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Published On

February 26, 2019

Behavioral finance expert Dr. Daniel Crosby talks about his latest book, The Behavioral Investor and cracks us up with stories of how “having to go” and other physiological, sociological, and psychological factors influence our investing choices. Plus, Joe and Big Al answer money questions about ACA subsidies and Roth conversions, strategies for reducing the tax burden on 1099 income to zero, and donating a required minimum distribution to multiple charities.

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Show Notes

(00:49) Dr. Daniel Crosby – The Behavioral Investor
(12:45) Dr. Daniel Crosby – The Behavioral Investor (part 2)
(21:30) SEP IRA to Roth Conversions and Stretch Roth IRAs and RMDs (video)
(32:37) Can I Split My RMD and Donate to Multiple Charities? (video)
(35:10) ACA Subsidies and Roth Conversions
(41:02) How Can I Get My 1099 Income Tax Burden Down to Zero?

Transcription

This might possibly be the funniest interview we’ve ever had on this show. As it turns out, physiological, sociological, and psychological factors influence our investing choices in ways you might not expect. Today on Your Money, Your Wealth®, behavioral finance expert Dr. Daniel Crosby talks about the findings in his latest book, The Behavioral Investor. Plus, Joe and Big Al answer questions about converting your SEP IRA to a Roth, stretch Roth IRAs and required minimum distributions, donating RMDs to charity, ACA subsidies and Roth conversions, and strategies for reducing the tax burden on 1099 income to zero. But first, grab a Big Gulp and settle in, here with our guest Dr. Daniel Crosby, are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

:49 – Dr. Daniel Crosby – The Behavioral Investor

Joe: Alan, it’s that time of the show.

Al: It is, we’ve got a guest and I’m excited.

Joe: Yeah he’s one of my favorite guests, he’s been on the show several times, and he’s a doctor.

Al: Yes. And that already classes up our show, doesn’t it? (laughs)

Joe: Dr. Daniel Crosby How are you, my friend?

Dr. Crosby: I’m laughing because you called me a doctor and no one ever does, so thank you. Thank you for respecting me in ways my parents still don’t. (laughs)

Al: (laughs) They don’t call you Doctor?

Dr. Crosby: No. Much to my dismay. (laughs)

Joe: The last time you were on, we were talking about The Laws of Wealth. Which was phenomenal. How many books now, is this like your fifth book?

Dr. Crosby: It is my fifth book. But one of them is a children’s book. Are we going to count a children’s book?

Joe: Yes we are. That’s one of my favorite books.

Al: That’s one we understand.

Joe: Isn’t that one like “You’re not as smart as you think you are?” It’s something that’s kind of with a little…

Dr. Crosby: No it’s more depressing. I have a book called, You’re Not That Great. That’s for adults. Then I have a children’s book called, Everyone You Love Will Die. (laughs)

Andi: That is amazing. Wow.

Joe: That is true. Well, let’s talk about everyone that you love will die. (laughs) Let’s just dive in right there. OK, The last book, I don’t know how much more behavioral finance can you fit in another book? In this one, you did it. I’m proud of you, first of all. But second of all, so what, did you just want to take even a deeper dive into the world of our minds and how bad we are with money?

Dr. Crosby: I wanted to be done with it, frankly. So now I am. I say in the first line of the book that the aim of this book is to write the most comprehensive guide to investor psychology that’s around. And one of my reviewers on Amazon doesn’t think I did that, but I think I did and I’m super proud of it, and I can say, I will say here for the first time, I will never write another book about investor psychology, because I think a lot of truths about human behavior just don’t change. So I think there’s a lot of great stuff in this book and now I’m going to write more depressing kids books.

Al: (laughs) Perfect.

Joe: Well tell our listeners a little bit about, what is, I guess the difference between your previous books and this one.

Dr. Crosby: So the last book was called The Laws of Wealth and it was about, sort of, the Ten Commandments of investor behavior. If you want to get the most out of your investments, these are the 10 things that you need to do. So it’s a great sort of beginners guide. This book is a deeper dive on the sociology, the physiology, the psychology, the neurology of how we make choices about money. So we dig into society, we dig into your brain, we dig into your body, all of this to try and understand. And, spoiler alert, everything around you, everything about who you are and the world you live in primes you to do dumb things with money. So we try and identify why you’re wired that way and then help you make better choices.

Joe: Well let’s dive in. What are some of the things you found? Why are we so bad with money?

Andi: You know, we really should mention, this book is called The Behavioral Investor. We haven’t got that in yet.

Joe: Don’t worry about it, Andi. Can we turn her mic off? Give her a leash and now all she does is she wants to run the show.

Al: Yeah. It’s impossible. It’s already on. We can’t put it back in Pandora’s box.

Joe: I know. It’s awful. Sorry about that Doctor, we have some behavioral issues here in this podcast.

Dr. Crosby: Sorry about it? She’s helping me. She’s helping me slang books! That was wonderful.

Al: See? He’s on her side.

