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Joe Anderson
ABOUT Joseph

As President of Pure Financial Advisors, Joe Anderson has led the company to achieve over $2 billion in assets under management and has grown their client base to over 2,160 in just ten years of the firm opening. When Joe began working with Pure Financial in 2008, they had almost no clients, negative revenue and no [...]

Alan Clopine
ABOUT Alan

Alan Clopine is the CEO & CFO of Pure Financial Advisors. As CEO he currently leads Pure Financial Advisors along with our executive team. As CFO he is responsible for the financial operations of the company. Alan joined the firm about one year after it was established. At that time the company had less than [...]

Published On
August 3, 2021

Is it better to pay tax on $5 million than on $1 million, or is that crazy talk? Also, an asset location strategy to lower RMDs and taxes but still maintain portfolio growth, and an argument against Roth IRAs. Is it a valid one? Plus, what counts as contributions if you withdraw from your Roth IRA after 5 years? Why not pay the tax on a Roth conversion out of your IRA? Roth conversions vs. the medical insurance ACA subsidy, and what? Joe, arrogant?!

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Show Notes

  • (00:52) Does This Asset Location Strategy Lessen RMDs and Taxes While Maintaining Portfolio Growth? (Wes, Unincorporated Gwinnett County, GA)
  • (04:50) We Think Paying Taxes on $5M is Better Than Paying Taxes on $1M. Is This Crazy? (Julia, FL)
  • (12:00) Is This a Valid Argument Against the Roth IRA? (Ken, Alaska)
  • (18:23) What Counts as Roth IRA Contributions If I Want to Withdraw After 5 Years? (Narender, FL) 
  • (22:04) Comment: Less Joe, More Al – Joe is Arrogant
  • (26:28) Can I Convert 401(k) to Roth IRA Over Several Years? (Miriam, UK)
  • (29:03) Why Not Pay Roth Conversion Tax Out of the IRA? (Russell, MS) 
  • (33:20) Roth Conversions vs. Medical Insurance ACA Subsidy (Chuck, Western PA)

Free resources:

Why Asset Location Matters Guide

The Ultimate Guide to Roth IRAs5 Year Rules for Roth IRA Withdrawals

Listen to today’s podcast episode on YouTube:

Transcription

Today on Your Money, Your Wealth® podcast #337, is it crazy to think it’s better to pay taxes on $5 million than paying taxes on $1 million? Plus, Joe and Big Al spitball an asset location strategy to lower RMDs and taxes but still maintain growth in the portfolio. The fellas also consider an argument against the Roth IRA. Is it a valid one? What exactly counts as contributions if you want to withdraw them after they’ve been in your Roth for 5 years? Cn you convert 401(k) to Roth IRA over several years? Why shouldn’t you pay the tax on a Roth conversion out of the IRA you’re converting from? What do you do about Roth conversions if you want to keep that subsidy on your medical insurance? And… what? Joe, arrogant? I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP®, and Big Al Clopine, CPA.

Does This Asset Location Strategy Lessen RMDs and Taxes While Maintaining Portfolio Growth? (Wes, Unincorporated Gwinnett County, GA)

Joe: “Joe, Al, Andi. Hello from Unincorporated Gwinnett County, Georgia. Do you think that’s right?

Al: I think so. Gwinnett. Yep.

Joe: “I have a question about asset location and RMDs. I’m 14 years away from my RMDs. Does the following asset location strategy make sense in order to lessen RMDs and the associate future taxes? While maintaining overall portfolio growth, the strategy to reduce bonds held in the taxable account increased stock funds in the same amount, while simultaneously increasing bonds and decreasing stocks in my 401(k). Thus shifting assets will be done in a manner that does not change the overall stock bond allocation I’ve chosen. By doing this asset allocation or location shift, overall portfolio growth, which should mostly come from my stocks over the next 14 years, will happen in the taxable account. The bonds will be in the 401(k), while providing portfolio stability will likely not grow as much, thereby lessening future RMDs. Keep up the good work.” Was that a statement or question?

Al: Well, I think he’s-

Joe: – asking for verification?

Al: – a second opinion or verification.

Joe: He’s right on. Very good.

Al: Totally agree.

Joe: Totally agree. So let’s talk a little bit about that. Asset location really mean this, is that you want certain assets in, depending on the taxable that they’re in. We’ve talked about taxables, one’s tax-free, which would be a Roth; taxable, which would be a brokerage account; tax-deferred would be the IRA or 401(k). And your tax-deferred accounts because you’re going to be paying the highest rate potentially, ordinary income. You would want asset classes that are a little bit more stable and have a lower expected rate of return. Because you don’t want an asset class that will, let’s say on average, does 8% because you’re going to pay the highest tax on that. You would want an asset class historically that does maybe 4% because you have to pay a higher tax rate. In your brokerage account, like Wes just said, he wants to keep his stocks there because they’re going to be taxed at a lower rate, capital gains. If you have a loss in your brokerage account, you can also take that loss in your brokerage account and you can offset that loss against future gains in the future. And again, Roth IRAs are tax-free. So you would want to have asset classes that would, I guess ideally give you the highest expected return or the most risky. So asset location is a tax play. But then as Wes, you get closer to retirement, then you have to figure out where are you going to be pulling the dollars from. Because you don’t want to have your brokerage account all full of stocks if you need to pull money from there. And same with your Roth and so on. So I think he’s on to the concept. But then when you put it in practice, you just have to look at your specific situation a little bit further.

