If a fortunate equity event or liquidity event should cause your income to skyrocket, what will that do to your taxes? Joe and Big Al spitball tax strategies to help you manage this good problem to have. Plus, Backdoor Roth, contributions, conversions, and income limits explained, converting twelve and a half million bucks to Roth, and what happens to retirement accounts when you pass – will there be a tax bill due? Kicking it off with the 7-twelve portfolio – what is it?
- (00:52) Is The 7-Twelve Portfolio Too Diversified or Too Simplistic? (Sugar Magnolia, Greensboro, NC)
- (10:21) What the Hell Will a $1.5M Company Equity Event Do To My Taxes?
- (20:22) Can We Invest in Our Hobby Farm at a Loss and Convert 401K to Roth to Offset Tax on Huge Liquidity Event?
- (25:21) Backdoor Roth, Contributions, Conversions, and Income Limits Explained (Nancy, WI)
- (31:10) Should We Convert $12.5M in IRAs to Roth? Retired, $100K Pensions, $205K Income (Frank, San Diego)
- (35:27) Mom Passed, Her 401K is Still at Vanguard. How Can Dad Avoid a Tax Bill? (Anonymous)
- (39:16) What Happens to Our Retirement Accounts When We Pass? (Butch from the Bait Shack)
- (44:56) The Derails
Free financial resources:
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Today on Your Money, Your Wealth® podcast, if a fortunate equity event or liquidity event should cause your income to skyrocket, what will that do to your taxes? Joe and Big Al spitball tax strategies to help you manage this good problem to have. Plus, Backdoor Roth, contributions, conversions, and income limits explained, converting twelve and a half million bucks to Roth, and what happens to retirement accounts when you pass – will there be a tax bill due? Visit YourMoneyYourWealth.com and click Ask Joe & Al On Air to send in your money questions, comments, suggestions and requests as an email or a priority voicemail. We’ll kick things off today with the 7-twelve portfolio – what is it? I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.
Is The 7-Twelve Portfolio Too Diversified or Too Simplistic? (Sugar Magnolia, Greensboro, NC)
Joe: “Hi, Joe, Big Al and Andi. I found your podcast about a year ago and love it. You all have the perfect mix of thought-provoking insights and entertainment. I’ve learned a lot from you. Thank you.” Well, thank you. “I live in the Piedmont of North Carolina. I drive a 2013 Honda CRV with 190,000 miles and going strong. I have a-“
Andi: – rescue terrier chihuahua mix.
Joe: What is SPCA? Special Pet California-
Andi: Oh it actually stands for Society for the Prevention of Cruelty to Animals. Wow.
Al: We’re being educated.
Joe: All right. “A little margarita on the rocks with a lot of salt. Here’s my question for you. Have you heard of the 712 portfolio? It consists of 8 equity diversified funds accounting for 65% of the portfolio, small, mid, large US. Stock funds, developed international emerging market funds, REIT, natural resources, and a commodity fund. And it also has 4 fixed income funds accounting for 35% of the portfolio. US Bond Tips international Bond and cash. All funds are equally weighted at 8.33%.” No, I’ve never heard of the 712.
Al: I haven’t either.
Joe: So 712. So there’s 7 asset classes consisting of 12 funds, I believe, is the 712.
Al: Probably, yep. With 12 different funds, all owned equally, 8.33% each.
Joe: With a 65% equity, 35% fixed income.
Joe: Got it. Okay. He’s “55, recently retired with $1,500,000.” Congratulations. “55, $1,500,000 portfolio and $53,000 annual spending need, including taxes. I like the 712 because of the diversification and simplicity. They use mostly Vanguard Index mutual funds, ETFs to build this portfolio. I put the highest risk reward funds in my Roth IRA in after-tax accounts and more conservative funds in my 401(k) since that is where I’m withdrawing most of my money, $40,000 from the 401(k) and $13,000 from my after-tax brokerage account at 0% capital gains. But I’m curious to hear your thoughts on this investment approach. Is it too diversified? Too many funds? Is equal weighting too simplistic? I appreciate you sharing your insights on this portfolio approach. Until next time, Sugar Mangolia.”
Andi: Magnolia. It’s a beautiful flowering tree from down South.
Al: What did you say? Mangolia?
Joe: Magnolia. All right.
Al: Got it. Just call her Sugar.
Joe: Sugar Magnolia.
Al: There you go. You got it.
Al: So what do you think of that investment approach?