Dr. Crosby: That’s right. So yeah, The Behavioral Investor, just named the best investment book of the year by the Axiom Business Book Awards. So take that, reviewer on Amazon. I’m not mad about it. (laughs) We’ll start with just the world that we live in. So the very first chapter in the book talks about how we are wired as a human species to think communally. So our ability to think in terms of, “what will my neighbor think about this? What will my best friend or my parents or my spouse think about this?,” is the very thing that separates us from the rest of the animal kingdom. Our ability to think in relational and cooperative terms is where we are different from any other animal. But I also cite examples of how this very literally leads us to think in packs and understanding the opinions of those who are close to us can actually change the way that you see, the way that you think, the way that you and interprets space and time. So I go into that in the book. But other people’s opinion can physically alter the way that you move through the world. And that’s not true of a deer or a penguin, right? And so this allows us to build great churches and great states and nations, but it also means that when it comes to investing, we are running as a herd, and that’s a profoundly, profoundly damaging thing. So one of the themes that runs throughout the book is things that have served us well evolutionarily or in other contexts are very bad for us as investors – and that’s just one easy example.

Joe: A question for you. I would say over the last 10 years there has been a lot more research. There have been a lot more great books published, like yours, on this topic of getting into the psyche, getting into our brains, to figure out why we are not very good with money. And I think everyone over the last hundred years, it’s like okay, well, we should buy low, sell high. And I think that’s very common investment knowledge but no one else can do that. Have you seen improvements? In the studies that I’ve seen, I haven’t seen any improvements, if you look at Dalbar, if you look at the outflows and inflows of certain funds when markets react, even though with all this work that’s being done. What have you seen? Have you seen any improvements in the average retail investor on how they’re dealing with their money?

Dr. Crosby: Are you saying that my life’s work has been a waste? (laughs)

Joe: Pretty much.

Al: No, I’ve got a different take – it’s like, this is why we need it, but then it’s like, how do we apply this? And I know that you try to do that in your book. But I think that’s why a book like this is needed.

Dr. Crosby: No, let me tell you my life’s work has been a waste. (laughs) So in the 1990s, we started putting nutrition labels on everything. You know when you go to the store what the chicken or the crackers or whatever, you know how much fat is in it, how much sodium, calories, whatever. So since that time, America has gotten twice as fat – like the percentage of people who are obese has doubled, and the rate of morbid obesity has tripled. And so you would think that with better knowledge comes better outcomes, but there’s actually very little to suggest that.

And so I think that what investors need is a three-legged stool. Part of it is knowledge – part of it is books like mine. But that won’t get you very far, candidly. It’s necessary but not sufficient. And the other two things that we need are good environments and good relationships. So let me say a little bit more about that. If you read my book and you’re nodding your head throughout, you go, “you know what, this guy makes a lot of sense.” And then you go watch CNBC for four hours and you’ve got people screaming at you that the sky is falling, and the economy is going to crumble, and some hedge fund manager says that it’s great recession 2.0 right around the corner, the lessons of my book are going to be out the door pretty quickly. So not only do we need good knowledge, we need to surround ourselves with the type of voices and the type of context that is conducive to good investment performance, which is, candidly, like ignoring it, mostly. And then finally, we need good relationships that will give us just-in-time advice. So we need people who, in a moment of panic, because even if you’ve done your best to learn the right lessons, even if you’ve done your best to surround yourself with the right kind of voices, you’re still going to freak out. Like markets are volatile, they’re still going to be times when you want to do the wrong thing, and you need someone – a coach or a counselor or an advisor – who, in a moment of panic will go, “this was not the plan. Stay the course, let’s stick with it.” So yeah. Books like mine don’t do nothing, but they’re really just a small part of the puzzle.

Joe: You know what I thought was really cool, what you wrote about in your last book. If people understood a little bit more of exactly what they’re investing in it would help them. Because let’s say if I was investing in a mutual fund or an exchange-traded fund or something like that, and all of the different companies I had a huge passion for, that I was really strongly, emotionally tied to these particular companies for some reason or another. And if I see that mutual fund or that stock or whatever go down, I’m not necessarily going to sell it, because I have a little bit more emotional attachment to it, where that would probably be good. Because I think with people with individual stocks, even though I don’t believe that individuals should own individual stocks, but I bet they have better behavior when it comes to buying and selling, even though they’re buying maybe not the right types of stocks, or having too much concentrated risk within a particular issue. But I thought the concept of saying, if I’m really supportive of a certain organization or a certain foundation or certain charity or something like that, and all of these different companies that are within that, I might be less likely to make, I guess, a trigger reaction when things happen.

Dr. Crosby: So when it comes to individual stocks, I think it amplifies the tendency in good and bad ways. Like it amplifies the tendency for you to stay the course, maybe, if it’s a really cherished company or really cherished business. But I think it also exacerbates some other behavioral problems. Like if you love a company, you’re not likely to be as critical of it. You’re not likely to do as much due diligence or manage risk as well, because it’s sort of a darling company. So I think it amplifies things in both directions that way. Where I’m really high though is on values-based and sort of socially responsible investing, which – this is an unpopular opinion and my mailbag will blow up after this. (laughs) I don’t think it does much good in the world. I don’t think that me with my $10,000 divesting of oil stocks, I don’t think that makes the world an appreciably greener place. I think someone with less values that way comes and snaps it up at a discount. But what I do think that it helps a lot with is the behavioral stuff, because now you can invest in gun free funds and green funds and Republican funds and Democrat funds and women’s leadership funds. And I think if you are someone who cares a lot about gender equity in the workplace, you are much more likely to stay the course with your women’s leadership fund than you are with your S&P 500, which is kind of toothless. So yeah, I think that values-based investing has a lot of behavioral upside and will give you the diversification that you need.