Al: Yeah, and I think a lot of times when we see people, they have all their stocks in their IRA and all their cash or short-term bonds in their non-qualified non-retirement account. And from a tax standpoint, it’s completely backwards because you have the highest growth in the IRA. You pay the highest tax, ordinary income. You could have capital gains in the non-retirement accounts, but yet you’ve got cash or bonds that are producing ordinary income anyway. So that is a good thing. But Joe, I agree with you. I was going to make the same point, which is when you’re actually pulling money out of the accounts, if you have all stocks in your non-retirement account and you need to pull from that account and the account goes way down, then you’re kind of stuck. So you want to have some liquidity or some safe money in actually each of the 3 pools when you’re doing distributions.

Joe: Especially Roth accounts, because we talk so much about it. If you’re doing conversions, just paying a bunch of money and you need to spend that at some point. And then the market turns and you have individual securities or something like that, it just takes a bath, spend all this tax to get it there. Then also when you’re down 40%, it’s going to hurt. You need time for it to recover.

Al: Correct.

Joe: Hopefully that helps, Wes. Thanks again for the question.

We Think Paying Taxes on $5M is Better Than Paying Taxes on $1M. Is This Crazy? (Julia, FL)

Joe: Julia from Florida. She has a question. “I’m 43 years old, married with two young children. Both my partner and I work full-time in government services with combined gross pay of $200,000. We both contribute the maximum to our thrift savings plan, combined balance of $1,000,000; and to individual Roth IRAs, combined balance, about $500,000.” How old is she? 43? My gosh. That’s impressive.

Al: It is impressive.

Joe: $200,000 of income and they got $1,500,000. Then they contribute another $1000 a month to a 529 plan for each child. “We do not have any housing costs and we will receive a pension upon retirement.” What the hell are you writing in for?

Al: This is like the ideal person here. It’s like, why don’t you, Julia, why don’t you just join us here so you can tell our listeners how to do this? Joe: My goodness. “My partner plans to retire after 20 years of government service in 7 years. I will continue working for at least 10 more years. We’re doing fine financially.” Yeah, you think? “I’m not concerned about that. However, what level of concern should I have regarding nearly all of our wealth in a brokerage account? The current balance is $2,200,000.” What does that mean? I thought she’s got $1,000,000 in a TSP?

Al: She does.

Andi: This is what she’s got in a brokerage account.

Al: This is maybe in addition to?

Andi: Yep.

Joe: So they got $1,500,000 in retirement accounts and then, I’m not concerned about that, the $1,500,000. Why I am concerned, is that-

Al: -she’s got money in a brokerage account.

Joe: “We got a current balance of $2,200,000 in our brokerage account.

We are invested 99.9% in equities, and have been comfortable weathering the ups and downs in the market. For example, in March 2020, we saw $300,000 go down the drain. Did nothing. Gained it all back. And probably a lot more. We don’t own real estate. I’m not really interested and don’t want to dedicate the time to it. So this might sound ridiculous, but we don’t know where else to put the money.

We crank it out all into the stock market. We see the results and it’s hard to change course. I understand that someday when we want to have access to all the brokerage account money, we’ll have to pay taxes. We are following the general mindset of paying taxes on $5,000,000 is better than paying taxes on $1,000,000.” I would agree with that.

Al: Me too.

Joe: “Let’s just make as much as possible in the stock market and be happy to pay the taxes on those massive gains. Is this crazy? Is there something different that I should consider doing with all the money? I plan to adjust the investment distribution to be less aggressive when my husband retires, because I guess that is the responsible thing to do. But until then, I just want to keep investing. What are your thoughts on this? Also, I drive a Subaru Forester, gray with black interior.” All right Julia. Keep doing what you’re doing, you know what I mean? Why make it more complicated than you need to?

Al: It sounds like- well, first of all, you’re not going to need the money for quite some time, maybe never.

Joe: Because of the pensions.

Al: Because of the pensions and everything else. I’m not sure how you’re spending, but realize this. We’ve had a, what, 11, 12 year bull market-

Joe: Market timing alert.

Al: -and maybe we’ll have another 12 years. There’s no way of knowing that for sure. But things tend to cycle. And we did have a pretty good recession. We had the Great Recession, 2007, 2008, 2009. So just be aware of that. If you have the mortal, the mental fortitude to be able to stomach stuff like that. This last year went down for a month and we didn’t know we had and by the time you would have done anything, the market already went back up. If you can stay the course for a year or two or more when we have another recession, then I think you’re an ideal candidate just to keep doing what you’re doing.

