMAA.

Al: I know, but it doesn’t matter as much. You’re right it does matter, but I would do some bigger conversions. Mike has about $800,000 to work with that he’s trying to convert, which is, you know, it’s a good, it’s a good sum. If he doesn’t do anything by the RMD age, it’s going to probably be $1.5 million to $2 million maybe, depending upon the market. I think it makes sense to keep doing it. But that’s what I would do. I would do my bigger conversions after I was taking Medicare. So I’m not part of this federal subsidy. And yes, it’s going to increase my Medicare premiums. I understand that. But the increase in Medicare premiums is a lot less than the $12,000, I’ll tell you that.

Joe: Yeah, if he stays in the 22% tax bracket, but he also has to realize too that tax rates are potentially going to go up. So just do the math. If he goes a little bit higher than that 12%, I don’t know what the subsidies start at and I don’t know what his taxable income is. So you could play with the numbers there too. I don’t know if it’s at the state marketplace that he’s referring to in Utah or is that a federal, is he talking about the Affordable Care Act on the federal side?

Al: Well, I think it’s the same thing. Affordable Care Act, but it’s run by the state exchange. So I think that’s what he’s talking about. He’s getting subsidies from the feds for the state run insurance. I think that’s what he’s talking about.

Joe: I think you check what those limits are. Maybe you go to the top, because you see the top of the 12% tax bracket, but could you jump in the, a little bit into the 22 and still get the subsidies?

Al: As a married couple, I don’t think so. If I recall, it’s around $20,000 for a person, a couple would be about $40,000. I might be a little off. Or no, let’s see. No, I said that wrong. I think it’s $20, 000 for a couple, but then you multiply that by four, 400% to get to 80 and once you hit $80,000, roughly in rough numbers, then you hit this cliff where you get no benefit whatsoever.

Joe: Got it, So yeah, I mean, you’ve got a handle on it then I do.

Al: You are right, Joe. I mean, just do the math and find out what makes the most sense. Future tax brackets versus now. But that’s probably the conclusion I would come to is smaller conversions till 65, bigger ones after. That’s probably what I would do.

Joe: Yeah. I don’t know.

Al: I figure you might have a different answer.

Joe: I do because, well, first of all, he’s got several million dollars. Or at least a couple million dollars. And I think the subsidy program wasn’t necessarily built for people that had a couple million dollars. But I get, you gotta, you know, you can plan and save and do all of those things. So God bless you.

Al: You can make that argument, but there’s also the argument that these benefits are here for those that are, can take advantage of them. And so why not? Right?

Joe: Yeah. He’s doing good planning. I would run the numbers. I think sometimes people trip over dollars to pick up pennies.

Al: I would agree with that statement.

Joe: If he’s got longevity, and he already knows the power of tax-free because he’s done a phenomenal job of getting over a million dollars in a Roth IRA. So, He’s still young enough where you get the compounding effect of tax-free dollars. I mean, it’s huge. It’s the purchasing power of those dollars that are going to be worth more in the future. So I would just look at it to say, Hey, yeah, I might have to spend a little bit more by doing these conversions. But if I believe that tax rates are going to go up and if I want to have a lot more flexibility, Or if I want to leave a legacy tax-free to the next generation, I mean, there’s a lot more things that he should be considering versus $12,000 today versus whatever in the future, because I think the future benefit is probably going to be larger. That’s just my two cents. I don’t know him with Adam. I don’t know what his goals are, and I don’t know anything besides that.

Al: Yeah. So I disagree, but that’s cool. And I think also, Joe, people that have saved this well. Right? It’s hard to bypass the $12,000 benefit.

Joe: For sure. Right. That’s why he’s got several million dollars.

Al: Correct. Yeah. It’s kind of hard to flip that switch. So anyway, we have a slight difference of opinion, but there’s no wrong answer. Mike, you’re in a great spot no matter what you do.

Joe: All right. Congrats, Mike and enjoy the hike in the mountains.