For a transcript of this interview, to listen to our previous interview with Dr. Daniel Crosby, for our other interviews and transcripts, and to subscribe to this podcast and share it with everyone you know, visit the show notes for today’s episode at YourMoneyYourWealth.com. Once you’re subscribed to YMYW, new episodes will automatically download to your device for free, and you can listen whenever you choose. Next week on YMYW, Tanja Hester from the Our Next Life financial independence blog shares her story of retiring at the age of 38 and creating a Work Optional life. Subscribe at YourMoneyYourWealth.com. Now, more with Dr. Daniel Crosby.

12:45 – Dr. Daniel Crosby – The Behavioral Investor

Al: When you wrote your latest book and kind of putting it all together, were there any surprises or studies or things that you thought well this seems contrary to what I thought I was going to find out?

Joe: He’s a doctor, Alan, nothing surprises him.

Cr. Crosby: No, here’s the worst part about becoming a doctor is you feel stupider on the day you graduate because you’ve just learned all the shades of gray. You go in like, “Yeah, I got this,” and you come out, you’re like, “oh my gosh, I know nothing.” So here’s one funny study. I don’t know how consequential it is, but I thought it was funny. In the chapters about the body, I learned that people who need to pee have exceptional investment performance. (laughs)

Al: We do a much better show when we need to pee. (laughs)

Dr. Crosby: I’m sitting here with a Big Gulp, frankly. (laughs) So what they found was something called inhibitory spillover. So basically, the same restraint that you’re using to “hold it” extends to you being able to control your temper, and “hold it,” as it were, in investment markets. So yeah, they did all these studies on people in different physiological states. People who were hungry were horrible investors, people who needed to pee were excellent investors. So stay thirsty.

Al: So in volatile markets, go get a Big Gulp and have one filled all the time.

Dr. Crosby: Hold it until you turn purple.

Al: (laughs) Got it. Okay. Well, that’s good advice.

Andi: Wow, this interview is going places I never expected.

Joe: Going back maybe to the basics. What are some of your favorite behavioral issues that we have when it comes to money? I mean you’re the expert in all of this, and I still think that people don’t really realize that we have some of these biases and tendencies when it comes to our money because maybe it’s hard to look at ourselves in the mirror and find faults. What are some of your favorites when it comes to why we are such really bad investors?

Dr. Crosby: So first of all, I think you make a really important point there, which is I get mail all the time from people who are like, “hey, I read your book, and it’s totally my neighbor… this part totally reminded me of my spouse.” And I have to write back and go, “I wrote the book for you, read it again.” (laughs) Because you don’t read these type of books with a finger pointing and blaming mindset. You look at it to try and better yourself and turn that introspective lens back on yourself. So I think that’s a really important place to start. So in the book, I outline four sort of primary error tendencies. There’s like two hundred and something different sort of small behavioral biases we can fall prey to. But when I examine that literature, I found that they consistently fell into one of four camps. So those four camps were ego, which is this tendency to be overconfident. Emotion, which is just what it sounds like – making emotional and not rational decisions. The third is attention, which is our tendency to evaluate the likelihood of something, not based on how probabilistic it is, but on how sort of sensational it is. My favorite example there is that many, many more people die taking selfies than in shark attacks.

Al: (laughs) That doesn’t get the press though.

Dr. Crosby: It doesn’t get the press, right. So like if two people a year die in shark attacks it’s the front page of Time Magazine. But the person at Disneyworld who was taking a selfie and stumbled into the road got hit by a car doesn’t make the news. We do this in investing too. We’re always worried about, when is the next depression and the Great Recession? And what’s the next Bitcoin or pot stocks or whatever. And we’re missing 100 more impactful things along the way. And then the last one is conservatism, which is our tendency to confuse what we know with what’s good or what’s safe.

Joe: Tell me more about that.

Dr. Crosby: Yeah. So one of the biggest examples of this comes from what’s called home bias, which is, people think the stocks of their country are more knowable, more safe, more desirable. And in the US, we’re such a large economy, we’re about 52% of all the equity markets in the world. We have about a 52% share of that. And so if people are over-concentrated in the US, it’s not great, but it’s not killer. But what we find is that people in places like Greece – you go to Greece or Finland or Canada or somewhere – and people have an 85% allocation to Greek stocks. Well, you’re overweight olive oil and tourism there and not much else. So people tend to get wrapped up in this idea that what they know is what’s safe. And we even see that within the US – people in the Midwest are way over-allocated to agricultural stuff, and people in the Northeast are way over-allocated to financials, and so yeah, people just really confuse, “I’ve heard of this, so I should invest in it,” and it’s pretty damaging.