Joe: A couple of things- you should be looking at rebalancing and tax loss harvesting opportunities. For someone that has a couple of million dollars in a brokerage account, you could be very tax-sensitive within those dollars. So it’s not like we’re going to pay all these taxes on $5,000,000 in the future if you manage it appropriately along the way. So, for instance, you lost $300,000 in March. Was that a true loss? Did you sell and then buy something different? That’s called tax-loss harvesting. You could take that $300,000 loss and offset it against future gains.

Al: Yeah, good point.

Joe: And so then you’re still building wealth within that overall account, but you’re not building the tax time bomb.

Al: Or little less than one because you got some loss carryforwards.

Joe: Right. And I don’t understand why she’s more concerned about the brokerage account being- see, this is the mentality too of people- and we just talked about this. Is that Wes asked this about asset location. Hey, I want to shift my mindset a little bit and I want to have more stocks here, less stocks there. So Julia writes in and she’s like, I got $1,500,000 in retirement accounts. I’m not worried about that. What I’m worried about is my brokerage account. Money’s money. You just got to look at how is it taxed? In a brokerage account, it’s going to be taxed at a lot favorable rate. And you could do a lot more tax management with those accounts in a brokerage account long-term.

Al: Yeah, this is where you want to have your gains. It’s kind of like if I owned a company and Joe, you’re going to buy my company. And you’ll either pay me $1,000,000 or $2,000,000. And I’m going to say I’d rather sell for $1,000,000 so I could pay less taxes? No, I’m going to sell for $2,000,000. And the same applies here. I’d rather pay taxes, especially capital gains, I’d rather pay capital gains on $5,000,000 than $1,000,000 any day of the week.

Joe: Right. So, yeah, keep doing what you’re doing. If you’re saving that much and you have that much and you’re 43 years old. Why work? Do something else. Congrats.

So we’ve determined that asset location is figuring out whether to put investments in your brokerage account, or your Roth, or someplace else, based on how each asset class is taxed and what kind of returns you expect them to have in the future. Properly locating your assets has the potential to boost post-tax returns in your retirement portfolio. If that sounds like a good idea to you, maybe downloading our free “Why Asset Location Matters” guide would be a good idea too. Or you can just schedule a financial assessment, also free, for a comprehensive and personalized look at your overall financial situation. Download the Asset Location guide and schedule a free financial assessment in the podcast show notes at YourMoneyYourwealth.com. just click the link in the description of today’s episode in your podcast app to get started.

Is This a Valid Argument Against the Roth IRA? (Ken, Alaska)

Joe: Ken writes in from Alaska. He goes “Hey Joe and Big Al. I’m a new listener and have been binging your podcast. My wife and I are 30 years old and make approximately $175,000 a year, with no kids. My job recently added a Roth 401(k), and a Megatron option that I’ve been stuffing money in.” Good for you with the old Megatron. “17% to max Roth 401(k), 8% to after-tax that auto-converts to Roth. I was talking to a friend and he said that contributing to Roths doesn’t make sense. His reasoning, if we want a similar income in retirement that we do now, we could contribute to pre-tax accounts and save at our marginal tax rate. When we withdraw the money, we’ll be paying at our effective rate and therefore paying less taxes overall. His reasoning feels wrong to me, but I didn’t know how to get around his process. I was hoping you could provide some guidance on why Roth was a better choice. We have pre-tax savings already and have been contributing a lot to Roth and trying even them out some. Perhaps that is the wrong strategy, and we should be putting more all to pre-tax. Thanks for all your great advice, support too, and your response, Ken.” All right, so I guess, do we need to explain marginal versus effective?

Al: We do. So effective would be your average tax rate. And the way the tax brackets work, the lowest rates, 10%, then there’s a 12%, then there’s a 22%, 24%. It goes as high as 37%. And depending upon what bracket you’re in, like let’s just say you’re in the 24% bracket. Well that doesn’t mean you pay 24% on all your taxes. It just means that you pay it on whatever income falls in that bracket. So some of your income is taxed at 10%, some at 12%, some at 22% and some at 24%. So when you blend those all together, that’s your effective rate. And so if you take my example, maybe your effective rate when you blend those all together is 18%, whatever, some figure like that, that’s effective rate. That’s nice to know, but it’s not very good for tax planning. For tax planning, you want to know your marginal rate, your highest rate, because that’s what the rate you’re going to pay if you add $1 more of income or have $1 more of deduction. So the marginal rate is always what’s important to consider when you’re thinking about a Roth IRA versus a regular 401(k). In other words, if you’re the highest bracket, 37%, maybe your effective rate’s 23%, but your marginal rate’s 37%. That’s a high bracket. So you might want to do a Traditional 401(k) to get that tax deduction. But the concept is the same, whether you’re working or in retirement. That’s why this is a flawed analysis, Ken, by your friend. Because the way to think about it is that when you’re- basically if you have the same income and the same income need in retirement versus now, that would imply that your income is the same. And if tax rates stay the same, you’re going to be in the same bracket.