Joe: It’s fine, totally fine. It’s super simplistic, and that’s okay. It’s diversified. It’s probably redundant. I don’t know how efficient it is. You know what I mean? So I like the approach a lot, to be honest with you.
Al: Yeah, because it’s diversified. That’s what I like.
Joe: Right. I don’t know. I guess it’s easy to rebalance if you know all right, I want 8% in each asset class or each mutual fund that I have. And so you could easily put a spreadsheet and say, okay, well, that’s at 9%, sell it and get it to 8%. And someone’s at 7% buy more to get it to 8%.
Al: Yeah, you know exactly what it should be. To me, the reason why I wouldn’t do it is because there are certain asset classes I’d rather have more of.
Al: I probably rather have more large company growth because that’s kind of more stability and I’d probably rather have less in treasury inflated protected securities which is a type of bond just because that’s pretty volatile. I might not want that much in emerging markets even though that’s a great asset class, super volatile. So I might not pick the same- But I will say this, it’s not a bad idea because what do most people do? They buy one or two mutual funds and they’re completely redundant and they think they’re diversified.
Joe: Yeah, or the opposite. They have 15 different funds and they’re almost identical.
Al: They got all the same stocks in them.
Joe: Exactly. Right. They all have different names and different companies and things like that. So that’s a super redundant strategy. Not diversifying. At least Sugar here is looking at all right, well I want 8% in small cap. I want 8% in large cap. I want 8% in international. I want 8% in emerging markets. I want 8% in large cap value, large cap growth, whatever. Because I guess there’s 12 different funds and I like that strategy if you keep it very low cost. Sugar is going to Vanguard which is a low-cost option. Sounds like Sugar is doing a little asset location by-
Al: – which we agree with.
Joe: – putting asset classes that give you a higher expected return in the Roth or the non-qualified account. But I don’t know if Sugar is doing so-
Al: No, I think it’s fine. Here’s what I would say. To me, it’s more important to be globally diversified and low-cost investments than it is how much you do in this fund versus that fund.
Joe: But I like your point Al, is that you want to cater to your specific situation depending on where you’re at in life and what you want to do. So let’s say that I was 55 even though I’m nowhere close to that age.
Al: You’re getting there.
Joe: I will have a lot more money- so my portfolio, because I want to work for another 15 years, not here, but somewhere where I enjoy going to work.
Andi: You want to consult.
Joe: Sell beer at the state fair.
Al: That would be good.
Joe: Looking at- I might have more funds that are small cap or emerging markets because I don’t want every fund to have the same percentage because that’s how you can gain a higher expected rate of return in your overall portfolio with the same amount of risk. So you want to tilt portfolios towards certain asset classes. So you could have actually more bonds or less bonds depending on how your portfolio is structured. Large cap growth is the safest stock investment but even though it’s very volatile and risky because it’s a stock but a large cap growth stock is a lot safer, quote unquote, than a small cap value stock.
Al: Yeah. It’s less volatile. It doesn’t bounce up and down as much. It is volatile, don’t get me wrong. But like emerging markets, typically is the most volatile. However, it often has the best rate of return when you look back 20 years.
Joe: So he’s retired or she’s retired, Sugar is retired, and I don’t know, taking money out of the portfolio- I don’t know if it’s a good strategy for this specific situation. Because once you’re retired and taking money from the portfolio, it’s a totally different ballgame there, too. And then one of the things that concerns me a little bit is that, okay, I have my safe investments in my IRA, and I’m pulling money from my IRA to live off of, and then I’m supplementing that with my brokerage account. Okay, well, maybe you should be looking at Roth conversions if you’re in the 0% or 12% tax bracket. And then if you’re pulling money from the brokerage account or eventually you’ll be pulling money from the Roth account, you don’t want to have your highest expected return. You need to have a more globally diversified portfolio based on your income needs and how you’re going to distribute the money from each of these different accounts.
Al: Yeah, I think that’s well said, because when you are in retirement, when you’re taking money out, probably your investments should be a little bit different. Your investments at 20 and 30 and 40 are probably going to be different than 50, certainly 60 and 70 and 80, when you’re starting to take the money out.
Joe: Right. Even if you retire at 55, if you have a retired person at 55 versus someone that’s continuing to grow their portfolio, let’s say they have the same risk tolerance, the portfolio needs to be set up differently on how they’re distributing the money and what is the tax strategy. Because eventually you want to pull money from all 3 accounts, your taxable, your tax-deferred, and your tax-free to keep you in the lowest tax bracket for life.