Joe: Right. It’s like people in St. Louis have Budweiser or people in Atlanta own Coca-Cola. People here in San Diego own Qualcomm. Peter Lynch once said, “buy what you know.” But I think that could have been some of the worst advice possible.

Dr. Crosby: Well I say in the book, I mean, I specifically call out Peter Lynch, who’s got a lot more money than me (laughs), so I don’t think he’s super worried about it. But I say, “look, this is some of the worst advice you could ever fall prey to.” Because I live here in Atlanta and everyone around here is loaded up on Aflac and Coke and UPS and all the local companies. And if you think about it, a lot of times that’s your job. Your house is in that location. So if Aflac or UPS or Coke goes under, your housing prices – you’re gonna lose your job, your house value is going to diminish, and now you’ve got stock too? So you’re triple concentrated in this? So yeah, if anything, you want to run the other way from stuff that you know and you want to diversify into things that you don’t have a lot of exposure to. Because if you live in Atlanta – even if I never owned one share of Coke stock, my home value is profoundly impacted by Coke’s performance.

Joe: We’re talking to Dr. Daniel Crosby. His latest book is The Behavioral Investor. I want to talk about your podcast. What, because you were on our podcast for the last several years, you’re like, “hey, I want to start my own?”

Dr. Crosby: Yeah, you… (laughs) How do I say this in a way that it’s never been said before. You’re the wind beneath my wings. (laughs)

Joe: I’m a big fan.

Dr. Crosby: I have a podcast called Standard Deviations, which is a lot more serious-minded than this one, by the way.

Joe: Yeah. Half the time, Al and I show up drunk, so…

Al: We get accused of talking in circles.

Joe: That’s why we have to have very smart people on like you, my friend. Standard Deviations, it’s an awesome podcast, by the way. I’m a big fan of it.

Dr. Crosby: Yeah, thank you. I’ve started it kind of as a lark and it’s turned into a thing, so what do you know? Thank you. Thanks for the shout out.

Joe: Yes. Everyone, get his book. It’s called The Behavioral Investor, it’s now available on Amazon or anywhere else, I would imagine, where finer books are sold?

Dr. Crosby: Anywhere fine books are sold. If they don’t have it, you are in a place of ill-repute, and run. Run to the door. (laughs)

Joe: Where else can people get more information on you?

Dr. Crosby: Yeah, Twitter @DanielCrosby, check out the podcast, Standard Deviations, check out the books, and I’m also very active on LinkedIn. So yeah, find me any of those places.

Joe: How is your firm doing?

Dr. Crosby: Well, I sold it and I joined another firm. So I’m the Chief Behavioral Officer at Brinker Capital, based just outside of Philly there. It just happened a couple of months ago. So really good, lovin’ life there.

Joe: Well congratulations my friend. It’s always such a pleasure having you on. And I know you’re a busy guy, so I really appreciate it.

Dr. Crosby: This was a blast. Thanks all.

Visit the show notes for today’s podcast at YourMoneyYourWealth.com for links to Dr. Daniel Crosby on LinkedIn and Twitter and to buy his latest book, The Behavioral Investor. And hey, is your retirement going to get punched in the face? Find out how to Avoid a Retirement TKO this week on the Your Money, Your Wealth® TV show. Watch online at YourMoneyYourWealth.com, and download the Quick Retirement Calculator guide for free while you’re there.

Be sure to subscribe to Your Money, Your Wealth® on YouTube to catch new episodes on Sundays. Now it’s time to get to your money questions. If you want to email us or send us a voice recording of your question to be answered on the podcast, just visit YourMoneyYourWealth.com and scroll down to “Ask Joe and Al On the Air.” Voila!

21:30 – SEP IRA to Roth Conversions and Stretch Roth IRAs and RMDs

Joe: We got Susan from San Diego. “Hi Joe and Al. My husband has money in a SEP IRA that he was able to save when he had a small business years ago. He no longer has that business, just his regular income which is reported on a W-2. As he cannot add any more savings to the SEP, he was thinking about converting this to a Roth IRA this year. He will have to pay the taxes on the conversion but is it possible for him to convert straight from his SEP IRA to his Roth? Susan, yes. The answer is yes. Absolutely. But you would want to be careful, I guess. I mean what’s the balance of the SEP IRA? What tax bracket are you in?

Al: Sure. You’ve gotta ask a few more questions, and I think that’s a great question, because a lot of times when you’re reading or listening to pundits that talk about, “you could do an IRA to Roth conversion,” you could also do a SEP IRA to Roth conversion, you can do a 401(k) balance to a Roth conversion. You can take any retirement account and convert it to a Roth IRA. And now it used to be that you could recharacterize if you converted too much. You had until the filing date of your tax return, and you had to recharacterize generally back to an IRA, regardless of where it came from. But those rules are gone. So it’s very simple – whatever account you have, it’s a SEP IRA, you can convert that directly to a Roth. The question is should you? What’s your tax bracket now, what’s it going to be in the future? Maybe you’re in a low bracket, maybe you’re in a high bracket. The lower the bracket you are, the more likely you’re going to want to do a conversion now while tax rates are lower. Maybe you want to fill up your current bracket, so maybe you don’t convert at all. Maybe you convert part of it. So those are things you’ve got to look at.

