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Published On
June 1, 2021

Questions answered about Roth 401(k) contributions and “Megatron” (that is, mega backdoor) Roth contributions for highly compensated employees, and the Roth conversion strategy of filling the tax bracket. Plus, moving a pension to an investment plan, owning real estate in a self-directed IRA, paying off the mortgage vs. refinancing, spousal vs. survivor Social Security benefits, rolling a whole life insurance policy to a variable annuity, and more.

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Show Notes

  • (01:13) We Have $6M Retirement Savings and $475K Gross Income. Should We Contribute to Roth 401(k)? (Dan, NYC)
  • (05:52) Highly Compensated Employee “Megatron” Roth Contributions: Do These People Have Rocks in their Heads? (Nick, OH)
  • (16:23) Is Filling the Tax Bracket the Best Roth Conversion Strategy? (JR, Charlotte, NC)
  • (27:30) Should I Move My Pension to an Investment Plan? (Brandon, Ft Myers, FL)
  • (36:43) Is Rental Real Estate in a Self-Directed IRA a Good Idea? (Jim Santa Cruz, CA)
  • (41:23) Should We Refinance Our House? (Deborah, CA)
  • (44:48) Spouses Vs. Survivors Social Security Benefits (Dave, AZ)
  • (53:33) Should I Roll from a Whole Life Insurance Policy to a Low-Cost Variable Annuity? (Ajay)
  • (57:13) Limericks and Comments

Free resources:

Ultimate Guide to Roth IRAs:The Ultimate Guide to Roth IRAs

Can I Buy Real Estate in an IRA?Can I Buy Real Estate in an IRA?

Get Real About Real Estate in Retirement:
Get Real About Real Estate in Retirement

Listen to today’s podcast episode on YouTube:

Transcription

Today on Your Money, Your Wealth® podcast #328, with $6 million in retirement savings and $475,000 gross income, are Roth 401(k) contributions a good idea? Is filling the tax bracket the best strategy for doing Roth conversions? As a highly compensated employee, Nick’s wife in Ohio is having trouble diong a Megatron Roth contribution and Nick asks if the folks at her company have rocks in their heads. We’ll let you decide who has rocks in their heads after hearing Joe and Big Al’s response. Plus, moving a pension to an investment plan, complete with a limerick, Jim calling from Santa Cruz wants to know about moving his house to a self-directed IRA – or rather, Jim’s brother does, Deborah wonders if she should refinance her house, clarification on spousal vs. survivor social security benefits, and Joe and Al discuss rolling a whole life insurance policy into a low cost variable annuity. We need more of your money questions, comments, limericks and stories, so email them in or leave us a voice recording – visit YourMoneyYourWealth.com and click Ask Joe and Al On Air for your spitball analysis on YMYW. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

We Have $6M Retirement Savings and $475K Gross Income. Should We Contribute to Roth 401(k)? (Dan, NYC)

Joe: “Hey Joe, Big Al. Love, love, love the show. I’m Dan from New York City. Love your great advice, especially done with great humor. I crack up when you start ripping on the questions you get. Hysterical.” Yeah Dan, this question sucks.

Al: You’re already ripping on the question.

Joe: Get to it already. “But most importantly, I learn so much by applying the answers you give to others to my own situation. Here’s some background you may need to answer my question. My wife and I earn a combined gross income of $475,000. I’m 63. She’s 62. We expect to retire at 65 and 67 respectively. We have $6,000,000 between us in tax-deferred accounts; 401(k); deferred comp; 403(b); it’s all 90% in equities. In after-tax accounts, we have $1,300,000 in cash; $150,000 individual stocks; and $150,000 in a diversified equity mutual fund. Our employers started offering Roth 401(k)s a few years ago. We never contributed. Does it make sense to do so now? Thank you. Dan.” Yes, Dan. $475,000 of combined income. He’s probably maxing out 401(k)s, let’s call it $400,000 of income, married. What’s that? 32% bracket? or?

Al: That’s 32%. 32% goes up to, call it $420,000.

Joe: So he’s in the 32% tax bracket. You’re always going to be in a pretty high bracket since you have $6,000,000 in retirement accounts and tax-deferred comp. 6 times 4 is $240,000 plus Social Security is going to give them about $300,000; tax rates at $300,000 level is probably going to be at the 28% or 32%.

Al: I guess as of right now, it’s in the 24% bracket, which goes to $329,000, but don’t forget in 2026 we revert back to our old rates, which $300,000. And if the state tax deduction comes back, New York has high taxes, they’re going to be subject to alternative minimum tax. I’m going to say they’re going to be in that bubble where they’re paying 35% tax that we used to talk about. Years ago.

Joe: The alt-min.

Al: So I think that’s right. Or you could also say, you know what, you’re in such a high tax bracket, just take the deduction and you’ve got a lot of money. You’re just going to have to pay a lot of tax. But, it’s nice to have some diversification because if you’re going to be perhaps in the 35% bracket with the new rates coming back because of Aultman, because of the loss of the state tax deduction and you’re paying 32% now, then mathematically that makes sense. But on the other hand, if the rates stay the same you’ll be in the 24% bracket and it may not make as much sense.

Joe: You know, we’re not talking about a large portion or percentage of his total liquid net worth. He’s got about $8,000,000 of liquid net worth. You do this for her- rest of her career and his career. I mean it’s what, $150,000 maybe, if you totally max it out. Maybe a little bit more than that.

Al: Yeah, you’re right. And just to have some more diversification would probably be a good idea. The tax rates aren’t that much different than what they’re going to be. So yeah, I guess I’ll buy that.