Al: And so that brings up another really good point, and that is when you’re distributing assets and if you are withdrawing from all 3 accounts, you need to have some safe assets in all 3 accounts, including Roth, including your non-retirement account, including your retirement account. So just be aware of that too.
Joe: Alright, Sugar.
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What the Hell Will a $1.5M Company Equity Event Do To My Taxes?
Joe: Go to YourMoneyYourWealth.com, click on the icon, Ask Joe and Al On The Air, and we will answer your questions when we get around to it.
Al: Yeah. No promise on timing.
Joe: No promise on timing. It’s funny. It’s ebb and flow. When the markets are a little volatile, it seems like people are scared. They don’t write in. And then when they kind of pick back up, then we get flooded.
Al: Right. And then we can’t get to them.
Joe: Then we can’t get to them.
Al: We got 3 questions, and then we got 25.
Joe: You got it. But we will read them all, unless they’re full of weird stuff that sometimes we get as well.
Let’s start right now. We got-
Joe: “Hi, Joe, Al and Andi. Absolutely love your podcast and look forward to every weekly episode. Originally, I started listening to one of the other retirement podcasts, which will remain nameless, which helped me understand the basics, but soon felt too simplistic. After a while, felt like continuing- after a while, continuing to ride a bike with training wheels.”
Al: Yeah. Too basic.
Joe: Take those off. “Plus it was a little too touchy-feely about feelings related to retirement, and that got old pretty fast.”
Andi: Well, now I know which one it is.
Joe: I could not listen to, like, 30 seconds of that.
Al: That touchy-feely? You and I have done this, where you go to workshops, and then they want to meet in small groups and discuss something. Like, how do you feel about retirement?
Joe: Tell me how you really feel, Al. No, how do you really feel?
Al: And then you and I decide- we picked that spot to go to the bathroom. Sorry. Really got to go.
Joe: Al and I got a really small group. We’re going to talk about how much we hate this. I don’t know who this is, but I guess Andi-
Al: Andi knows. Somehow.
Joe: Andi knows. All right, little touchy-feely. We don’t get touchy-feely here. We get flippant-
Andi: – and snarky.
Joe: – and snarky. Arrogant.
Al: Yeah. Sarcastic.
Joe: It’s like, understand your numbers, people. Jeez. Instead of ohhh, what are you going to do when you wake up in retirement?
Al: Yeah, that’s not our show, is it?
Joe: No, it’s not. I can see why it got pretty old. Well, welcome to the- welcome to the club here, sir. “I need a little more substance then found you guys. Holy crap. If the prior podcast was a primer, your podcast is like a graduate education.”
Joe: I learn so much even when questions don’t seem to apply to my situation. Joe, what really impresses me is that you can read a very detailed email question from a listener that includes way too much information, and let’s be honest, it’s obvious that you are seeing the email for the first time when you read it-”
Andi: No kidding.
Joe: No kidding. All right. So you do like to show. “- and you can distill it down to essential questions before being asked. It’s like you have some kind of magic filter and can get to the basic issues. So that is probably your superpower.”
Al: I agree with that. You are great at that.
Joe: Oh, well, thank you, Al.
Andi: Do you think that’s your superpower, Joe?
Joe: I don’t know. No, I don’t think so. I don’t even understand what he’s trying to- because there’s a lot of fluff, and I probably know where the question‘s going?
Al: You get all these numbers and comments, and you go right to the meat.
Joe: Got it.
Al: That’s one- that’s not your only- that’s one of your superpowers.
Joe: Right. “Anyway, I have a simple question, though I feel guilty for asking it. I work for a private company, not publicly traded. We have an option of being a part owner, and I have a number of shares of the company. The shares themselves are not particularly valuable, but we are in an industry in which equity investors have an interest. There’s a new equity investment deal every 5 or so years. So there is a new influx of cash to our company. And as a part owner, I stand a profit next time there is an equity event.” A little private equity.
Al: I like it.
Joe: So, private equity buying. So they flip every 5 years, it sounds like. “My wife and I are 62, hoping to retire at 65. We have approximately $2,000,000 in a variety of 401(k), brokerage accounts and old SEP IRAs. We do not yet have any Roth accounts, but hope to start converting soon. I would estimate our gross income could be about $225,000 per year. We have 3 children, two still in college, but college expenses are covered by prior 529 plan savings. We have about $100,000 balance on our mortgage, with about $500,000 in equity in our house. Really no other debt to speak of. My question is this, it is likely there will be a company equity event in the next year, it will probably net me around $1,500,000 or more.“ Oh, congrats. “Will likely be paid out in increments annually over 36 months. Then I retire and go fishing every day.” I was thinking about a little touchy-feely moment there.