Joe: You’re going to be in the same effective rate.

Al: Same effective rate, so it doesn’t really matter if you have an extra $1 of Roth versus 401(k), you’re going to be saving at the marginal rate at that time. So it works the same way.

Joe: Define your effective rate, what, you just divide the amount of taxes into your gross income?

Al: Yeah, what you do is, you take your total federal tax and you divide it in, before add-on taxes like self-employment and things like that, your total regular tax, divide that into your taxable income. That’s your effective rate and your marginal rate is your highest bracket that you’re in.

Joe: To give you a quick example on this, let’s say that Ken’s friend wants to spend- he’s making $100,000 now and he wants to make $100,000 in retirement. And assuming the tax rates stay the same. And if all of his money is in a pre-tax account. When you take money from the pre-tax account, the first $19,750 of taxable income is going to be taxed at 10%. But he wants to spend $100,000, so he needs to pull more money out of the retirement account. So the additional dollars up to $80,000 is going to be taxed at 12% and then the remaining $20,000 is going to be taxed at 22%. So his marginal rate is 22% because that’s the top rate, but his effective rate is going to be a lot less. So if he had a Roth IRA, he could then be in a lot less marginal rate and effective rate by having the blend that Ken wants to do. Because he’s saying, hey, do I want to balance these out a little bit? The answer is yes. That’s what tax diversification is all about. Because now let’s just say that Ken is diversified from a tax perspective. He pulls out the $20,000 out of his 401(k) that’s pre-tax. He pays his 10%. And then he wants to pull maybe a little bit more out of the 401(k) that’s pre-tax, and he pays 12%. But he doesn’t want to get in the 22% tax bracket. So he pulls from his Roth IRA and avoids that 22% tax bracket altogether.

Al: Correct.

Joe: So Ken’s effective rate is going to be a lot less than his buddy’s and his marginal rate is going to be less than his buddy’s because he did the appropriate tax planning upfront.

Al: And your example, I think is a really good example of why you never want to convert 100%. Because if you convert 100% or all your money goes into a Roth, then probably you pay too many taxes going in. And when you pull the money out, you would have been in a 10% or 12% bracket. So there’s a balance here, right? In other words, you want to have tax diversification. You want to be able to fill up the lowest two brackets while you’re in retirement. So you don’t necessarily want to either put all your money in a Roth or convert all your money because then you will have paid too much in taxes to get there.

Joe: We oversimplifed and of course, there’s going to be deductions and things like that, but you get the gist of a marginal tax rate.

What Counts as Roth IRA Contributions If I Want to Withdraw After 5 Years? (Narender, FL)

Joe: Nan-

Andi: Narender-

Joe: Narender-

Andi: Yep.

Joe: Narender. All right. Narender writes in. “Greetings, Joe and Al. I’m a resident of Florida. I’m a 46 year old male. I’ve been contributing to employer sponsored Roth 401(k) plans for the last two years. I have contributed $30,000 till now from my end, which is my base amount. The account has grown to $40,000, which means $10,000 is earning in this Roth 401(k) account during the last two years. I don’t have a Roth IRA till now. I’m planning to quit employment now, 46 years of age, to take a new job. I’ll roll over all money from my Roth 401(k) to a Roth IRA after leaving my employer. After rolling this money to a Roth IRA, I’ll wait 5 years for a Roth IRA to get seasoned. During this 5-year period in Roth IRA, I’ll invest this money in SPY U.S. Stock Index ETF. Let’s assume this account grows from $40,000 to $60,000 over this 5-year period. So $20,000 will be the earnings within the Roth IRA account after initial rollover. Question, at age 51, after 5 years in a Roth IRA as season, would I be able to withdraw the 401(k) from the Roth IRA?

Andi: The $40K.

Joe: In other words, should I consider all initial Roth 401(k) rollover money of $40,000, $30,000 plus $10,000 of earnings, which were Roth 401(k), as my initial contribution to a Roth IRA? I recently came to know your show on YouTube and have been educating myself on Roth accounts and strategies. God bless you, your families and your team.

Keep up the good work of education on your show. Thanks, Narender.” No. The answer is no.

Al: Well, part of it’s right. Well, let’s just say when you roll money from a Roth 401(k) to a Roth IRA, it continues the same character as it went into the Roth 401(k), meaning that if $30,000 is your initial contributions, that’s what it is in your rollover Roth IRA as well. So only $30,000 is your contributions. You don’t get an extra step-up.

Joe: I guess my concern is why is he even thinking that?

Al: In case he needs the money, perhaps. Or maybe- I guess maybe-

Joe: Then don’t even put it into a Roth IRA. Put it into a- invest in the SPY brokerage account because it’s fairly tax efficient. If you’re thinking about using FIFO tax treatment, pulling it out at age 50, the real true benefit of a Roth IRA is the tax-free compounding of it all.