Joe: I would do that all day long, Dan. Absolutely. Why not? What the hell? You’re not going to miss the taxes anyway that you’re paying on the Roth. You’re going to have tax-free growth for the rest of your life. You don’t have to have a required minimum distribution of that. You’re probably going to start conversions, and that starts- you roll that into an IRA, starts your 5-year clock. There’s a lot of pros there because he’s going to retire in two years. His income, I don’t know how much she makes versus him. I’m just assuming they make the same amount of money, then the gross income gets cut in half. Probably do some conversions to the top of the 24% tax bracket at that point. He’s got plenty of non-qualified in cash assets to live off of until she retires, push out Social Security until age 70. Then you do conversions to both of your age 70s. Or 72 or maybe even 75, which is because of the RMD age is potentially moving up to 75. So I like that plan. Thanks a lot for the question, Dan. Appreciate it. Like your sense of humor as well.

Highly Compensated Employee “Megatron” Roth Contributions: Do These People Have Rocks in their Heads? (Nick, OH)

Joe: “Hello, Andi, Joe, Big Al. Hope all is well. This is Nick from Ohio. Big fan of the show, especially the outtakes, which I’m sure this rant question will be in.” I’m sure. You’re kind of pretty high on yourself, Nick from Ohio. Just kind of coming in hot.

Al: He thinks it’s gonna be funny.

Andi: He is saying he thinks that it’s going to be in the derails instead of being in the actual part of the show.

Al: That could be.

Joe: “I’m a 46 year old, driving a 2020 Jeep Grand Cherokee. My wife and I have an Irish Setter at home (see picture).” Oh, very cute dog. Now people are sending pictures of their dogs. I love it.

Andi: That’s like two.

Al: Second dog picture we got.

Joe: We get pictures of background of their jogs, like that one guy, ‘here’s my walk every day.’

Andi: New York City. Yeah.

Joe: I lost like, 200 pounds listening to you guys.

Al: That’s right.

Joe: I mean, we’re a weight loss, financial planning, tax strategy-

Al: We help people with their health, as well as their finances-

Joe: – mental health-

Andi: – and their wealth.

Joe: – everything. We’re changing the show. It’s ‘Your Wealth and Health’. “Background, my wife is highly compensated employee at a company of around 80 employees. Her Safe Harbor 401(k) allows for after-tax dollar contributions and in-service Roth 401(k) transfers. The summary plan description says you can do as many Roth 401(k) transfers that you want to from any source. All great news at this point.” Sounds like an earlier-

Al: – related to something we already answered.

Joe: Yeah. “Come to find out, no one at the company has ever contributed to the after-tax source. Thus no one has ever done the Roth 401(k) transfer. Her bonus shows up in March. It’s $15,000. Great news. But she was limited on the dollar amount she was allowed to put in the after-tax source to $11,000 due to the ADP/ACP pre-testing in March and taking into consideration all of the other highly compensated employee sources, including the after-tax portion. Regardless, I did not think Safe Harbor had tests. So she fills out the paperwork to do the Roth 401(k) transfer of the $11,000, and they say she can only do 60% of the $11,000. It’s like come on already.”

Al: It’s getting worse and worse.

Joe: “I maybe understanding limiting an employee on a contribution, even if it’s after-tax, so you don’t fail the test for everyone’s sake and preventing over contributions and all the paperwork. However, only letting an employee transfer a limited percentage of her own sources makes no sense to me. SPD says nothing on this. The dollars are already in there. Why does it matter what bucket it’s in after you already made the contribution? I want to further the conversation with their company. But she says, leave it alone. Questions: do the people giving these suggestions have rocks in their heads?” Rocks in their heads. Do they have rocks in their heads? Geese, Nick. “If anyone, anywhere, ever thinks there is something fishy going on with their retirement plan, how would you address this? Thanks again for all the time you all put into the show. Peace, Nick, hashtag Megatron.” He wants to do the Megatron so bad he’s getting-

Al: He does.

Joe: – just very hostile-

Al: He is.

Joe: – with his wife’s plan administrator. She’s like Nick, leave it alone. It’s not that big of a deal. He’s like, no, honey, we’ve got to do the Megatron. We gotta do the super duper backdoor barnyard backdoor Roth.

Al: We gotta do it. Here’s my first comment, is and this happens with us, too. Sometimes we call 401(k) companies and ask to transfer this or that or in-service withdrawal. And the person says, you can’t do that. And we know that they can. We generally just said, OK, thank you, hang up and then we call back later, get a different representative. So that’s one choice that has sometimes worked for us. I would say I don’t know anything about this plan, of course, but ADP is a very reputable company, so-

Joe: No, no, he’s talking about the testing, Al.

Al: I know, but ADP is doing the testing. ‘Due to ADP/ACP pre-testing’. So I’m guessing they know what they’re doing.

Joe: Here’s the issue. This is what I’m saying, because remember when we tried to do this stupid thing with our plan.

Al: Right. And PayChex said you can’t do that. And we said-

Joe: I mean we’re $3,500,000,000 RIA. And we have a PayChex 401(k) plan. That just tells you- It’s like the cobbler’s kids walks around with no shoes on.

Al: Well, yeah. I mean, the other choice, you have- two other choices. One is ADP is usually kind of the next level, actually next level after that is –

Joe: No, ADP stands for something else, Alan. It’s like a deferral percentage is ADP and then like a contribution percentage. It’s not ADP and PayChex. So there’s testing that goes into these 401(k) plans. It’s a Safe Harbor 401(k) plan. And so she is the only one that is participating in the after-tax accounts. So because of- there’s still testing to use the after-tax component. So smaller employers- I think they have like, right, they have 80 employees, like we have 80 employees. And the only person, people that would want to use the after-tax component to do the Megatron are people that have discretionary income that can put money in the after-tax accounts. Because she wants to save not- I don’t know how old Nick is. Nick is younger I think. 46? So they want to they want to blast this thing out. They want to do the max 401(k) contributions and then max out the after-tax contributions up to, what, $54,000, $58,000 and do the conversions. However, she can’t do it because she’s the only one taking advantage of the after-tax component. So it’s up to these ADP/ACP tests, like what is the deferred plan? How much is in the plan? What are other people contributing to the plan? So there’s going to be limitations to the amount, even though the plan doc allows it, there’s not enough people doing it to allow her to truly maximize the Megatron.