Joe: Yeah. So again, to refresh our listeners on what the heck a conversion is, it’s taking money – so a SEP IRA is just a self employment pension plan. So her husband, Susan’s husband, was self-employed and set up a retirement plan for his small business. And so it was a pre-tax plan. So he got the tax deduction for money going into the SEP, the money grows tax deferred. And then when he would pull the money out, it’s going to be taxed at ordinary income rates. Susan is a big fan of the show. And so she’s like, “well wait a minute, maybe it might make sense for him or us to have tax-free money in retirement.” So strategies that we’ve talked about in the past is taking retirement accounts, any accounts for that matter, and moving some of that or all of it into a Roth. The reason why you would want to do that is that all future growth of that investment will grow 100% tax-free. So you convert $10,000, that $10,000 grows to $15,000. Let’s say you need a pull of a few thousand out to live on. That would be 100% tax free for you, as long as you qualified for a tax free distribution, and that just means you have to be over 59 and a half or the Roth needs to be open for five years or longer. So what we look at, and what we talk about, is that yeah, tax rates are a little bit lower now. We had the tax reform, so marginal rates have dropped. And so, it could be a really good strategy for a lot of people to look at. So looking at your tax return is going to determine how much that you convert.

Al: You bet. And so what we’re talking about, like for example, a married couple, the 24% tax bracket goes all the way up to about $321,000 of taxable income for 2019. Realize when you do a Roth conversion, you have to do it in the tax year that you’re in. In other words, it’s not like a contribution where you can do it April 15th. You have to do it by year end. So now we’re talking 2019. And so for a lot of folks it’s like, well this is a lower bracket now than I’m going to be in retirement, because the old tax rates are coming back and alternative minimum tax will be a bigger factor when it comes back. And so why not? And for single, that 24% bracket goes to about $160,000, so that’s pretty good to take a look at that. I think virtually everyone listening should be considering it. Now, whether they should do it or not is based upon their own circumstances.

Joe: And she goes on to write, “it would be very beneficial for your listeners is you highly recommend everyone having a Roth IRA.” Susan, we do not highly recommend anything on this show. We share ideas. We do not give advice. That’s compliance. “Thank you for all the great information you share.” OK, so she wants to learn a little bit about a stretch Roth IRA. So let’s say that her husband then converts the SEP IRA to a Roth IRA, and then the Roth IRA is growing tax-free and the husband dies. What happens to that money? So a few things can happen. Let’s say Susan is still living. She could keep it in the deceased husband’s name and she has full access to the money like it’s her own, because she is the beneficiary. As long as she’s the beneficiary on the account. So she can keep it in his name. And let’s say Susan’s under 59 and a half, she can have full access to the dollars. That’s the only real reason why you would want to keep it in the deceased spouse’s name is that if you’re under 59 and a half and you need access to it. Because if you are a beneficial owner of a retirement account, you have access to those dollars without that 10% penalty. So it would still be tax-free to you Susan, as long as that account was open for five years. If it wasn’t, you would still have to wait for the five year clock to get any type of interest out of that account. Maybe you’re wondering what happens to that account, and both of you are spouses, and let’s say you have a son or daughter that is going to be the beneficiary of that account. So if it’s after the second spouse passes, how it works is that it would still be in the deceased’s name. So to make this easy, let’s say her husband passes, Susan puts the Roth IRA into her own Roth IRA, which she can, because they’re spouses. Now she passes away and it goes to her child. Now the child cannot put the Roth IRA into the child’s account. It will blow the thing up. It would unravel everything and 100% of that Roth IRA would be distributed. Then any future growth of those dollars are going to be taxed at either a capital gains interest or dividend. So you don’t want to do that, especially if you’re converting them and paying tax. You want to have it parlayed tax-deferred as long as you possibly can. So you pass, Susan, it goes to your heir. And so what happens then is that it still stays in your name though. That’s the biggest tricky part about all retirement accounts going to the next generation, or any non-spouse beneficiary, I should say. So it would stay in Susan’s name for the benefit of her issue.

Al: Which is “kid.”

Joe: Which is “child.”

Al: (laughs) Or any beneficiary.

Joe: Well he’s probably caused some “issues” in Susan’s life. (laughs)

Al: Yeah. Just clarifying. (laughs) You got legal on us.

Joe: (laughs) I read a book over the weekend. But here’s the catch with Roth IRAs. You don’t have to take a required distribution. If it’s your account, you do not have to take a required distribution. What that is is that it’s a mandatory distribution, age 70 and a half, thereafter you have to start taking money out of the account. In a Roth IRA you do not, as long as you’re the owner of the account. Once you pass away though, you’re still the owner of the account, the beneficiary is a beneficial owner. So it’s not a true ownership of that account. So that non-spouse beneficiary will have to take a required distribution from the Roth IRA based on that child’s life expectancy. The distribution is tax-free, but they do have to pull money out of the account based on their life expectancy.