Andi: Then he stamped it out.
Joe: “I know this is an unusual windfall situation, but I’m wondering, what the hell will this do to my tax situation?” Well, you already said it’s net $1,500,000 so he’s already calculated some sort of tax. “This will likely push me into the highest tax bracket over the 3 years in which my income will look particularly high. Are there any mitigation strategies I can consider to lower my tax burden over those 3 years? I do not think my company offers any kind of deferred comp which would allow me to spread it out over several years. Any help you can give would be appreciated. By the way, I drive a 2019 Tesla Model 3. Costs me around $50 a month to charge, compared to my wife’s $80 per week SUV. Have a recently neutered one-year old yellow lab, and I prefer a nice cabernet for my drink of choice.” Little cab guy. “Thanks for all you do and for the excellent information you provide, I learn something new every week. I recommend your podcast to all my friends and family. I’ve never seen your videos, but I listen to your podcast in my car.” All right, so let’s talk about taxes on his payout from a private equity firm that’s going to come to him over 36 months. $1,500,000 net. Just say it’s $2,000,000 paid over 36 months. It’s going to blow him up. What does he do?
Al: I’m going to say that net means net after closing costs on the deal instead of net of tax. But I’m going to assume it’s $1,500,000 gets set over 36 months. I guess the first thing is this is capital gain. It’s not ordinary income. So regardless of your ordinary income amount, capital gains sit on top of that. Capital gains get taxed either 0%, 15% or 20%. So based upon $225,000 year of salary, and let’s just say you get $500,000 over the next 3 years. So that will put you into a point where some of the capital gain will be taxed at 15%, but some at 20%. Yeah, there’s a 5% delta if you could spread it around a little bit more evenly. And then also, I’m not really clear, you say it’s your company? or are you investing it? If it’s your company, if you’re actively involved, if that’s where your salary comes from, then you don’t have to worry about that net investment income tax, which is another 3.8% tax on top of the 15% or 20%. If this is an investment, then you do have that tax. So actually it would be more like 19% and 24% versus 15% and 18%, roughly like that. But here’s a thought I have, which is, depending upon when the deal closes, maybe you only have half a year, where you get half of it, and then you have two years of full and then another year of half. So it may not be quite as bad as you think, for the reason that it may be spread out more than you think. Maybe kind of straddle 4 years instead of 3. And it’s capital gain, which is a lot better than ordinary income rates.
Joe: So straddle is what you’re saying.
Al: I like straddle.
Joe: Okay. Straddle. Straddle the payments to get over 4 years versus 3.
Al: Yes. And I think that will probably happen unless it closes, like, right at year-end.
Joe: January 1st or-
Al: – yeah.
Joe: Well, I guess some strategies that you can look at to reduce capital gains tax is that a capital loss will offset a capital gain, dollar for dollar.
So if you have a brokerage account that is not a retirement account, which I believe he does, and if you have losses within that account, you would want to sell those and buy something similar to capture those capital losses, which would offset the gain.
Al: Here’s another one. This is kind of out there, but you could-
Joe: – put it in a trust?
Al: Yes, if your company allows it, you could put it into a charitable remainder trust, and then when it’s sold, then that money will flow into the trust. There’s no tax to be paid because it’s a tax-exempt trust. You will receive a lifetime earnings stream. Yes, that will be taxable, but at least you don’t pay all the tax up front.
Joe: Let’s see, what else? You can do some tax credits? low-income housing? How about opportunity zones?
Al: Buy an electric car?
Joe: Yeah, we could buy an electric car.
Al: They’re changing the rules on that, although-
Joe: – but his income is too high.
Al: That’s right.
Joe: Opportunity zone?
Al: Yeah, could do that. We were going deep, aren’t we? Oil and gas?
Joe: Oil and gas. I was just gonna say that. Let’s see.
Al: And we’re not recommending any of those things.
Joe: We’re just talking.
Al: We’re just spitballing on things you could do.
Joe: Throwing up ideas.
Al: Throwing up is right.
Can We Invest in Our Hobby Farm at a Loss and Convert 401K to Roth to Offset Tax on Huge Liquidity Event?