Where to Invest After Maxing Out 401(k)? Backdoor Roth? (Mark, MD)

Joe: Got Mark from MD from Maryland. “Hey, Joe, Big Al, Andi. My wife and I drive boring company cars.” All right. So, Mark, “he used to drink anything and everything. But eventually had to pass that baton to the younger and more spirited generation due to health reasons.” Ah, that’s too bad.

Al: Yeah, that’s too bad.

Joe: “The wife likes the occasional glass, sometimes the whole bottle of Chardonnay. Spitball where to invest after maxing out the 401(k)?” Okay, so Mark, he’s 59. He makes $120,000 a year. He’s got $750,000, he’s got $1 million in retirement accounts. His spouse is 62, she makes $160, 000, and she’s got $1.2 million dollars in retirement accounts. So keep score about $2.5 million $2.2 million in retirement accounts. He’s got a home of $500, 000, no mortgage. Got a joint account of $2 million at Vanguard after tax mutual funds, eTrade account with some individual stocks, got $600,000 in cash-like stuff. Have maxed out $30,000 each in our employer 401(k) plan. So now what?” All right. So here’s some bullet points. “We can not have a front door Roth IRA contribution. All right. So let’s see, what’s his total income? $280,000 minus 25 minus 60 will get them to just under the limit.

Al: It’s close, but he’s got $2 million in brokerage, so it’s probably capital gains, interest dividends, I’m guessing.

Joe: Okay. So I agree with that. We cannot make a Roth 401(k) contribution. Okay. I don’t know why you can’t. Is it because the company doesn’t allow it?

Al: I’m guessing it doesn’t have one.

Andi: or doesn’t have one

Al: It doesn’t have a Roth option. Most companies do though.

Joe: I know. I would double-check with your HR to see if you have a Roth provision in the 401(k) plan.

Al: Yeah, me too. Or if you don’t, first of all, you work for one of the few companies that doesn’t have one, but why not try to lobby to get one?

Joe: So yeah, God, with $60,000, I would like to look at his tax return. Because he might be able to squeeze in Roth contributions.

Al: Close. It’s pretty close. I agree.

Joe: Because what’s the AGI limit for Roth is 218 to 228? Call it 220 to 230. This is at 280, minus 60 plus the standard deduction.

Al: It just depends upon the interest.

Joe: Interest dividends.

Al: Yeah, capital gains, all that stuff.

Joe: Okay. So Roth 401(k) contribution. Double-check your employer. See if you can do that. “Can either of us make a backdoor Roth conversion? I would have a problem with the pro rata rule, but can my wife?” Yes she can. Yes. Even though she’s fully funding her 401(k) plan, she does not have any IRAs. So she could do a non-deductible IRA and then convert that into a Roth without paying tax. Because it’s an after-tax contribution.

Al: Yeah, and a lot of people don’t realize Joe you can max out a 401(k) but still max out an IRA or Roth contribution or backdoor Roth contribution.

Joe: What about a post-tax 401(k) contribution? Well, if you don’t have a Roth provision, do you think he’s got a post-tax?

Al: Yeah that would be super unlikely. I mean, most plans have Roth provisions, but very few have the after-tax. Some do.

Joe: So, all right, he’s looking at after-tax contributions. So, if you’re making an after-tax contribution into the 401(k) plan, Those after-tax dollars could be converted directly into a Roth IRA without paying any tax as well. It’s just like a backdoor Roth contribution. You’ve already paid the tax on the dollars. Those dollars go into a Roth IRA and then compound tax-free the same as after-tax contribution into a 401(k). So he goes, there’s a contribution limit of $73,500 minus, Joe, this is a minus sign. Thank you. Pre-tax contribution, less employer matching. I changed it to less just in case there was any confusion.

Andi: He’s got minus and less in his sentence.

Joe: Yeah, he’s a little smart pants. He’s ribbing on me, which I enjoy. Keep it up. This grows tax-free, but we’ll have to come out with RMDs, correct?” No, they changed the rules with Roth 401(k)s. I forget when that starts, Next year?