Al: Yeah, and Andi helped us out. You are right, Joe. ADP stands for accrual deferral percentage. It has nothing to do with ADP, the payroll company, which is what I thought. You are correct. I mean, in other words, generally a Safe Harbor plan, you don’t have to do this kind of testing. But I think the rules are different for the after-tax. Very few plans have them. As you said, Joe, our provider says you can’t even do it even though we know you can.

Joe: But here’s the deal, because it’s a small- like Microsoft. They have- these large companies that have a lot of participants within the plan. They don’t have to go through it because there’s so many more people that are participating. When you only have 80 employees, it’s going to be highly skewed to highly compensated people that are taking advantage of the after-tax. So they’re not going to make the full contribution allowable.

Al: Yeah. So, they still have to do the calculation as a larger company. But what you’re saying is it comes up a little bit less often because you have so many people that are contributing, which may be true. Particularly, it depends on the company, like Microsoft would have a lot of highly paid employees. So that would be true. For other companies, maybe, I don’t know, like a contractor-type company with lots of employees and where people are not making that much, that might be different.

Joe: Qualcomm, for instance. They have the same- if you want to put after-tax monies in, then you can convert it right out. No big deal because you’ve got a lot of employees at Qualcomm and there’s a lot of employees at Qualcomm that make a lot of money. And they’re all taking advantage of it. So these rules were put into place to- not to have, let’s say, the owner of the company or, the top people in the company have a big tax shelter by utilizing some of these plans while the rank and file are not necessarily utilizing the plans. It’s like, well, no, you can’t have that big of an advantage, even though you set up the 401(k) plan. Now you’ve got to set it up as a Safe Harbor plan. And the Safe Harbor Plan is that, highly compensated person, you can still max the plan out, but you’re going to have to match all the other people. You’re going to have to motivate them and have a higher or better benefit for them contributing into the 401(k) plan. And then now with the Megatron that we just started this huge craze, everyone wants to go to the big backdoor after-tax and then convert. But smaller employers are still going to be subject to the ADP testing. So that’s what he’s falling into. And then good thing it didn’t say PayChex’s testing because that would have really blew you up, Al.

Al: It would have, wouldn’t it? I thought I had it too, but apparently not.

Joe: That was good.

Al: OK, I got a great answer here.

Joe: I got this. I’m killing the game.

Al: I got it. I got it Joe. Raise my hand. Let me talk.

Joe: I’m just sitting here just watching you just implode.

Al: I got this nailed. I  know what ADP is. That’s a payroll company. Which is true. It’s just not the right one for here.

Joe: Oh God, that’s awesome. People still write in. Unbelievable. Oh, gosh.

Is Filling the Tax Bracket the Best Roth Conversion Strategy? (JR, Charlotte, NC)

Joe: Got JR. He writes in from Charlotte, North Carolina. “Joe, Big Al and Andi, love your show. The best I’ve found. And I’ve spent many hours listening to your podcasts while I exercise so I can take extra credit for extending my life. Thank you. QX 60 Infiniti.” Big Al, do you know what that is? Is that a big one?

Al: It’s a big one yeah. It’s a SUV. And he’s got QS 50. That’s the smallest one they make. The biggest one is 70 or 80, I think. I guess he’s thinking it’s not big enough to be manly.

Joe: “I know not the most manly, but it works. No pets. Like women, they have proven to be more trouble than they’re worth.” Wow. “Sorry Andi.” JR-

Andi: That’s alright JR.

Joe: JR, tough road there. “Divorce squared- ” oh boy.

Al: So he’s all done with that.

Joe: 3 times the charm. JR, come on. Don’t get out of the game just quite yet. “I’m 59; $1,200,000 saved for retirement; $500 Traditional 401(k); $150,000 Traditional rollover IRA; and $10,000 in Roth; $540,000  in a brokerage account; own a S CORP with unpredictable income. Total compensation normally is $200,000, but never know for sure. I typically max out $26,000 into my Traditional IRA. Here’s my question-“ Well, first of all, he’s putting $26,000 into a Traditional IRA, Al.

Al: Yep.

Joe: $26,000 in an IRA?

Al: Well, he means 401(k). I didn’t even catch that. He meant a 401(k), I think.

Joe: You and JR are tight. I know you guys talk about old divorcee stories.

Al: I got none of those.

Andi: I was gonna say, are you implying that Al is an old divorcee?

Joe: I don’t know. He’s been married 32 years. I don’t know what he did before that.

Al: At 33, I was too young. So says I’m still a youngster.

Joe: Got it. “I really want to get more into Roth, but want to stay in the 22% or 24% tax bracket. Don’t expect my expenses to be much more than $6000 a month in retirement, which will happen in about 7 to 10 years. Since my income is unpredictable, is it best to continue to do the Traditional 401(k) instead of the Roth 401(k)? And at the end of the year do a Roth IRA conversion to fill up the bracket? What is the downside? I know I’m almost as old as Big Al, but I’d like to get rid of the IRA rollover so I don’t have to worry about the pro-rata rule for the backdoor in the future. Thanks for all your help. If ever in Charlotte, North Carolina, beer’s on me. JR.” I’ll take you up on that JR. So this is a very good question. I like this question by JR. He wants to do conversions, Alan. So he wants to get his money out of the Traditional IRA, which he has $100,000- $150,000, wants to get it out there so he can start doing a little backdoor Roth, which is the town favorite in Charlotte. They talk about it all the time, I hear.

Al: You think so, huh?