Joe: “Hey guys, first time caller, long time listener. I’m 36, happily married to a former pageant hottie-” Wow, okay. –“and 3 kids living in Lincoln, Nebraska.” Boom. Congratulations. “We had a fortunate liquidity event in 2021 where I sold 50% of my shares in a tech startup. Overnight we went from having $400,000, mostly “lore” tax-“
Al: – pre-tax-
Joe: “- in retirement accounts to $2,000,000 investable total, with 50% of shares still invested. Income is about $120,000, which is in the financial services industry.” So this guy’s got a pageant hottie, just sold 50% of his company for $2,000,000.
Al: That’s right.
Joe: The guy’s 36, living large in Lincoln, Nebraska.
Al: Can you picture it?
Joe: I can picture it now. You got to just visualize so you can help these people with their financial spitball here. All right. I just can’t wait to see what he drives. I just bought a Ferrari. Okay. “We have a startup hobby farm that is starting to show a little profit.” Of course it is. There’s nothing that goes wrong in this guy’s life.
Al: Just trying to lose money to save taxes.
Joe: I’m trying to save some taxes, and next thing you know I killed it again, another $5,000,000. And by the way, I got a side little pageant hottie- “-start showing a profit, but we have lots of capital investments needed to make the farm grow. We need a tractor, we need a barn, etc. My question is if we could look at a tax strategy where we invest into our active farm business, resulting in a significant loss and simultaneously convert all or portion of our pre-tax 401(k)s at more advantages- more advanced-“
Andi/Al: – advantageous-
Joe: Oh, my God. Am I half- just mentally ill?
Al: It’s because of your broken toe. You’re not thinking clearly.
Joe: I can’t even read. And people write in every week for us to give them some sort of-
Al: – and they always pick long words.
Joe: “-advantageous marginal tax rate.”
Al: There you go.
Joe: All right. “I drive a 2015 Chevy Silverado.
Al: That’s getting upgraded.
Joe: Yeah. There you go. “And Michelada.” Yeah, Midwest. I guarantee he has a fridge in his garage as well.
Al: Got it. Yep. Probably So.
Joe: So Hobby Farm.
Al: So the question is, I’m making a lot of money. Can I set up a farm and buy a bunch of capital equipment, take a big write-off, and then I got loss now, then I can do Roth conversions. I like the idea. The idea is to create tax deductions so you can do Roth conversions, net them together to where you pay very little tax, if any. So here’s the problem with that, and that is a capital investment is not necessarily deductible when you purchase it. Like a tractor, a barn, these are capital assets. You have to depreciate them. So a tractor’s probably over 5 years, I’m guessing. A barn would be probably 27 and a half years. So you get to take a little piece of it each year. Now there is bonus depreciation, and honest to God, it changes every year. So I’m not even going to try to tell you if there’s bonus depreciation in this year, but check that out, because you might be able to get extra right off there. If you’re buying stuff like farm supplies or things like that, you can write that off. So you can create a loss. And that loss, as long as you have a profit motive, which you do, you’re already making a profit. Then, yeah you can take that against other income and do a Roth conversion. But just be careful. You can’t just buy a whole bunch of capital equipment and expect to write that all off.
Joe: Because he’s thinking a tractor is going to cost a pretty penny.
Barn is going to cost me a lot. Maybe I can go dollar for dollar. Write it all off.
Al: Yeah, right. It’s a great idea, but it doesn’t quite work that way.
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Backdoor Roth, Contributions, Conversions, and Income Limits Explained (Nancy, WI)
Joe: This question came in from Nancy from Wisconsin. Nancy writes us every week it seems like, Al. Or maybe there’s a Nancy that’s multi-
Al: Maybe there’s a few of them.
Joe: Well, I guess Nancy is a pretty common name in Wisconsin.
Al: Probably more than one Nancy in Wisconsin.
Joe: Probably. “Hi, Joe, Al and the great and powerful Andi.”
Andi: Wow. Thanks, Nancy.
Joe: “Regarding podcast 391-“ remember that one?
Al: Yeah. 23 minutes in-
Joe: It was so good.
Al: That seemed like just yesterday.
Joe: What a great show that was. “32 year old Mike said he made his Roth $6000 contribution through a backdoor conversion. Maybe I’m off base here, but I wonder if there is some confusion related to the conversion in contribution terms. His income for a contribution was too high for a direct Roth contribution. However, if he is converting to a Roth IRA, that’s a different story. And he should not mark it on his taxes as a contribution because it’s a conversion. The $6000 limit is also for a contribution, but not a conversion. For Mike’s sake, in case there’s confusion on the terminology, can you explain the difference between Roth contributions and their limits income and contributions compared to a Roth conversion with limits income conversion, not contribution. Thanks, Nancy.” Nancy, I believe if I could just go back in time to podcast 391.