Al: Yeah I believe you’re right. It’s either next year or I don’t know, but it is soon.

Joe: It doesn’t matter. I mean, if you’re going to retire or you have time before your RMDs, let’s say if I had Roth money in a 401(k) today, I would just move those Roth 401(k) dollars into a Roth IRA. That would avoid the RMD entirely. Or if I have the Roth 401(k) and I’m not going to be RMD age or my required beginning date is not for several years, then don’t worry about it because if we’re to change the law in a couple of years, there won’t be any RMDs out of the Roth 401(k).

Al: Yeah. 100% agree.

Joe: Okay. Also, Do I have to track basis with this style of investing to get any benefit? No. He’s thinking, well, it depends because some of the dollars might come out pro rata, but on your 401(k) statement, you’re going to see pre-tax and post-tax dollars. And so let’s say I had $100,000 in my retirement account on my statement, because I have a Roth provision in our 401(k,) so I have pre-tax and I have post-tax, when I look at the statement, it’s going to say $50,000 Roth, $50,000 regular unleaded. Right. So you already know how much money that you have in regards to basis. So if your plan is going to come out pro rata, this is where the distribution rules get funny depending on the plan documents. Because if it comes out pro rata, let’s say you take $1 out, well, $0.50 is going to be tax-free and $0.50 is going to be taxable because you have 50% of the account in Roth, 50% of the account in pre-tax. So some 401(k) plans say it’s got to come out pro rata. Other accounts are going to be, you’ll be able to choose and pick and say, no, I want to take a distribution, but I want to take the distribution from the Roth, or I want to take the distribution from pre-tax or here’s the percentage that I want to take out in pre-tax versus Roth. So you’re going to have to do a little bit deeper look at your plan document. That’s why I think it always makes sense just to roll the money into IRAs because then you don’t have one account with pre-tax and post-tax in it that could get confusing as you’re taking money out.

Al: Yeah, and the mechanism for that is when you roll it out to an IRA, the pre-tax part goes to the IRA. The Roth part goes to the Roth IRA. So then it’s completely separate. You can do what you want.

Joe: All right. Let’s see. I think that’s it. Thanks a lot for the question, Mark from Maryland. I’m glad you loved the show. “Do you think a Roth 401(k) would be a better strategy for 2024 and 2025?” Yeah. Go for it. You’re in the 20% tax bracket. You don’t have any Roth money? I think so.

Al: Yeah, I mean, for people that can afford it, Mark is in the 24% bracket, which is a great bracket based upon what other income and assets he already has. So yeah, I think it’s a great idea.

Andi: Let’s talk for a second about the word recession: does it make you want to run for the hills, or do you look for a golden opportunity? Uncertain market conditions have some pundits forecasting a recession, which can impact your portfolio and your ability to retire. And taking the wrong actions during a recession can take decades to recover from, and it can delay your retirement. Watch “How to Build a Recession-Proof Portfolio” on YMYW TV and download the companion guide for free from the podcast show notes. Learn the signs of a recession, how to position your portfolio accordingly, and how to prepare to grow your wealth, regardless of the economy and market conditions. Click the link in the description of today’s episode in your favorite podcast app to go to the show notes, watch How to Build a Recession Proof Portfolio, and download the Recession Protection Guide, all free, all yours, courtesy of Your Money, Your Wealth.

How to Get More into Roth Without Paying More Tax? (Steve & Sharon, Roseville, MN)

Joe: Got a little email coming in from the homeland here, Big Al. We got Steve and Sharon from Roseville, Minnesota.

Al: Wow. You know where that is?

Joe: I do know where Roseville is.

Al: I bet you do.

Joe: “Dear Andi, Joe, and Al. I have a question about asset location. My biggest worry is that I don’t have enough money in tax free Roth accounts and it’s going to cause issues after we retire.” Well, that’s no good. “Early in my career, my income went above the limit to contribute to a Roth IRA, so there isn’t much in there now. I’m wondering if we should do a backdoor Roth.” Okay, sure. Everyone loves the backdoor.