Joe: Oh, I don’t know. It seems like everyone loves it here. So what do you think? So he’s like, well, let me do the Traditional- let me go pre-tax, $26,000, and then we’ll see kind of how I end up because his income’s unpredictable. And then I’ll figure out and then I’ll just convert to the top of whatever bracket at the end of the year. I love the idea. I think, financially speaking, that’s probably the best way to do it, because you can really get super tight on your numbers. We would absolutely recommend this 100% of the time, especially when there was re-characterizations. We would always want our clients to do the pre-tax and then do conversions, because if you converted too much or something happened along the way, you could always re-characterized any part of the Roth IRA. That is no longer the case. So whatever you convert, sticks. So, yeah, I like that idea. What do you see as the issue there? What’s the downside, Al?

Al: Well, I like the idea too first of all, I’ll agree with you. Because when you’ve got uneven income like in an S Corporation, you don’t really know what it’s going to be till closer to year-end. It’s best to do Traditional and then fill up whatever bracket that you’re trying to fill up by doing a Roth conversion at or near year-end. It has to be done by December 31st. But let’s say come December 5th or 10th, you kind of know what the first 11 months look like and you have a sense of what the last month might look like. So that’s probably your best time to convert to try to get to the top of the 22% or 24%. Now, the 24% bracket for a single taxpayer is $164,000. So if he’s making $200,000. And he’s got a $13,000- $12,000 call it, standard deduction and he’s putting $26,000 into a Traditional. So what’s that? $30,000- call it $38,000- call it $40,000- easy math. So $200,000 minus $40,000 is $160,000. He’s pretty much just about there. He would only do $4000 Roth conversion, in that example. And some years when his income is higher he might do none and other years when it’s lower, he could do a much bigger conversion. Joe: But why doesn’t he take advantage of more pre-tax dollars? He could do that as well, depending on how his income is set up. He’s a S Corp, sole proprietor, he’s got a Solo 401(k), I’m thinking.

Al: Does it say sole proprietor?

Joe: Got an S Corp, I’m just assuming he doesn’t have employees.

Al: Yes. OK, so good point. So here’s the question. Do you have employees or not? If you don’t have employees then what you really ought to be doing is doing the profit sharing component and a $200,000 salary at 25%, that’s $50,000 that you could put in pre-tax, get a deduction, and then you could do another $50,000 Roth conversion. So that would make potentially a lot of sense. But if he’s got employees and then if it’s a safe harbor 401(k), then if he did a 25% profit share for him, he’d have to do 25% profit share to every other employee and he probably doesn’t want to do that.

Joe: Correct. So JR, I guess it- look to see- if you’re sole prop, because we see this quite a bit. Is that all they set up a Solo 401(k) for themselves, they’re an S Corp, they set up an S Corp, LLC, whatever, but they don’t realize that they have the ability to save a lot more pre-tax or they could – what is it- what am I trying to say?

Al: Mix and match?

Joe: Mix and match. Thank you. Mix and match some of the Roth and the pre-tax just to kind of even out your tax bracket there. The one thing it depends on- this guy’s a saver, right? JR, even though he’s been divorced twice Al, twice.

Al: And he’s got $1,200,000. That’s very impressive.

Joe: Well maybe he’s getting money from the ex-spouses, right?

Al: Maybe. Maybe he married well.

Joe: Both of them did. They didn’t marry very well because he’s divorced twice, squared.

Al: Squared.

Joe: But still, usually when you see divorcees, they’re hurting because half of their asses got split either way, either went to the male or female, it doesn’t necessarily matter. But he looks like a pretty good saver. So one of the things that we see is that we would recommend going the Roth 401(k) versus converting is that it’s easier to pay the tax that way.

Al: True, because it’s taken out of your paycheck.

Joe: Because when you convert at the end of the year, let’s say you convert $10,000, $20,000. Now you’re adding $20,000 that the taxes weren’t withheld from that throughout. So you’re going to have to come up with some money in April.

Al: That’s right. But the downside is, if you really wanted a Traditional, you can’t undo it because your tax bracket’s too high. So that’s the downside.

Joe: Correct. So, there’s pros and cons. So if your tax bracket’s too high and then let’s say you doing the Roth 401(k) and all of a sudden at the end of the year, you get a big bonus, now you’re in the 32% or 36% tax bracket. It’s like, well I probably should have done pre-tax this year versus the Roth. You can’t undo that. That’s why going the Traditional way is that I know I’m going to get the tax deduction, but then I can always convert and get the same amount of money into the Roth. The downside of doing that strategy is that you just have to come up with the tax money in April, which is not that big of a deal. But for some people that are not necessarily disciplined or they don’t have any non-qualified assets to do the conversion to pay the tax, they could run into, I guess a couple of different roadblocks there.

Al: Yeah, I agree with that. So he’s got $540,000 in the brokerage account, so that should work out all right. And I should say- we should say- that the maximum you can put into a 401(k) or any combination of your own contributions, plus the company is $58,000. And when you’re 50 and older, it’s $64,500. So in my example of $200,000 of profits, $50,000 is the employee contribution. Just realize when you add your own contribution with the employee contribution, it can’t be more than $64,500 when you’re 50 and older.

Joe: So there ya go, JR. There’s some stuff to noodle on. So I guess the biggest question is if he has employees, keep doing what you’re doing. I like the rip out the IRA, convert that at the end of the year, get to the top of whatever bracket that you feel comfortable with and then you can do the backdoors, if you like, later on.

Find out more about getting tax free growth for life on your retirement investments by downloading the Ultimate Guide to Roth IRAs from the podcast show notes at YourMoneyYourWealth.com. It’s free, and it’ll tell you all about the differences between Roth conversions and Roth contributions, Traditional IRA, Roth IRA and Roth 401(k), and more. Click the link in the description of today’s episode in your podcast app to go to the show notes and start downloading.That said, if you’re really serious about making the most of your retirement dollars, schedule a no cost, no obligation financial assessment with a CERTIFIED FINANCIAL PLANNER™ professional on Joe and Big Al’s team at Pure Financial Advisors. Click the get an assessment button in the podcast show notes now to schedule yours.