Al: Yeah I think that bears a little repeating. So it’s still tax-free – when you do the Roth conversion, what’s in that account is tax-free for whoever inherits it. But if it’s a non-spouse, if it’s a child or nephew or friend, a non-spouse, then they have to take a required distribution. They could be eight years old and still have to take a distribution based upon the eight year old’s life expectancy. And the reason is because the IRS doesn’t want these accounts to grow generation after generation tax-free.

Joe: And so in recent tax law, that did not pass, what they want to do is eliminate, basically, the stretch IRA.

Al: Right. And we thought they would, because both the Democrats and the Republicans wanted that.

Joe: So they were saying, “No, this is a retirement account. We want you to distribute in your lifetime, because it’s for your retirement, not your child’s retirement.”

Al: That’s right. Or if you die early, it’s got to come out in five years.

Joe: Right. Get the whole thing out. We want our tax money, let’s recycle the money. And so what the latest proposal was is that you could pass about $450,000 – 400 or 450. That would be able to stretch. Everything else has to come out within five years or that year.

Al: Yeah. And that was the proposal, which did not pass.

Joe: Right. It didn’t pass so we still have the stretch.

Al: We still have the full stretch on regular IRAs and Roth IRAs.

Joe: And I mean, there have been rumors of, maybe you can pass a million dollars. Maybe it’s 200, and maybe it’s 4, whatever. so stay tuned on that. But just know that if you ever inherit a retirement account, you have to take a required distribution. We just had an individual that came in, inherited an account, never took a required distribution for like three or four years. And they were with a broker, we’re like, “well what did you tell the broker?” And then they’re like, “oh yeah, they’re gonna run some numbers for me.” And I was like, “Well when did you inherit this thing?” “Well, four or five years ago.” “And you’ve never taken an RMD??” I looked at the tax return -nothing. So that’s a 50% tax penalty each year that you don’t take the RMD. When you’re looking at beneficial IRAs, it’s completely different than a regular IRA. Most custodians, iIf you’ve got your money at TD Ameritrade, Fidelity, Merrill Lynch, whatever, they usually will send you a letter saying, “hey, we have your birth date here, you’re 75 years old. You need to take money out of this account. And here’s the amount, roughly, that you need to take out.” And they’re just going to give you the number on the accounts that they hold. So maybe you have an account at Fidelity. You have an account at TD Ameritrade and Charles Schwab? Maybe Charles Schwab doesn’t do it or forgets it. And then you get the number from TD Ameritrade and you only take that RMD? You’re gonna be short the RMD. Be careful with that. But non-spouse beneficiaries, a lot of them don’t even calculate that – they don’t even know, they’re like, “Screw it. I don’t even know how much,” that’s on you. You are the taxpayer, you are responsible for taking the required distribution. The custodian is not. They’re doing it as a service – as a customer service perk. The IRS does not mandate Fidelity to send you out a statement, for what I know.

Al: Right. Wow, you got pretty fired up.

Joe: Well, I just don’t want people to lose money. I got a big heart, Al.

Al: (laughs) Apparently.

Joe: You’ve got a big wallet. I’ve got a big… heart.

32:37 – Can I Split My RMD and Donate to Multiple Charities?

Joe: Carrie from San Diego, she’s donating her RMD directly to charity. She would like to know, “can you split the RMD to multiple charities, or a charity and yourself, assuming the management would do that? So I’m assuming Alan, let’s say she’s got a $20,000 required minimum distribution. There’s something that’s called a QCD, a qualified charitable donation. (Editor’s note: Qualified Charitable Distribution.) And what that law allows us to do is that if you are 70 and a half or older, and you are now taking your required minimum distributions, you are able to give all or part of that required minimum distribution directly to a charity. It never shows up on your tax return so there’s no taxable event. A lot of times people are taking these RMDs and reinvesting them and paying taxes on it, where this would eliminate the tax altogether and it’s a pretty slick way to give to a charity and also get a pretty good tax benefit. Going back to Carrie’s question. She’s asking, “hey can I give to multiple charities or maybe can I split it up with multiple charities and take some of the RMD for myself?”

Al: Yeah. And the answer is yes. So the way that you do that, so the money has to go directly from your IRA. So the custodian has to actually write the check directly to the charity, but it can be as many charities as you want. If you have 10 charities, you could do this 10 times and you could still take more yourself. In fact, something that people don’t know is you can actually do more than your required minimum distribution – you can actually do $100,000 if you want to. That would be a big donation, but you could do that. So yeah. There’s a lot of flexibility. But the key here is that you cannot receive the money yourself and then give it to charity. If you do then it’s just like any other charitable donation – you write it off on your taxes. But Joe, a lot of people are not going to be able to itemize their deductions anymore because there’s a much higher standard deduction. So doing it this way, since you didn’t get any donation deduction benefit anyway, doing it this way you’re going to save taxes because it doesn’t show up as income on your return.

For more information about required minimum distributions, qualified charitable distributions, Roth IRAs, and many, many more financial topics that matter to you, check the show notes for today’s episode at YourMoneyYourWealth.com. We’ve got white papers, educational videos, and tons of other free resources, including video answers to some of these money questions! Send us your questions to be featured in the podcast: just visit YourMoneyYourWealth.com and scroll down to “Ask Joe and Al On the Air.”