Al: You remember that, right?
Joe: 22 minutes in, 54 seconds. I would imagine that 32-year-old Mike was doing a backdoor Roth contribution is what the terminology is, the mega backdoor, the megatron, the barndoor, backyard, whatever. It’s a conversion. But he’s making a contribution to a non-deductible IRA.
Joe: And then he’s converting the non-deductible IRA to a Roth.
Al: And people just seem to call that backdoor Roth contribution. I mean, that’s just what it’s called. But it’s two different things.
Joe: So he is making a contribution to an IRA. He’s not making a contribution to a Roth IRA. He is not allowed to take a contribution to a Roth IRA because he doesn’t qualify. Because there’s income limits. As a single taxpayer, the income limit is-
Al: $129,000 is where that starts phasing out.
Joe: So $130,000. So if you have more than $130,000, then you can no- or you’re phased out- what’s the top?
Al: The top is $144,000. So in other words, if you make, as a single person, if you make more than $144,000 of income, not taxable income, of income, then you’re phased out of being able to make a direct contribution to a Roth. Otherwise, you could do $6000. If your income is below $129,000, you could do a $6000 contribution directly to a Roth and $7000 if you’re 50 and older.
Joe: And if you’re married-
Al: If you’re married, the phase out starts at $204,000 and goes to $214,000.
Joe: Okay. So that’s income limitations for Roth IRA contributions. What Mike was doing is he was still making a contribution. So he can still make the $6000 contribution or $7000 contribution, but he’s not going Roth, he is going into an IRA.
Al: And that’s allowed to anybody regardless of income level, as long as you have earned income. Or if your spouse has earned income, you can use that, too.
Joe: Perfect. So he’s making an IRA contribution of $6000 and then what is he doing after he makes that contribution is converting that contribution into a Roth IRA. There is no income limitations to convert. There is no dollar figure that’s limit to convert. So if you want to convert $1,000,000, you can. If you make $1,000,000, you can still convert $1,000,000 if you want to. You’re just going to pay the tax on whatever you convert. In this scenario, he already paid the tax on the contribution because it was an after-tax contribution, because he was not allowed to take the deduction. So he paid the tax, made an after-tax contribution and then turns around and converts it into a Roth. There is no tax on the conversion, and it’s just called a backdoor Roth contribution. But it is a contribution and a conversion in the same sequence or same strategy.
Al: And it’s just a workaround for avoiding those income limitations. And it’s the same net effect. You get that $6000 into the Roth IRA. It’s just a two-step process. Realize though, if you have other IRAs, doesn’t work so well. Because you got to treat all your IRAs as one. And now when you convert, you’re going to have some of it is taxable and some non-taxable, depending upon the ratio of that $6000 to everything else you have in the IRAs.
Joe: Yeah, the pro rata and aggregation rules. I think we were just talking with Mike on podcast 391 that he did not have any other IRAs.
Al: Yeah, the other weird thing is 401(k)s do not count in that computation, nor does a 403(b), TSP. So it’s only IRAs that count, and inherited IRAs do not count either. That’s a separate type of account.
Joe: We got a question coming in here, it goes-
Should We Convert $12.5M in IRAs to Roth? Retired, $100K Pensions, $205K Income (Frank, San Diego)
Joe: “Hi, Joe and Big Al. My wife and I are both currently retired. We live in San Diego.” All right, little neighbors.
Joe: “Both of us have pensions that net around $100,000 each annually.” Jeez, big baller there.
Joe: “My IRA is $11,000,000-“? or $1,100,000?
Al: He says $11,000,000.
Joe: Look at this guy. “$-11,000,000 and my wife has $1,500,000 in hers. Our combined taxable income is $205,000. Does it make sense to roll over any of these assets to a Roth rollover? Appreciate your time. Thank you. Frank from San Diego.” What do you think there, Big Al?
Al: Well, we could use a little more information, but with what little we know, that’s a lot of money in an IRA, and your required minimum distributions are just going to keep getting higher and higher. I don’t know how old you are, but at age 72, roughly 4%, we’ll add the two together to call it close to $13,000,000. 4% of $13,000,000 is- whatever-
Al: $550,000. Whatever. Anyway, that’s a big number. It’s going to keep you in very high tax brackets-
Joe: On top of the $200,000?
Al: – so I would be converting right now based upon what little I know. Because you’re going to be in high brackets anyway, so why not get some of it out? While we’ve got actually a little bit lower brackets until 2026, and then you’ve got more tax diversification later.