Should I Move My Pension to an Investment Plan? (Brandon, Ft Myers, FL)

Joe: Brandon writes in. Fort Myers, Florida. Alan. “I e-mailed the show before, I guess my question was a bore. I thought it’d be funny. I need help with my money. Now maybe Al and Joe won’t ignore.” Wow.

Andi: I checked. I could not find any previous emails from Brandon, so I’m not sure what happened. It got lost in cyberspace or something.

Joe: Brandon, we didn’t get it. We answer questions here on Your Money, Your Wealth®. We don’t keep people behind. It’s like, someone gets shot. We don’t leave them behind. We grab them, pick them up, we put them in the helicopter.

Andi: I was trying to figure out where you’re going with that.

Joe: Watching a lot of war movies.

Al: I wasn’t sure either. But anyway, Brandon did write us a nice limerick, which seems to be a common theme of our show.

Joe: I don’t know.

Al: We didn’t ask for limericks, but they keep coming. ___ another format of poem that we’ll start getting.

Joe: “Joe, Big Al, thanks for all your podcast advice. I really enjoy listening to the show during my evening walks. I don’t own a dog. My wife and I are both 46. I am the main breadwinner. Combined, we’ll have substantial retirement savings at my age 55. My wife’s a school teacher with a fully vested pension. She is currently in year 21 out of 30. Her pension increases exponentially over the next 9 years. In other words, if she quits now, she would only receive $3400 per year versus $13,800 annually with 7 more years of work or $22,400 annually if she completes the entire 30 years. The Florida retirement system has a provision that allows for a one-time decision to move her pension to an investment plan. If we decide to take a lump sum distribution, which I intended on doing down the road, she would have to be in the investment plan to do this. I’m very leery on the information on the state website because I know deep down they want people to stay in the pension plan.” He knows this deep down. He just has a gut feeling.

Al: He does have a gut. He’s thinking big brother wants to keep the money. That’s what he’s thinking.

Joe: “See the options below that they are indicating with the assumption that she will retire after 30 years of service at age 55. Pension plan, annual benefit of $27,468.” So that’s option one. Take the annual benefit of $27,468 when she retires at age 55. “If you elect to enroll in the investment plan now, the estimated starting balance would be $130,000.” She’s 46, so she’s going to retire in 10 years. In 10 years, she’s going to get- call it $30,000 for life or she can roll now $150,000 into the investment plan. The $30,000 ln 10 years from now is no longer. But she’ll have $130,000 call it in 10 years from now. She’ll have a little under $300,000.

Al: Yeah, just double it to $260,000- ish. $300,000 Good enough.

Joe: OK, I’m rounding, Al. Rounding.

Al: I get it.

Joe: Got it.

Al: I’m giving some color as to how you got there.

Joe: Got it. Thank you for that color. “If you elect to enroll in the investment plan now, then terminate employment at 55 and start receiving benefit at age 55, the future value of your investment plan is estimated to be $244,000.” Oh, well, we did that just kind of back-of-the-envelope.

Al: Yeah, I got to $260,000. You got $300,000, rounded up.

Joe: So $250,000 is what they’re going to get. “If you elect to stay in the pension plan for the next 9 years and then just prior to leaving employment at age 55, change the investment plan, your estimated lump sum on the investment plan will be approximately $377,000.” OK. “I don’t understand how a pension plan is estimated to gain $133,000 more than the investment plan over the same 9 year period. Pension plans are highly regulated and typically don’t earn more than 5% to 7%. The investment plan assumption above, $244,000, is based on a default age-based retirement fund. I could obviously choose more riskier, higher performing mutual funds and probably come out better than $244,000. But even with a top performing mutual fund, I don’t see how I can get to $377,000 they are estimating if we stay in the pension until the last minute. What am I missing here? Thanks a bunch.” Well, what is Brandon missing here? Is it a magical rate of return that the state of Florida school system has? Do they got Warren Buffett there managing the money?

Al: He’s concerned about Big Brother. I think. He’s trying to figure out what their angle is.

Joe: Well, because he’s saying if he takes it out now, he’s going to get $250,000 if he takes a target date fund. If he keeps it in the plan, it’s going to be $377,000. So he’s taking the delta, the $350,000 versus- or $250,000 versus $377,000. It’s like I don’t get it. What’s the math? What are they doing? The pension plan can’t necessarily grow that much more than I could do on my own. So what’s the secret? What are they doing? The answer is, Brandon, is that there’s mortality credits or something that has to be involved here. Because it is a pension plan that is a pooled plan for many people. This is a guess. I have no idea. I’m just guessing.

Al: Wow. I was thinking I don’t know how to answer that one. You came up with something that sounded really good.

Andi: He’s a better BSer than you, Al.

Al: He is.

Joe: But this is logical to me.

Al: Yeah, that’s makes sense.

Joe: So some people live a long time. Some people die. Some people take the lump sum. And so let’s say if I take- I deserve $25,000 a year. I’m going to take the pension and my boy Brandon that we forgot to answer his question before, his wife is going to take the lump sum and we’re the same age and boom, I take $25,000 pension, single life, only me, and I die the next day, I get struck by lightning down in Florida playing golf. So where does the rest of the money go? They owe me $25,000, but I selected single life payment, right? I didn’t select a joint life. I didn’t select a period certain to make sure that it pays my beneficiaries out for the next 10 or 20 years. I picked a single life. I died. Where does all of my payments go? It goes back in the kitty. Goes back in the pool. It’s not going to get paid out because that was my election. It is a pension plan that you can elect to, say a single life, joint with rights to survivor, joint with rights to survivor with period certain. There’s all sorts of different types of ways that you can claim a pension income payment. And some people want the biggest bang for their buck and so they take a single life. If I took a joint with rights to survivor and if I died and it went to a beneficiary, it’s not going to be $30,000, there would be something lower than that because it’s based on two lives. So the annual benefit of $30,000, I die prematurely, that money goes back in the kitty. That is then distributed out to the other pension holders. That’s why they’re able to have a higher benefit if you hold on to that plan. I’m not working at the state of Florida. I don’t know what they’re doing in that. And I could be completely off base. But that is my best guess. We don’t give advice anyway here. We’re just shooting the you-know-what.