Al: Yeah, I agree.

Joe: And if it’s this amount, $40,000, $50,000, $60,000, it’s well, you get some benefit of the Roth. But if you wait until 65 and let that thing grow for you, that’s a better strategy. But if you’re looking for liquidity needs, I don’t think the Roth IRA is the right option. Just say hey, in 5 years, I want to make sure that I can take my basis out.

Al: But if you have an emergency at 51, you can always pull out your contributions.

Joe: Yeah, but Narender here’s kind of planning on it.

Al: I know.

Joe: I want to take the money out to spend, or live off of. Maybe he wants to-

Al: He want to know if he can take out $30,000 or $40,000, the answer is you can take out $30,000. But our suggestion is to take out zero. Let that thing grow tax-free.

Comment: Less Joe, More Al – Joe is Arrogant

Joe: Alan, we got this review. “Joe’s arrogance. Less Joe, more Al.” So I think I’m retiring from the show.

Al: I kind of liked that.

Joe: Yeah. So you’re taking over brother, I’m out.

Al: But I will say she could have just as easily written more Joe, less Al. Joe is interesting. Al is boring.

Joe: “Joe’s arrogance.” I don’t- am I- do I sound arrogant?

Al: On occasion.

Joe: How do you know? I don’t think I’m arrogant at all. I don’t know. I’m- maybe I’m just- I’m having- this my personality. I don’t think I’m arrogant.

Al: It says you talk over me.

Joe: What the hell are you doing talking Al? I’m trying to- “Over talking

Big Al and demeaning comments about people that write in is off-putting.” Well, when you read and answer questions-

Al: – for a living.

Joe: – for a living, and you talk to clients face to- this is my outlet.

Al: This is your chance to let loose, right?

Joe: And to be really honest and say, you know what, I want to help you. I’m just going to help you behind the microphone.

Al: Right. Got it.

Joe: Because when you ask really stupid questions, it’s fun for me to say, wow, that was really stupid. Even though I don’t say it, but I guess I’m super arrogant on saying that.

Al: Well, if you ever want to learn how to be nicer, I’ll take you to my yoga class and you can learn more about Zen.

Joe: I’m fully Zen. “The show provides meaningful information, but it’s just hard to get past Joe’s self-important attitude.”

Andi: Hey you got 4 stars for that. It’s pretty good.

Al: So it got 4. Is the 4 for Al?

Andi: I think so.

Joe: I got the negative one. Well I don’t know.

Al: That’s pretty funny.

Andi: Joe, have you ever done yoga?

Joe: No.

Al: That would be interesting to watch.

Andi: You’re too self-important for that.

Joe: I’m very arrogant for yoga.

Al: I do it every Saturday morning. Whenever you’re ready brother. Just come on over.

Joe: I’m on the golf course, drinking Coors Lites.

Al: I know you are.

Joe: Just being self-absorbed, blowing everyone out.

Al: Every time you hit a great shot.

Joe: Ohhhh.

Al: Look at that.

Joe: I am so awesome.

Al: Can you believe that?

Joe: And you are terrible.

Al: And someone else has a good shot, well that was whatever.

Joe: Oh God. Andi, am I arrogant?

Andi: Oh, don’t ask me, Joe. Please don’t ask me.

Joe: So we did- we’re back doing these webinars. And it was a complete and utter disaster.

Al: Why?

Joe: Oh I blew up.

Andi: Joe forgot how to do it.

Joe: Out of practice. We were in the TV studio. The heat lamps were on. I’m sweating.

Al: Those are bright lights.

Joe: Oh my gosh. You know, and then all of a sudden some of the slides were a little bit different than I was expecting. And I was like, oh my God, I gotta get outta here.

Andi: Then he just started yelling at the camera.

Joe:  And I got arrogant.

Al: Was that live?

Joe: Oh, yeah.

Al: Of course.

Andi: Yep.

Joe: We were live.

Al: Oh boy. We’re going to get some reviews on that one.

Joe: We’re gonna get some reviews. Oh, I don’t know.

Al: You’re not even get to get 4 stars on that.

Joe: I know. That’s- we’ve been doing this for 15 years.

Al: Well, all I know is it doesn’t really matter. Sometimes people love you, sometimes they love me. Sometimes they don’t like you. Sometimes they don’t like me. Usually-

Joe: I don’t think anyone doesn’t like Big Al. We’re gonna have Tax Chat with Big Al.

Al: Well, can you imagine listening to 90 minutes of me? It just wouldn’t be that interesting. Even I would fall asleep on that.

Joe: Well, yeah, I think-

Al: Although maybe, because I have trouble sleeping, maybe that’s a good idea.

Hey, real quick: share your opinions about the Your Money, Your Wealth® podcast – good, bad, or arrogant – for your chance to win a $100 Amazon e-gift card! Click the link in the description of today’s episode in your podcast app to go to the show notes and fill out the 4th annual YMYW podcast survey. You’ll be in the running for the hundred bucks. US residents only, no purchase necessary, survey giveaway closes and winner chosen at 4pm Pacific time on August 31st, 2021. Go do it now while you listen to some more Roth talk! 