35:10 – ACA Subsidies and Roth Conversions

Joe: Todd from San Diego. “Joe and Al, I was first introduced to the mysteries of IRA conversions at one of Joe’s seminars.” It’s not a seminar, Todd. It’s called a class. And that was… I remember Todd very well. Of course I remember Todd. How could you not remember Todd. Yeah it was Mira Costa College, Oceanside.

Al: Was it my brother named Todd?

Joe: No, it wasn’t your brother. “Since then, I’ve heard you guys talk about converting traditional IRAs to Roth frequently. I look at it near the end of every year. I know you disagree on whether one should convert if one is over the 12% bracket, still under the 22% tax bracket, but something new to consider I haven’t heard you mention: if one is in the 10 and 12% brackets, one is likely to qualify for the ACA subsidies.

Al: That’s Obamacare.

Joe: That is I like to call it the Affordable Care Act, Alan.

Al: Yes I know. You’re more politically correct than I am.

Joe: “That means you do not only need to be aware of the top edge of the tax bracket, but also need to keep the various thresholds of ACA subsidies in mind. Converting to fill up the 22% bracket may reduce your subsidies, and depending on how much that is, could easily kill any potential tax benefits.” Todd continues. “By the way, through disciplined investing for most of my life I was able to retire at age 55. My wife and I met with Joe a couple of years ago to discuss my plan. He saw my retirement spreadsheet and immediately asked if I was an engineer and introduced me to a Monte Carlo analysis. He should know that so far the plan is working out very well and the Monte Carlo I did on it show a 94% chance of success. Many thanks.” Well Todd, I’m very proud of you buddy. Yeah, he had multiple spreadsheets. There was a lot of flaws in the spreadsheets.

Al: Were there?

Joe: I thought so.

Al: Okay. I didn’t see it.

Joe: But no, it was very well done. I’m just giving Todd a hard time.

Al: Yeah. The point being made is absolutely correct. And so here’s the deal, before age 65 when you qualify for Medicare, let’s say you retire, and so you’re paying for your own health insurance, or maybe you have an employer that doesn’t have health insurance. So you have to buy your own insurance. And generally it’s for people that are retired and they’ve got savings – they got savings to live off of. So they can keep their actually current income pretty low. And if your current income is low, and they have these poverty levels – 100% poverty all the way up to 400% poverty level – if you’re below those levels, then you get a subsidy on your health insurance. In other words, you get a tax credit for being in a low income bracket. And that’s absolutely true. And when you’re looking at Roth conversions and you’re subject to this insurance, where you’re getting these subsidies, you absolutely want to look at that. And I would go so far to say as for those that are getting the subsidies in the 12% bracket, and they’re in the poverty range, if you do any Roth conversions at all, you certainly want to stay below the 400% level, otherwise your effective tax rate is not 12%. It’s more like 25% or more.

Joe: Yeah but here’s the deal. You know where I stand on this.

Al: I know where you stand. But that’s the truth.

Joe: Yes. We have clients that have millions of dollars.

Al: I know, and you don’t like it.

Joe: I don’t! It’s like, OK, I got four million bucks and we’re able to create income from the non-qualified account, but I can do tax loss harvesting, tax efficient, so that very little shows up. And then they got another couple million bucks sitting in their IRAs. And it’s like OK, no, let’s do some conversions, let’s get this thing out, because it’s going to blow you up long-term. “No, I like my subsidies.” The subsidy is not meant for you! You have four million dollars!

Al: Right. Nevertheless…

Joe: It’s the law. I get it. But it’s just like come on. You’re tripping over dollars to pick up pennies. Run the numbers. So you get a subsidy for one year, you save a couple thousand dollars. I guarantee you, if you do the numbers correctly, and if you can get money – I mean, because you’ve got to add that back into your effective tax rate. Let’s say you’re in the 12% tax rate, 22% tax rate, but you lose that subsidy. So you add that cost back in as a tax, and then you divide that into what your income is to find out what your true effective tax rate is with the loss of subsidy.

Al: Yeah. That’s how you do it. But one correction – you cannot guarantee.

Joe: Did I say guarantee?

Al: Yeah. It’s impossible to guarantee that.

Joe: I didn’t guarantee anything. I just guarantee that that pisses me off. (laughs)

Al: (laughs) Anyway. I get it – it wasn’t intended for you, but nevertheless, your statement is correct, Todd. (laughs) It’s why we haven’t talked about it, because we always have this discussion.

Joe: (laughs) Right. Because if you look at it, I believe, personally, because I’ve run the numbers, you’ve run the numbers, you’ve seen the numbers. If you lose a subsidy for one year and you can get $100,000 converted at a fairly low rate, I mean, these rates are not going to be here forever. These are extremely low tax rates. If you have a lot of money – and I’m not saying – I don’t remember exactly, I’m not saying that Todd is the one with millions of dollars. Todd might only have $50,000. I don’t know. I don’t know Todd. I just remember him from the class. It was not a workshop, Todd, it was a class. But congratulations to Todd.

41:02 – How Can I Get My 1099 Income Tax Burden Down to Zero?

Joe: OK. We got Jay Paradise.