Al: They do.

Joe: We haven’t really talked about backdoor routes lately. It’s coming back.

Al: Making a comeback, huh?

Joe: Yep. “Should I start investing in my company’s Roth 401(k) instead of a regular 401(k) or just wait until we retire and our income tax rate is lower to do more backdoor Roth. I think he means conversion.

Al: Yeah. I think so.

Joe: We currently have $6.4 million in assets of which $465,000 in cash, $6 million is invested and $1 million in my wife’s rollover IRA. He’s got $2 million in his 401(k). He’s got $800,000 in a brokerage account. $400,000 in the ESOP, $65,000 in 529. $30,000 in my wife’s SIMPLE, $32,000 in my wife’s SEP. $25,000 in Roth IRAs, $20,000 in IRAs, and $20,000 in HSAs, and $1.6 in our house that’s paid off.” Congrats, man.

Al: Yeah, that’s a lot.

Joe: Killing it in Roseville. Our investment mix is 70% stocks, 20% bonds, 5% alternatives, 5% cash. We also draw $18,000 per year from $1 million NIMCRUT.” Uh Oh, we are getting sophisticated here.

Al: Net Investment Makeup, Charitable Remainder Unit Trusts.

Andi: I was going to say, that’s an acronym I have not heard before.

Al: It’s a mouthful.

Joe: NIMCRUTs. Remember NIMCRUTs, bud?

Al: Yeah, I do. We had some clients, whether they did the net income crut or the net income makeup crut. Or what was the one that changed midstream? The flip crut. Remember that? We still use those.

Joe: Al and I were on the roadshow. This is prior to the real estate crash of 2008. Real estate was going through the roof. Everyone here in Southern California just wanted to be a real estate guru.

Al: Myself included.

Joe: We were talking about how to get rid of highly appreciated real estate tax efficiently. So we’re doing these workshops all over Southern California and the people that would show up there, it’d be like, why on earth would you want to invest in anything else but real estate? You know how much money I made in real estate and everything else. Then just like six months, eight months later, boop.

Al: Lost everything.

Joe: There goes your net worth, brother. People would say, oh, I would never invest in the stock market because I can drive by my house and look at it

Al: I can touch it.

Joe: Right. I can touch, I can, I can touch the grass. . You can’t touch stock. Oh my God.

Al: Yeah. We heard that a lot. So we talked about,

Joe: I can smell it. I can kiss it.

Al: We talked about charitable remainder trust quite a bit because that is a really good vehicle if you have a highly appreciated property that you want to sell and not pay current taxation. Another day, another topic, but anyway, that’s what that is.

Joe: Yep, and so, this was created five years ago, so our buddy from Roseville, Minnesota, he had a highly appreciated company stock. And he used those funds to pay for a $2 million whole life insurance policy for his kids at five at $9,000 annually. We don’t count this in our net worth for investments. He’s 54. Would you set up a NIMCRUT and a life insurance policy expecting to die at 50.

Al: It seems a little early, but I have seen that before, Joe. I have seen that.

Joe: Yeah. All right. Some master planning there. Because you’re kind of stuck with that strategy.

Al: You think, uh, he met with our friend, Mark K.

Joe: I wonder if he’s got a QPRT?

Al: Pretty sure he does.

Joe: All right. So he’s 54. He’s making $300,000 a year. 2019 Ford Raptor. Ooh, drink a little rye whiskey. Old fashions. My wife’s 48 years old. Self-employed. $100,000 a year. Drives a 2019 Volvo XC90. That sounds pretty sexy. Is that Volvo, uh… Instructable SUV, I believe.

Andi: Instructable?

Joe: I mean, that’s why you buy Volvo’s, right? Because you probably get

Andi: Oh, indestructible. Got it.

Joe: Indestructible.