Al: Spit balling is what we call it. So I don’t know anything about this plan either. And every plan’s different. So it’s hard even for me to speculate. But I would say one of the basic considerations on taking a lump sum versus the pension is exactly what you said. If you take the pension, well, then it’s guaranteed for life. And that’s a pretty good thing, particularly if you live a long life. But if you live a short life, you didn’t really get much of anything. And if you took a single life, as you just mentioned, your spouse or your kids would be out of luck. On the other hand, if you take the lump sum, you know, you live long or short. The money is still there. But there’s reasons to take the pension. You know, sometimes the pension payouts are pretty good. Sometimes they’re indexed for inflation. Sometimes people are not very good at having a lump sum. They want to spend it. If that’s you, maybe a pension is better. So there’s different considerations. But the math on how they come up with all this, that’s very plan-specific. I don’t know in this case.

Joe: I think I nailed it.

Al: That’s possible.

Is Rental Real Estate in a Self-Directed IRA a Good Idea? (Jim Santa Cruz, CA)

Joe: “Hello, Andi, Al and Joe. Jim here from Santa Cruz calling again. It’s been like 6 long days since my last email. Kind of sounds like I’m going to a confession. I’ve got something somewhat different for you today. You guys always laugh at the questions that begin with ‘my brother has a problem’ when you know darn well that there is no brother. The message writer was the problem. Well, this time it’s actually true.” BS, Jim from Santa Cruz.

Al: We’re not buying that.

Joe: No, he had to like puff this thing up. ‘Oh, you know. No, but this time, seriously.’

Al: Well, it’s always one of two things. It’s either the person or the person writing the question’s an advisor. And they want to know what to tell their client.

Joe: Right. “My married brother lives in Utah. About 10 years ago, he bought a house in Nevada paying about $200,000. The home has provided steady rental income for a decade, it’s now worth about $400,000, and my brother plans to make it his permanent home in retirement. However, the home is part of a self-directed IRA. The money used to buy the home has never been taxed. If not executed carefully, the situation would seem to have some brutal tax consequences. The first question, could he legally move into the house if it remains part of a self-directed IRA?” No.

Al: The answer’s no. He could legally, but then it’s fully taxable. Day one personal use, it becomes the $400,000 is a tax consequence and fully taxable at that point.

Joe: Yes. You’ve got to stay far, far away from that. You can’t even look at the house if it’s in a self-directed IRA.

Al: You can’t even I mean, if you look at the regulations, some would say you can’t even do repairs. You need to hire someone to come in and do repairs.

Joe: You can’t even mow your own yard. You can’t even pick weeds out of the sidewalk. “If he can and he does and he dies, _____ the house be transferred into a qualified tax-deferred account owned by his wife?” No, you guys can’t live in the house.

Al: So that’s becomes moot, that question.

Joe:  But however, if it’s remained a rental property, they didn’t move into the house. The house is still in the IRA. And then, yes, he could- she would be the beneficiary. And she moved that IRA into her name, no problem.

Al: True.

Joe: “I presume the value of the house would be included in his annual RMD calculations, correct?” No, if he moves into the house, it’s 100% taxable the day he moves into the house. If he keeps it as a rental, then the valuation would be included in his RMD. “If he cannot and he has to take the house out of the self-directed, that would seem to be a taxable event, correct? Big Al, you must be loving this question.” Are you loving this question, Al?

Al: Big time. I got the same answer 4 times in a row. Can’t do it. Can’t do it. Can’t do it. Can’t do it. Fully taxable. That was easy. Oh, yeah, that was good.

Joe: Well, let’s see, how do we get around this thing? Let’s see. No.

Al: I can’t think of a way out. You got to live in another home. Your brother- but we know it’s you.

Joe: So the house is worth $400,000. You paid $200,000. I wonder what the self-directed IRA is worth or what’s the total IRA worth? You could cash out that portion. You just get the house out, pay the $400,000 ordinary income tax and live in the house. That’s a pretty expensive house.

Al: That’s a brutal tax consequence as Jim would say.

Joe: It would cost him $600,000 to live in the house. Or it would cost him $200,000 in taxes. Right?

Al: Correct. Right.

Joe: So might as well just buy another house, that’s probably nicer.

Al: That’s what I think. Buy a $600,000 home, same same. Live happily ever after.

Joe: Oh, God.

Should We Refinance Our House? (Deborah, CA)

Joe: We got Deborah writes in, “AI, Joe and Andi, I enjoy listening to your show and I appreciate the information. Until recently, I didn’t own a car.” Didn’t own a car. “Walked or rode my bike to work, which didn’t happen this last year, since I’ve been working from home. I just inherited 1995 Celica which is the same age as my youngest daughter.”

Al: Oh, cool.

Joe: “Recently my bank has sent us a rate reduction off our mortgage. We live in California, so we have a jumbo loan, although we just paid it down. So it’s now under the jumbo limit. Yay! Our rate was 4% and the rate reduction would bring us down to 3%. There’s limited paperwork, no appraisal, no credit check. The fee’s $950. We are 11 years into the loan and the offer says that it would retain the same term as my existing loan. However, recently after my last daughter finished college, we began making extra payments, which meant our actual term has been reduced by two years. I plan on paying the same mortgage payment as if the loan rate had never been modified. Is this a good option? There are lower rates, but this avoids the hassles and expenses of a re-fi. Our house is worth $1,500,000. We owe $585,000. Thanks for your advice.” What do you think, Al? Should she ____ a rate for $950 at 1%.