Andi: Jay, in Paradise, California. (laughs)

Joe: (laughs) “I’m about to purchase a dump truck cash and work the next year six days a week 11 hours a day $160 an hour. I’m also a Camp Fire evacuee. Looks like $500K plus a year for the next two years. How can I get my 1099 down to zero?” OK, well that would be good on $500K plus a year, to get your taxes down “and keep it all,” he wants to. Jay. Can I buy real estate related to trucking and work? After $200K in Cal or Fed I believe the tax rate goes to 50%. We want to pay next to nothing. Does an LLC or non-profit help?”

Al: All right, Jay, I’ll start with this one.

Joe: So first of all Jay, I’m sorry about the Camp Fire up there in Paradise. I mean hopefully he didn’t lose his home. And so he bought a dump truck, Al. And he’s gonna make $500,000 dollars a year. Zero him out please.

Al: Yeah. Okay. So that’s difficult, to say the least. But let’s try. (laughs) So right off the bat, when you have earned income, this is earned income, so you’re gonna have to pay income taxes and self employment taxes on that. And so that tax rate, especially if you’re in California, which you say you are, Paradise. The tax rate probably is close to 50%. In some cases it could be even a little bit higher, but that’s probably a good range. You’re not going to pay 50% on all your income because you’ve got lower brackets to work up to, but your highest brackets will probably be close to 50%. So how do you get rid of that? Well, you can take part of your dump truck and you can write that off each year. You might be able to take Section 179. It depends – it’s has a weird rule, but if it’s over 25,000 lbs., then you get a better tax deduction. So be aware that. Any other deductions, like for example, driving to and from the job sites, things of that nature, supplies. But that’s not going to be worth $500,000. So you’re going to basically take that $500,000 down to $450,000 or $475,000. I don’t know how much you can come up with in deductions. So you still have to pay taxes on that. Now, the next question is, are there other deductions?

Joe: Well you can buy a $500,000 dumptruck.

Al: Well, you could, (laughs) but if you’re trying to better yourself – I mean, maybe you get the best dumptruck ever.

Joe: Right? Well that’s his job isn’t it, a dump truck driver?

Andi: For two years.

Al: Yeah and then maybe sell it – but then you’ve gotta pay tax on all that gain. But let me just sort of try to take this question. So what else you could do to create deductions is – the normal things are home mortgage and charity and things of that sort. Property taxes. What some people do over and above that is they buy real estate. But this is investment real estate. This is real estate that you would buy, like let’s say a big apartment building, and maybe you buy a million dollar building, and you get a deduction probably in the neighborhood of, I’m going to say $25,000 from depreciation, just as a quick guess.

Joe: But he’s asking, “Can I buy real estate related to trucking and work.”

Al: No, no you can’t.

Joe: And he won’t even be able to write off – if it’s related to his work that would be a business expense. But if he buys a million dollar apartment building as an investment he’s still can’t write that off. He can write off maybe the income because of depreciation, but $500,000, he’s going to…

Al: Yeah. So what I’m saying is if he buys real estate – I mean, if he buys a piece of commercial property that he houses his business in, then you can’t just write off the property, you get to write off a piece of it. Commercial properties over 39 years. residential properties over 27 and a half. That’s how much you can write off. So a million dollar property on a residential would give you probably somewhere around a $25,000 deduction because you got to factor in the land portion which is not a write off. So to get a $250,000 deduction, in that example, you would need ten million dollars of real estate.

Joe: Yeah but… I disagree. Because he makes so much money he’d phase out of the passive loss rules.

Al: Well yeah so the second part of that…

Joe: What, be a real estate professional? (laughs)

Al: Yeah. Yes, he would.

Joe: But he’s a trucker. He’s not a real estate professional. (laughs)

Al: I know I know. But I don’t know if he’s married or not. If he’s married and his spouse could then be the real estate professional, you could write that off. Anyway, I guess the bottom line, Jay, is this is very difficult. About the best you can do is come up with business deductions against that $500,000, and I bet you, legitimately, you can’t come up with more than 25 to 50 grand of deductions.

Joe: And then he could do, what, a retirement account. That’s another $24,000 and that’s about it.

Al: Yeah. Correct. That’s about it. Right.

Joe: Sorry. Big Al failed on that.

Al: Yeah I did. I’d love to zero out taxes.

Joe: Yeah here’s Big Al’s advice: buy a 10 million dollar property and tell your wife, that you’re not married to yet, to be a real estate professional, and then that would be good.

Al: Actually in this example he’s going to have to buy about a 20 million dollar property to get a $500,000 deduction. (laughs) Might be a little difficult.

Joe: All right, that’s it for us, we’ll see you again next week, the show is called Your Money, Your Wealth®.

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And, special thanks to today’s guest, Dr. Daniel Crosby for teaching us that the secret to investing is just needing to pee! Get The Behavioral Investor on Amazon and find links to Dr. Crosby on Twitter and LinkedIn in the show notes at YourMoneyYourWealth.com, along with all the links you need to subscribe to the podcast on Google Podcasts, Apple Podcasts, Spotify, listen on YouTube, or on your favorite podcast app.

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