Al: They’re safe. Or you could say they’re very safe.

Joe: Yeah. You might be prone to car accidents. So, pretty safe. “We have two kids, 13 and 11, burn about $150, 000 a year in expenses. I plan to retire before 60, my wife before 55. With our tax rate at 35/37%, I struggle to put money in towards Roth. Spitball is appreciated on our asset location question, Steve and Sharon from Roseville. All right, well, congratulations first on 48 and 54. They’re doing quite well.

Al: Yeah, fantastic.

Joe: Gosh, I still don’t.. Man, picking a $1 million out of your estate five years ago, 49 years old, and you’re just looking to pass that money to the kid. So he’s going to have to fund that policy for quite some time.

Al: You know where, where I saw this from someone younger, and this was years ago, it’s when the estate tax exemption was $600,000. Now that it’s $13 million per person, roughly, you don’t see this so much anymore.

Joe: But anyway, he got a tax deduction. I don’t know what he did with the tax deduction when he put the money into the NIMCRUT, maybe just saved some money on the ordinary income that was coming in with him and his wife. A few things that I see, I would change the wife’s 401(k). I mean, the SEP and the SIMPLE, unless she has employees. You could change that to a 401(k) plan, and then you could do a profit sharing on top of that. You have $800,000 in a brokerage account, so she could fund a 401(k) plan, and then she could also do a profit-sharing plan on top of that. So part of that would be, let’s say, a solo Roth 401(k), and then she could still get pre-tax dollars in. So it’s basically, you’re taking money from the brokerage account, And you’re just trying to put that into a Roth account by keeping your taxes neutral. So if you’re in the 37% tax bracket, right, how do I get money into the Roth IRA without paying more in tax? Or another way to say it, let’s say his tax bill last year was $100,000, just hypothetical. How can I keep that tax bill $100,000 and get as much money into the Roth IRA as possible? That’s one way to do it. You’re just kind of manipulating the taxes by setting up different types of accounts, especially for his wife who is self-employed. But he’s 54 and she’s 48. They’re young, right? And he’s, I would get money in the Roth IRA. You’re, you’re not going to miss the tax deduction. I would try to jam as much money in. I’m in a decent tax bracket. And I don’t care about the tax deduction today because I don’t want to pay taxes in the future. I’m ripping off the band-aid, I don’t care, I’m not going to miss the tax deduction. The few thousand dollars that I saved in tax today, I’m going to make that up in the future and I’m going to be that much more happy by looking at this giant pool of cash that’s going to come to me tax-free.

Al: I probably would do it differently.

Joe: Yeah. Because you’re a CPA.

Al: In the highest brackets, I would go for the deduction and then if I was going to retire in five or six years at age 60, I got 15 years to convert this stuff in lower brackets. That’s what I would do.

Joe: He’s got $3 million Al.

Al: I know it’s a big number. I, I get it. I get it. But anyway, that’s what I would do. I would probably, let’s see, I guess we didn’t even talk about whether there’s an after-tax component of the 401(k). That would be a good thing to get a whole bunch of money in that mega backdoor Roth and get money into a Roth that way. You know, another thought I had while looking at this, which is unrelated to a Roth, but still important is It sounds like maybe with an ESOP account, there’s a company that was pretty successful. Do you have company stock in your 401(k)? Is it a public company? If so, you might qualify for an NUA Net Unrealized Appreciation, where when you retire, the stock gets taken out of your 401(k), put into your brokerage account and you only pay current tax, ordinary income tax on what your cost basis is, what you paid for that stock. And then the capital gain part, when you actually sell the stock is that capital gain rate. So I don’t know enough about your situation.