Al: I’d do it.

Joe: I’d do it all day.

Al: Simple, easy. The math is not that hard. So if you’re saving 1%, you multiply that by your loan amount. So that would be $5850 interest saved. So basically, she pays $950 one time to save about almost $6000 a year. That’s kind of a no brainer. The only I think part of the question, though, is should she do this because it’s simple or should she go the route of doing a full refinance, which is finding the best lender, going through the credit check, going through the appraisal, signing a whole bunch of paperwork? Me personally, I like the easy option. This is- saving almost $6000 a year just by signing a couple of forms. Yeah, I would do that, personally.

Joe: Yep, yep, yep. Me too. Quick and easy. Bada boom. Bada bing. She could probably maybe get a lower rate because she’s under the jumbo limits now and all this other stuff. But I wouldn’t make it as complicated as it needs to be. You save $6000, pay $950. There you go. Paid the same extra payment that you are. You’ll have this thing paid off in no time.

Have you seen the Your Money, Your Wealth® TV episode on Getting Real About Real Estate in Retirement? Check that out, along with Big Al’s video on the topic of owning Real Estate in your IRA, in the podcast show notes at YourMoneyYourWealth.com. Investing real estate in retirement can be very lucrative and there are many ways to do it, but you gotta make sure you don’t screw it up. Big Al loves to talk about real estate and doesn’t get to anywhere near enough, so if you’ve got a question about rental properties, your primary residence, or any other money question for that matter, click the link in the description of today’s episode in your podcast app to go to the show notes at YourMoneyYourWealth.com to access all our free resources and to Ask Joe and Al On Air. 

Spouses Vs. Survivors Social Security Benefits (Dave, AZ)

Joe: We got Dave from Arizona writes in. A couple from Arizona back to back, Al.

Al: Right. How about that?

Joe: “Joe, Al, Andi, love the show. Thanks for the great info. My question today is regarding when to take Social Security. My wife is 10 years older than me. We are still several years away, but I was using the open Social Security calculator on open Social Security dotcom recently and identified that the best strategy based on our present value calculation is for my wife to take Social Security at age 70 and for me to take Social Security at age 62.

For reference, we both have about the same number of working years and our expected primary insurance amount are about the same in full retirement. If she outlives me, then no issues and she will continue to take her max from age 70 on. However, the calculator seems to be lacking in its ability to approximately calculate a scenario whereby, for example, I take my Social Security at 62 and my wife takes hers at 70 and then my wife passes away, heaven forbid, when I’m 63.” Oh, man. See how I’m building up the excitement here, Al?

Al: It’s crazy. I’m just on pins and needles.

Joe: We’re making Social Security fun here bro. “In this scenario, how are survivor benefits calculated related to my reduced primary insurance amount because I took it at age 62? The calculator seems to imply that I would continue to receive my reduced age 62 PIA benefit, plus a survivor benefit that would combine top-up to equal the full benefit that my wife was receiving before she passed away. Would the survivor benefit for me be reduced if I’m only 63 and I haven’t yet fully reached full retirement age? Or does it really top-up to my wife’s full PIA benefit regardless of my age is as long as I’m over 60? I’m worried that if something happened to her between the time that I am 62 and my full retirement age, the calculators recommendations are not correct and I will thus be subject to taking my reduced ongoing benefit and a reduced survivor’s benefit in perpetuity. I’m very leery of taking Social Security at age 62 due to the reduced benefit and would prefer to wait till at least 67 to avoid the situation that I described. Thanks in advance and look forward to hearing your feedback. I love the show.” So the scenario is he got on a calculator; wife’s older; wife takes it at age 70. The difference between taking it at age, let’s say full retirement age and age 70 is about- what is it- like 130% increase. You get an 8% delayed retirement credit each year that you wait. So there’s a difference between the survivor benefit and a spousal benefit.

Al: Yeah, I think he’s got those mixed up.

Joe: So a spousal benefit is that you could claim half of your spouse’s benefit as long as your spouse is claiming a benefit. So let’s say she claims her benefit at age 70, he turns age 62. Before he could just claim a spousal benefit, which would be half of her benefit at age 67 or 66, whatever full retirement age is, but with a penalty because he took it at age 62. However-

Al: That was the old rule.

Joe: – that was the old rule. Now it’s called what- deemed?

Al: The deem rule.

Joe: If he takes it at 62, she’s taking that 70. It’s going to take a look to say, hey, you take the spouse benefit or your benefit or both. It gets complicated. But what’s the rules on a survivor benefit, Alan?

Al: Survivor is completely different. You get your benefit or your spouse’s, the deceased spouse’s benefit, whichever is higher, without regard to when you took yours. So it’s completely different rules. So the calculator appears to be right in this case.

Joe: So he takes his at 62, she takes hers at 70, her age 70 benefit is a lot larger than his age 62 benefit. So what he’s thinking is that, oh God forbid she passes away. He claimed his benefit early. He’s going to be penalized for life or in perpetuity. In perpetuity, Al.

Al: That’s a long time, Joe.

Joe: That’s a very long time. And so he’s like, I don’t want to be cut with this lower benefit. I want to just wait until age 67. But if he takes his benefit at 62, she takes her age at age 70, she dies. He takes a higher of the two.

Al: Yeah, that’s right. It’s not reduced. So he takes the higher the two. So, Joe, I would say generally I like this strategy, given Dave’s situation with maybe one exception, and that is if both Dave and his wife believe they have exceptionally long life expectancy, they probably would do better both to wait till 70. But of course, you don’t know. That would be a reason why Dave might wait longer. But in terms of hedging your bets, and I guess they had about the same number of working years and same salary. So the benefits are about the same. So generally, we like to say that that the spouse that has the higher benefit, you wait as long as you can to collect. In this case, age 70 is the longest. And then the second part is that the spouse that’s the oldest. In this case, the wife. They both have roughly the same income, but that spouse is older. So, yeah, I agree with the strategy. Unless they both feel like they have a long life expectancy, then they might want to rethink.