Can I Convert 401(k) to Roth IRA Over Several Years? (Miriam, UK)

Joe: Miriam. Is that right?

Andi: Yep.

Joe: Well, what the hell do you know? “Dear Andi, Big Al and Joe. Love Your Money, Your Wealth®. I have listened to more than 100 episodes during the pandemic as I walk around Victoria Park in London in the United Kingdom.” Well, that’s cool.

Al: That is cool.

Joe: “After hearing you explain about Roth conversions, I finally did one in 2020. As head of household with one child and real estate losses, I ended up paying no taxes on my Roth conversion, which was awesome.

So I want to convert some more. Here’s my question. Is it possible to convert a 401(k) into a Roth IRA over several years? I have a 401(k) with an old employer that has $80,000. With my filing status, it would be great if I could convert $40,000 in 2021 and the remaining $40,000 in 2022 and pay no tax. Or am I making my life complicated and perhaps being greedy? And should I just convert the whole $80,000 at once? My concerns are the mechanics. Do I just instruct my employer to roll my 401(k) to an IRA, my Roth account is at Charles Schwab, then convert half to Roth and leave the other half for the next year? Will there be a pro-rata problem? I no longer have any Traditional IRAs, but might be creating one with a rollover. I do have money set aside to pay the tax if necessary. No pets, no car, no ability to do a mega door backdoor Roth conversion as I have no earned income in the US.” The only issue I see- I like your strategy quite a bit is that, can she do an in-service withdrawal from the 401(k)? Is she currently contributing to the plan?

Al: No. She says it’s an old plan.

Joe: Oh yeah. Then for sure, just move the 401(k) into an IRA and then convert $40,000 this year, $40,000 next.

Al: Yeah, I think it’s hard if you have an old plan trying to do a little conversion every year. Just roll it to an IRA and then convert as much as you want. And the amount that you convert is based upon your tax bracket, not half or a third or the whole thing. It’s like based upon your current tax bracket. So you got to look at that and see what’s going to make sense for you.

Joe: If your Roth IRA is at Charles Schwab, move to the 401(k) to a Charles Schwab IRA. And then it’s just super easy to do it that way. So but yeah, you’re right. Look at your taxable income to figure out what tax bracket that you’re in and then go potentially- unless you still have carryforward losses that would offset. But I don’t- I think she probably used them up. I don’t know. Hopefully that helps. From London, the United Kingdom, Alan.

Al: Like it.

Why Not Pay Roth Conversion Tax Out of the IRA? (Russell, MS)

Joe: Let’s see. “Sorry, no juicy stuff about me, my cat, my car or anything like that.” That’s cool. “I’d just like to hear your discussion more on why it’s a bad idea to pay taxes on a Roth conversion using money out of an IRA transfer account. I’m in retirement between age 62, turning on Social Security 70. At RMD age, I’ll have lower taxable income and be in a better tax situation for a Roth conversion. However, I don’t have readily available funds outside of the IRA to pay the taxes. It seems like if one pulls excess money out of their IRA and pays taxes, or if they already have money in a taxable brokerage account, then they’ve already paid taxes on those dollars at the time of deposit. It winds up being basically the same thing. So, Joe and Big Al, is it better to avoid the Roth conversion or go ahead with the conversion and pay the taxes on the regular IRA account? Love the show and the humorous discussions.”

Al: I bet Russell in Mississippi likes you. I bet he’d give you 5 stars.

Joe: See it’s humorous. It’s not arrogance.

Al: It could be both.

Andi: Humorous arrogance.

Joe: That’s right.

Andi: The new name of the show.

Joe: Russell. So do I pay the tax out of the IRA, Al? What do you say?

Al: Well, the reason we suggest not to do that is if you have money outside of an IRA, we’d rather have you get more money into the Roth not using IRA money to get money into the Roth. But we’ve said this before, if all you have is money in an IRA and you’re in a super low tax bracket, yeah, go for it. I don’t have a problem with that.

Joe: It’s just better. It’s more effective or efficient.

Al: Well, it’s better to pay outside, the tax outside of a retirement account because you get more in the Roth. Instead of- you do a $50,000 conversion, if you can pay the tax outside with a non-retirement account or you do a $50,000 but you can only convert $35,000 because you got to withhold $15,000 to pay tax, you’re not getting as much in a Roth. That’s why we like it outside- the tax to be paid outside. But I do agree with your comment, Russell. It’s kind of- it’s almost the same same.

Joe: Because the brokerage account’s after-tax dollars. And a retirement account is pre-tax dollars. So I’m going to pull $15,000 out of a pre-tax account that’s never been taxed and then I’m going to pay tax on it and put in my brokerage account. Then I’m going to do a conversion and then I’m going to pay the tax from the brokerage account. It’s kind of the same.