Joe: I already know what happened to Steve and Sharon here. Because of the ESOP plan, there was a liquidity event in his company five years ago. And he got company stock. I’m guessing, I have no idea who the hell these people are, but they’re from Minnesota, so I feel a connection here. And so they got the million dollars, and they got the big estate planning attorney and the broker. They came in, and they did a little dog and pony show, and they were like, this is what you do to avoid taxes. In this liquidity event that you’re going to have, you’re going to set up a NIMCRUT. We’re going to put the company stock in the NIMCRUT. You’re going to sell it. You’re not going to pay any tax. And then we’re going to distribute the money out to you. But if you die prematurely, guess what? All that money goes to charity. So we’re going to set up a wealth replacement trust. There, you’re going to pay a premium with this wealth replacement trust, and you could take some of the money from the NIMCRUT and fund that wealth replacement trust. Because if you die prematurely, then the heirs are going to receive $2 million versus the $1 million that’s in the account.

Al: Yes, I think you’re right.

Joe: That’s exactly what happened.

Al: I think you’re right on that part. 100%. I’m just suggesting, if there’s a public company and there is company stock in the 401(k), you might want to look at an NUA. But you know what? His question was. On asset location.

Joe: Well, he’s talking about tax diversification.

Al: Yeah. Yeah.

Joe: So he wants more money into a Roth IRA. Should I get more money in a Roth IRA? Is it a 37% tax bracket? He’s got $6 million bucks. He’s got very little in Roth. Yes. Put the money into the Roth. You’re young jamming in there. I don’t care. That’s what I would do.

Al: And I would say, wait till you retire, then do huge conversions for 15 years. That’s what I would probably do.

Joe: He doesn’t have that much money in a brokerage account. If he retires at 55 or she’s going to retire at 55, he at 60, I suppose that, yeah, that would work. All right. Thanks for the question, Steve and Sharon.

Roth 401(k) or Traditional 401(k) With New Employer? (Joseph from Wichita, KS)

Joe: “Joe and Al, Joe and Big Al, this is Joseph from Wichita, Kansas. I really appreciate your show. My CPA friend suggested it about a year ago, and I’ve been listening religiously since.” Well, thank you, CPA friend, and thank you, Joseph. “Currently listening as I clean out my apartment, drinking an ice-cold Keystone Light.” Oh, yeah. No Keystone. “I’m a simple man. But we’ll also drink whatever’s put in my face.” Oh, Joseph.

Al: Or in front of his face.

Joe: I can’t. I mean, there’s, I gotta draw the line.

Al: Like a double IPA.

Joe: Yeah, there’s no way I would drink that. I’d much rather have ice water.

Al: Ice water. Yeah. I hear you.

Joe: “My wife and I are moving and I took a new job in the private sector after working for a local government for the past three years. In my previous job, my employer did not contribute, but I was required to contribute 4% of the state retirement program. I knew I would not be working under the retirement program for long and wouldn’t be vested. My question, based on our finances below: would it be smart to begin a Roth or normal 401(k) with my new employer?” Got a little theme going.

Al: Yeah, we do.

Joe: “They will match 6% with an extra 3% added at the end of the year due to our larger allocation of Roth, with setting up my new retirement pre tax balance, our tax allocation more effectively or efficiently. We would like to retire around 55 and spend about $100,000 a year in today’s dollars. We currently spend $31,000 a year and save and invest $54,000 a year. I’m 29, my wife is 28.” Wow. Look at you. Look at the big wallet on Joseph here from Wichita.

Al: Yeah, that’s impressive.

Joe: How can you live off of $31, 000 a year? That is…

Andi: They are In Wichita.

Joe: San Diego. Wasn’t there just something, everyone’s like bitching about San Diego.

Andi: San Diego’s like the most expensive place in the country to live, I think it was a headline.

Joe: Who said that? Was that someone from San Diego? Or was that like a national publication?

Al: I assume it was a publication. I didn’t read it. I just heard that from Andi. So my source is my wife.

Joe: All right. He’s got $100,000 in cash.

Andi: Oh, guess what – US News and World Report is the one that said that we were the number one spot in the most expensive places to live.