Joe: Without question. He needs to look at what tax bracket he is right now, what tax bracket he’s going to be when RMDs hit, what tax bracket he’s going to be when the Tax Act reverts.
Al: Goes back.
Joe: And then you have to look at the heirs. Is he charitably inclined? How much money does he want to give the charity? Because you could do QCDs and you could give up to about $100,000, but it’s still RMDs are going to be $300,000, $400,000 on top of the $100,000 that you can do as a charitable gift. Then you want to look at the kids’ tax situation, because they’re going to have to- let’s say he and his wife pass tomorrow, God forbid, I would never want that to happen to you, Frank. But then the kids have to take the money out in 10 years. You take $13,000,000 out in 10 years. Now the kids are going to have to take out $1,000,000.
Al: Yes. And if there’s only one kid, that’s $1,000,000 plus per year.
Joe: And that’s ordinary income.
Al: Right. Think about that and then also think about- since you brought up passing, so one of you may outlive the other one, and then the survivor will be in the single bracket, which is a lot lower still. So consider all these things. You probably do want to convert, but we need a little more information to know whether it makes sense. It probably does, but as to how much, I don’t know.
Joe: Well, congratulations, first of all. Very successful. And that’s a lot of money in the retirement account.
Al: It is.
Joe: He only really has half of that because half of it is going to taxes.
Al: Yeah, typically that happens when you’ve got company stock in a 401(k) and it does well. Does quite well.
Joe: All right, let’s move on.
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Mom Passed, Her 401K is Still at Vanguard. How Can Dad Avoid a Tax Bill? (Anonymous)
Joe: “Hey, tried to send this on your website, but can’t tell if it went through.”
Andi: It didn’t.
Joe: Probably didn’t. Website sucks.
Al: That’s why we’re finally getting to it now.
Joe: Yeah, he sent this in 3 years ago. “My mom died unexpectedly 12 years ago.” So my mom died unexpectedly 12 years ago. Isn’t unexpectedly like recent? Not 12 years ago? or like it was 12 years ago?
Al: Well it was unexpected at the time.
Joe: Got it. We got this email 12 years ago.
Al: When we first started the company.
Joe: We’re getting to it now. “She died without a will. She was estranged from my dad, but not divorced. I didn’t have a good relationship with my dad either. In the last 6 years, we have reconnected.” Okay, positive.
Al: Cool. Touchy-feely.
Joe: Very nice. “He received a letter that my mom’s 401(k) is still at Vanguard. My dad is 72 and doesn’t need the money and doesn’t want it to get hit with a tax bill. What should he do? Can it remain unclaimed? My drink of choice is Coca Cola or Titos and Soda. Cheers. Looking forward to the spitball. Signed-“
Al: – anonymously.
Joe: Thank you very much. Okay, so a couple of things. Mom passed.
Al: 12 years ago.
Joe: Still married to dad. Son and dad didn’t get along. Now they reconnected. Dad is having a little Coca Cola or some little Titos and soda with son and said, hey-
Al: What should I do?
Joe: – got this letter from Vanguard saying your mother’s 401(k) is still at Vanguard. So because he’s still married, or is married to your mom, there was no divorce, that he has a spousal rollover. So I’m not sure how old mom would be today. So you can keep it in Mom’s name, and he would have to take a required distribution when your mother would have turned age 72. Or dad can just roll it into his own IRA. You can do that, no big deal. Now he just has extra dollars in his. But he’s 72, so he would have to take an RMD. There would be no tax on the whole thing.
Al: Right. I think that’s the concern and that’s right. It just can be- either way, there’s no tax until you take money out. And you have to take money out if it’s in your account at age you’re 72. If it stays in his deceased wife, then it would be her age 72, right? Or would have been.
Al: Had she got to age 72.
Joe: Then the RMD would have to come out of that account as it’s still titled in his mother’s name.
Al: Just as a side, when you inherit an IRA, or any asset for that matter, you can disclaim it, but you have to do that within 9 months after date of death. So that’s passed.
Joe: So put it in Dad’s name, Dad would have to take an RMD. Keep it in Mom’s name, he would have to take an RMD. He could then gift the RMD to you.
Al: Yeah, that’s the best answer.
Joe: If you’re thinking, hey, can he just unclaim this and I’ll take it? That’s exactly what he’s saying.
Al: I know that’s what he’s thinking. Or her.
Joe: Or her.
Al: But yeah, we’ll say he, so that’s probably what he’s thinking. So Dad takes the RMD, pays the tax on it, whatever the net is, gifts it to you. Same impact.