Al: It’s the same. It’s just that in my example, I’d rather pay the tax outside of the retirement account so I could get the whole $50,000 in the Roth instead of $35,000.

Joe: The only issue that we would have is that if the dollars that you’re pulling out of the retirement account is pushing you up into a higher tax bracket. And then you’re paying taxes on the money that you want to pay for taxes at a higher tax rate. Then it doesn’t make any sense.

Al: Or if you’re under 59 and a half, then it’s a very bad idea because now you get a early withdrawal penalty.

Joe: – a 10% penalty. But yeah, if you do the math, Russell, I guess that’s the only thing that we can say. It’s all- any type of tax strategy is really revolved on- it’s a little bit of art, but more science.

Ken, Narender, Miriam and Russell, and everyone else that’s got Roth questions, we have a couple free guides in the podcast show notes that will provide more answers for you. The Ultimate Guide to Roth IRAs is a basic primer on what a Roth IRA is and how it differs from a Roth 401(k) or a traditional IRA, the benefits of having a Roth – tax free growth for life on your money being the most obvious one – plus you’ll have the rules on contributions, conversions, taxation, and withdrawals, all right at your fingertips. Then, our guide to the 5-year rules for Roth IRA withdrawals will take a deeper dive into pulling money from your Roth depending on your age. Download them from the podcast show notes by clicking the link in the description of today’s episode in your podcast app. You’ll see all the free financial resources and the podcast survey right above the episode transcript. Like it? Share it!

Roth Conversions vs. Medical Insurance ACA Subsidy (Chuck, Western PA)

Joe: OK, let’s see. Chuck from Western PA. “Hi, Andi, Joe and Big Al. I’ve been listening to your show for about a year. It’s the best podcast I have found.” Yeah. Just gonna pump my tires, man.

Al: Getting your mojo back now.

Joe: I just need some more positive reinforcement.

Al: That’s right. That’s right.

Joe: Because I’m just a fragile, insecure idiot inside.

Al: By the way-

Joe: I got this hard, arrogant shell on the outside.

Al: Have I told you how much- how great you are?

Joe: Thank you.

Al: And how much I love you?

Joe: Oh, God. Feels so good. Just keep showering me. “I have a question that I haven’t been able to find any good answer to. But first, a little background. I drive a 2002 Buick, am married and have two cats. I am 54, planning on retirement, end of 2022 at age 55 and a half. I will have a pension of about $36,000 dollars at 55, would go up to $3000 per additional year worth; about $2,000,000 in investments; $500,000 Roth; $600,000 401(k); $500,000 IRA; $400,000 brokerage account. For tax years ‘21 and ‘22, I plan to complete Roth conversions to the top of the 24% tax bracket to take advantage of the current low tax rates assuming there is no change in 2022. I earn $140,000 dollars a year. Wife doesn’t work. And I maxed out pre-tax and post-tax 401(k) and do the Megatron backdoor Roth conversion, barn door is wide open.

Al: We’ve got a lot of those today.

Joe: Oh Megatron is big.

Al: By the way, that’s when you put after-tax money in your 401(k) over and above your $19,500 that you can contribute normally.

Joe: Yes.

Andi: And it’s actually called a mega backdoor Roth. But, you know, on this show, it’s called Megatron, thank you very much, Marcus.

Al: That’s what we call it.

Joe: Megatron. “I got into the Roth game too late, but I’m trying to get better tax diversity. My problem is medical insurance. With Medicare not kicking in until age 65, I’m trapped by having to keep my income below $68,000 to avoid the Affordable Care Act subsidy cliff. The American Rescue Act capped the insurance cost of 8% of the income of 2020 and 2021, eliminating the subsidy cliff, but that expires. Are there any good practical options for MediCal, i.e. a MediShare plan? Not really insurance I hear, to get me the age 65? Any good private insurance? I really mainly need catastrophic coverage but it seems you pay $20,000 to $30,000 a year with a $10,000 deductible, which seems to scream ‘gamble for 10 years without insurance until Medicare kicks in’. I don’t want to do this. It appears I have no real choice but to game the system and keep my income below $68,000 until age 65. I can’t do any Roth conversion post-retirement up to age 65, which is why I’m aggressively trying to do them pre-retirement. And we’ll have to live off of brokerage accounts, capital gains taxes, and my pension, Roth as a last resort after 59 and a half, to avoid the Affordable Care Act subsidy cliff. If the cliff wasn’t so dramatic about $6,000 year in insurance cost with subsidies earning $68,000 versus $24,000 a year in cost without subsidies earning $68,000, $68,001, I wouldn’t mind paying a little extra for the insurance. But this $18,000 difference per year or about $180,000 over 10 years. I hear you guys say this added cost is just like a tax, but that is substantial tax for the extra dollar of income. Any help would be greatly appreciated.”

Al: OK, well, I had a couple of thoughts. So Chuck, first of all, I don’t think you’re that bad a shape. You’ve got $1,100,000, I guess, ish, in an IRA. Let’s see did I get that right?