Al: Okay. Top of the list. Okay

Joe: So he’s got, let’s see, alright, $100,000 in cash. He’s got $65,000 in wife’s Roth. He’s got $13,000 in his Roth. Brokerage account of $37,000. He’s got $20,000 in a wife’s rollover. And, uh, he’s got a current retirement to be transferred to the new 401(k) of $12,000. My wife makes $55, 000 a year. I make $80, 000. We’re debt-free. Vehicles. Our GMC Canyon and a Honda Tucson. Joe, drink some Keystone.” Oh, you know me, brother. I’ll drink some Keystone with you. “Would appreciate any spitball about my new 401(k) situation or financial situation in general. But thanks in advance for your hard work.” All right. What’s he got in total, Big Al?

Al: Total. He’s got, call it $250,000.

Joe: $250,000, saving $50,000 a year. He is 29 years old. Would like to retire at the age of 50 something, he said.

Al: At 55

Joe: At 55. Okay. He wants to spend $100,000 a year. Let’s do some math for our friend Joseph.

Al: Okay. I’ll do it too. 250, 55. You want to go 6 or 7%?

Joe: 7%. I like it.

Al: 7% and we’ll call it, let’s just round it to 25 years. So I got 4. 8 million.

Joe: I got 5.7.

Al: Let’s see. 25 years, 7%, 250 to start 55. Yeah. 4. 8.

Joe: Yeah, 4.74. Okay. Sorry, I hit the wrong button or something. Alright, so $4.7 million.

Al: Call it $5 million, right?

Joe: $5 million. 4 times 5 is 20. So he could pull out $200, 000. I mean, yeah, I think he’s on track. Just put it back in the envelope. I think he could save $50,000 grand a year. I mean, that’s huge. What percentage of that, of their total income are they saving? I mean, 80 and 60 of 50 divided by 140. 36%. Yeah. I mean, that’s a huge number, Joseph.

Al: That’s giant.

Joe: I mean that’s, I mean, that’s the key. If you could save 35% of your income, your gross income, not your net. You’re going to be able to be very successful financially down the road.

Al: Yeah. I 100 % agree. And everything should go into a Roth – 100 % because at your age and the years that this can grow compound, that’s what I would do. And I think Joe will agree 100% with me. Everything that you can put in a Roth, please do.

Joe: Yep. Compound tax-free, $50,000 a year if you can do it. Keep pumping away and just keep looking at it, monitoring it. We have a globally diversified portfolio, 100 % stocks at this point. And then slowly, you know, take on a little bit less risk as you get closer to your retirement date. And I think you’re right there. He doesn’t have to worry about some crazy distribution strategy from a tax perspective because everything is going to come out tax-free for him.

Al: It’s like you’re done. Right. You’re all set.

Joe: Yeah. If everyone could call us, you know, in their twenties, and then we could fast forward 25 years.

Al: And you have to be able to save $50,000 a year, then we can help you. It’s very easy.

Joe: Here’s the caveat. Uh, all right. Is that it? That’s it for us. Andi, wonderful job. Thanks again. Thank you. Keep your questions coming. We’re slowly getting through them. Be patient.

Andi: I think we still have about 40 of them. So, yeah, definitely being patient right now is key, but keep sending them in. We will get to them eventually, right?

Joe: Yeah, we’ll get to them. Maybe you just, we’ll just do a little bit longer episodes. What are we doing? 45 minutes? Maybe we do 55. We can answer one more question a week.

Al: Yeah, yeah. Probably so. Yep.

Joe: Okay. All right. Al, when do you get back from Hawaii?

Al: Uh, in about a week and a half.

Joe: All right, enjoy and we’ll see you soon.

Al: All right. Sounds good.

Joe: All right. We’ll see you next week folks. That’s it for us.

Andi: Calling out other financial podcasts, springer spaniels, listening to podcasts while hiking around San Diego county, Tito’s and Crystal Lite, Tang, Malibu Rum, and Spam, company cars and vans, Hawaii vs. my studio, and Joe’s Grandma drinking Keystone in the Derails, so stick around to the end of the episode.

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The Derails

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