Joe: Yep. That’s the plan.
What Happens to Our Retirement Accounts When We Pass? (Butch from the Bait Shack)
Joe: We got “Hello Andi and the guys.”
Joe: Hey, what’s up? “I’ve been following your podcast for a long time and really enjoy listening to it while I’m killing time.”
Al: Right. Because there’s nothing better if-
Joe: I suppose if you got to kill time, you can listen this garbage. “By the way, my name is Butch and I have a question about how investment assets should move from a deceased spouse to a surviving spouse. My wife and I both have Roth 401(k)s, Roth IRAs, and taxable brokerage accounts, all at the same low-cost investment management firm. We are each other’s beneficiary, and we have no kids. So when that day comes, I imagine that the taxable brokerage account would just flow to the other’s taxable brokerage account. But would the Roth 401(k) and Roth IRA flow to the other’s Roth IRA? Or do we need to go into a separate inherited Roth IRA instead? Thanks a lot. And keep up the grand information. Butch from the Bait Shack.” All right, cool. “I drive a 2020 Toyota Highlander, manufactured in Princeton, Indiana.”
Al: Yep. In the US. Okay.
Joe: Manufactured in Princeton, but it’s a Toyota.
Al: Yeah. They have plants here in the US.
Joe: Got it. So you think he was like-
Al: He wanted to make sure he didn’t buy a product-
Joe: – in Japan.
Al: -in Japan.
Joe: Got it.
Al: So you just answered this question. So maybe you can recap.
Joe: Sure. You can do one or the other. Butch from the Bait Shop here didn’t give us their ages, but let’s just assume that him and his wife are the same age, then it’s irrelevant. It doesn’t necessarily matter. You could keep it in her name, or she could keep it in your name because you’re the same age. Why you would want to either roll it into your own or keep it in the deceased spouse name is if that deceased spouse passes- or if you’re under 59 and a half. Because let’s say you prematurely die, then you have access to the dollars if you keep it inherited IRA. So I’m married, and let’s say my wife passes, and I would be like, all right, well, I want access to her 401(k). So I would keep it in her name as an inherited IRA for the benefit of me. And I would be able to take distributions from that account without incurring a 10% penalty. But it sounds like Butch from the Bait Shop is older than 59 and a half.
Al: Could be. It doesn’t say.
Joe: So then you look at an RMD play. So if you’re the same age, well the RMD is going to be the same regardless, because the deceased spouse is going to have to take an RMD based on their age 72. And if you’re 72, the RMD has got to come out of the deceased spouse and then plus yours. So if you combine the two accounts, it doesn’t matter. It’s going to be a lot easier to manage the RMDs that way because you have to take an RMD out of both accounts. And if you don’t, it’s a 50% penalty. What’s all that noise? What are you doing there?
Andi: I think Aaron is actually moving files around.
Joe: Dude, why are you moving files around while we are taping a podcast. Please stop.
Al: He’s trying to be efficient with his time.
Joe: Yes, he’s just like, multitasking here.
Al: Because he used to listen to our show-
Joe: – and now it’s like, all right, well, here let me-
Andi: He’s killing time.
Al: Yeah, he’s killing time.
Joe: He’s killing time here. He’s killing me.
Al: Anyway, the only reason that you’d want to have one or the other is if you’re different ages. And then there’s pros and cons on both. If you’re the same age, just roll it into your own IRA or Roth and just call it good.
Joe: And the brokerage account, depending on how it’s titled, if it’s joint, then it just goes into- the other’s deceased. But it sounds like- if it’s separate property, then you might have-
Al: It would still go to your spouse.
Joe: Would you get a half step-up or full?
Al: If it’s a community property state, you get a full step-up. So Indiana, I do not believe is a community property. So he or she would get a half step-up.
Joe: So I would make sure the brokerage account is titled correctly as joint or in your living trust.
Andi: Just keep in mind that’s just where the Toyota was manufactured, that’s not necessarily where Butch’s Bait Shack is.
Al: Well, good point.
Joe: Yeah, I would imagine Butch’s Bait Shack is probably not in Indiana.
Al: Well it might be. They got-
Andi: That’s what I was thinking.
Joe: – lakes-
Al: – lakes and rivers.
Joe: All right.
Al: Could be.
Joe: Okay. Aaron, you want to do some more work and make some noise? Are we good?
We are good indeed. Stick around for the Derails at the end of the episode to be completely misled about what the three of us look like, and then check out our YouTube channel to see the truth.
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