Joe: I would have to look at the numbers, but I think this is the right strategy, to be honest, because she’s probably going to outlive him anyway.

Al: Well, I’m saying if she lives to 100-

Joe: And he lives to 110-

Al: – and he lives to 90 or whatever.

Joe: Right, right. Right, right.

Al: Then in other words, he’s going to do better waiting for his benefit at age- because by age 82- 81, 82 is where the breakeven is. That’s all I’m saying.

Joe: Here’s a couple of other things. So, Dave, to answer your question, what you need to understand is that there’s two rules in regards to a survivor benefit and spousal benefits. You’re getting those two things confused. So survivor benefit, if she passes, you’re going to receive what her benefit was. So the larger benefit that she took at age 70 will be your benefit. You lose your benefit. So it goes to two benefits to one benefit. Because of that fact alone, they’re saying the surviving spouse will get the higher of the two because you lose a benefit. So that’s the whole strategy of Social Security planning is that you’re looking at let’s maximize at least one person’s, because if they die prematurely or the other spouse dies, someone’s always going to have that larger benefit. That is a survivor benefit. Are you worried about that? That’s it. 62. You claim it. I get it. You might live a little bit longer, but if you do the math, it might kind of run out. And let’s say at age 95, you probably get a little bit more money out of the system. But then you have to look at other planning. What’s your tax situation look like? Do you actually need the income? Does it make sense to push the income out? Because then you get a lot higher guaranteed income where you can live off of some of the other brokerage or retirement assets, maybe you do Roth IRA conversions. Arizona- I’m not sure how Social Security is taxed in Arizona. If it’s tax-favored like it is in California, it might make sense to have a larger guaranteed income for the rest of you and your spouse’s life while you live off of other assets. So looking at the calculator will show you what’s the most that you’re getting out of the system, but it doesn’t tell you how to maximize your overall net worth or cash flow. Would you agree with that?

Al: I agree with that. It gives you an idea of- it doesn’t really get into your health and other income. And you’re right, sometimes people take Social Security so early they not only have a reduced benefit, but now their income is too high to do Roth conversions in years where it would have made sense to do a lot of Roth conversions. So, yeah, you gotta- there’s a lot of factors that go over and above a calculator. I agree.

Joe: Yeah. Arizona does not tax Social Security benefits, so that’s another reason potentially to push that thing out. So. All right, Dave from Arizona, appreciate your question.

Should I Roll from a Whole Life Insurance Policy to a Low-Cost Variable Annuity? (Ajay)

Joe: Let’s see, Ajay, he writes in. “I’m currently in a whole life insurance policy, which I was somewhat tricked into buying.” Tricked, Al.

Al: Yeah.

Joe: ” I’ve put in about $35,000 into the policy and premiums, the cash value of the policy is $25,000.” So he’s put in $35,000; cash value’s $25,000. So there’s a $10,000 loss. “I wanted to maintain the loss. I was told I could probably go into a really low-cost annuity like Fidelity’s. What’s your opinion about getting out of this whole life insurance policy, which I don’t need? What should I move the money to or roll it over to so that I can maximize or minimize taxes or maximize the loss?” He’s got $100,000 loss in the life insurance contract. He thinks that what he wants to write this loss off on some other gain.

Al: Yeah, I think it’s worth $10,000, right?

Joe: Yeah, what’d I say?

Al: $100,000.

Joe: OK, $10,000.

Al: So a loss of this type- let’s say he were to cash it out and he gets $25,000 and he put $35,000 into it. So there’s a loss of $10,000. That used to be a miscellaneous itemized deduction. That’s where you got to take it, which is no more. Those are gone. So essentially it’s a non-deductible loss.

Joe: So then he’s like let me put it into a variable annuity so I could carry over the basis, is what he wants to do. So I’m going to move the $25,000 into a variable annuity. But I want to see the basis is $35,000, even though it’s only worth $25,000. I’m like, why do you want to do this? It doesn’t make any sense at all to me because it’s not an ordinary loss. It’s a miscellaneous loss that you can’t even write off. If I just told the guy, blow out. Get rid of the life insurance. Don’t move it into an annuity, because here’s what’s going to happen if he moves it into a low-cost non-qualified annuity, it goes to $25,000. So he’s going to wait until it reaches age, the $35,000. And then what is he going to do, cash it out then and not pay any tax? Why are you waiting? Just get out now into a brokerage account. Because maybe it was- because the $25,000 grows to $35,000 and he’s going to have to pay capital gains? Is that maybe his rationale? Is that what he’s thinking?

Al: I think so.

Joe: But you can tax manage the non-qualified account, have it liquid because you can’t cash out of the variable annuity until you’re 59 and a half. That’s the biggest issue. I don’t know how old Ajay is, but I’m guessing, if he’s younger than 59 and a half, blow out of the insurance, get rid of it now, put it into a brokerage account. If he’s anywhere younger than 55, it doesn’t make any sense to put it into the annuity, because it’s going to sit in the annuity till he turns 59 and a half. And let’s say it’s 30 years from now, 20 years from now. Well, now there’s $25,000 turn to $50,000 turn to $100,000. Well he’s got a $35,000 basis but $65,000 of growth is going to come out and it’s taxed at ordinary income.

Al: Right. Instead of capital gains.

Joe: Instead of cap gains.

Al: Which is what would happen if he gets to that. 100% Joe. That’s exactly what I’d do. I’d just cash out of it and do something else.

Joe: Thanks for the question, Ajay.

Limericks and Comments

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My four fingers, Celsius, and color in the Derails of this very long episode. 

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