Andi: Well, he says he’s got $2,000,000 of investments.

Al: Let’s see, $600,000 401(k); $500,000 IRA. Yeah. So $1,100,000 in a tax-deferred, which isn’t that bad. I mean, you’re talking about a required minimum distribution, even if that doubles, but or maybe more than doubles. You know, you’re talking about $80,000 of income. You may not be in that high of a bracket. But here’s a couple of thoughts. You are correct. There’s this huge cliff. If you got the Affordable Care Act and you’re using that for insurance, once you’re $1 over that, all of a sudden you’re paying full-boat for your insurance and you’re not getting a subsidy. So what you might do- a couple of things that you might do. One is, if you’re working over the next two years and I assume you have insurance from your employer, maybe you just jam Roth conversions over the next two years.

Joe: That’s what he plans on doing up to the 24% tax bracket.

Al: That’s- I would do that. Or if you still feel like you want to do more, just pick one year out of the next 10 and just jam it, knowing that you’re going to have to pay extra insurance. Every other year, you stay below the $68,000 as long as we still have this Affordable Care Act insurance subsidy.

Joe: But here’s what- I think he’s not- you know my stance on this.

Al: I do know. But it’s wrong.

Joe: OK, I won’t even-

Andi: Oh, you’re so arrogant.

Al: Now I’m being arrogant.

Joe: OK, let’s say it’s $18,000 dollars difference. So that’s the added tax.

Al: That’s right.

Joe: You add that even to the Roth conversion, you could still stay in the 22% tax bracket and convert or even in the 12% tax bracket and convert, versus the 24% tax bracket. So what I’m saying is that if he still adds the dollar up, finds his effective rate on the conversion, adding the insurance cost, I still think you’d be better versus trying to convert in the 24% tax bracket when he probably is not going to be in the 24% tax bracket in retirement. So he’s trying to convert to avoid paying taxes, but he’s paying taxes at a higher rate and he’s got $2,000,000 and he wants the subsidies. And I think the subsidies were really not necessarily meant for someone that has $2,000,000.

Al: There you go. And I agree with that statement. Nevertheless, that’s the rule. So that’s why I made the first comment. I’m not sure you have to be near that aggressive. But I would personally- the reason why I said go big, is just like if you do $100,000 conversion, you’re going to have to pay the tax on that plus an extra $18,000, which is 18% extra on top of your other tax. Now, if you do $200,000, you have to pay the tax on that. But it’s still $18,000 now on $200,000. So that’s like 9% extra tax. If you do $400,000 extra conversion, now you’re at about 4.5%. So it becomes more affordable if you go big one year and don’t do any conversions other years. That’s what I meant to say by that. Got it? You follow me?

Joe: Yeah, terrible advice. Go to YourMoneyYourWealth.com and click on ‘Ask Joe and Al On The Air’ if you want to ask us a question or give us a review. Just give us a comment about how great we are. Or how terrible we are.

Al: But you missed the good review, which 5-star “highly recommend this show and is so informative”.

Joe: Oh, great show. I just like to dwell on the negativity.

Al: You do. You like to go dark.

Joe: Yeah, I like the bad reviews- kind of just to-

Al: Fires you up, huh?

Joe: Grounds me, Alan. Oh, man.  So no cocktails this week.

Andi: You didn’t have the Landshark? You were supposed to go try the Landshark and discuss it this week.

Joe: I know.

Al: He’s talking about our listeners. They didn’t tell us what they’re drinking.

Andi: Ah.

Joe: Yes. So we got a lot of cats, a lot of cars.

Al: What have you drank over the last week? Let me guess. Coors Lite and Fireball.

Joe: Yep. I had a little bit of Coors Lite. I did have some Fireball on the golf course. You know they have those little kind of shooters there?

Al: Yeah, yeah, yeah, yeah.

Joe: Birdie juice?

Al: Got it. Birdie juice. Does it work?

Joe: Well hopefully you get a birdie, then you can have one.

Al: Oh got it. So that’s the incentive.

Joe: Yes.

Al: Got it.

Joe: So you work like hell.

Al: I thought you drank it then you got the birdie.

Joe: Usually if you drink it you’ll probably get a bogey, or maybe a double bogey.

Al: What was I thinking, right?

Joe: So yeah, when you get a birdie you have one of those and then you’re like OK, you just got to keep your cool.

Al: And last week I had different craft beers. I’m kind of liking the hazy IPAs these days.

Joe: Yeah? Is that why your eyes are a little hazy? A little tired.

Al: A little foggy. A little hazy today, Joe. You know why.

Joe: I had a rough day, so that’s where the old hazy IPA-

Al: I had one last night.

Joe: Thanks for your comments, your questions, and your reviews. We got to get out of here. We’ll see you again next week. The show’s called Your Money, Your Wealth®.

_______

All the Derails made it into the main content today so we’ll just leave you with these thoughts to drink your beer by: 

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