What will you actually need to spend in retirement? Joe and Big Al explain how to really think about and calculate your retirement expenses. Plus, if you want to reduce your tax-deferred account balances, does it make more sense to do Roth conversions or reinvest? What about doing Roth conversions to a higher tax bracket than the one you’ll be in during retirement? Also, the fellas explain the alternative minimum tax, how Social Security spousal benefits work, and when in the year you turn 72 you must take required minimum distributions from your retirement accounts. And finally, what should someone with no credit history, who hasn’t paid taxes, do with a sudden $100,000 windfall?
- (00:55) How to Forecast Expenses in Retirement (David, Huntsville, AL)
- (09:45) Convert to Roth or Reinvest to Reduce Tax-Deferred Accounts? (Sunny D, AZ)
- (16:25) IRMAA: Does it Make Sense to Do Roth Conversions to a Higher Tax Bracket Than in Retirement? (Chris, Straight Outta Austin)
- (33:24) Alternative Minimum Tax (AMT) Explained (Smitty from the Villages)
- (36:29) How Much Social Security Benefit Will My Spouse Receive? (Gus, Philly)
- (39:47) When in the Year You Turn 72 Must You Take RMDs? (Ricky, AL)
- (41:02) No Taxes Filed, No Credit History. What Should Son-in-Law Do With $100K? (Karen)
- (47:50) The Derails
Free financial resources:
DOWNLOAD | End of the Year Tax Strategies Guide
What will you actually need to spend in retirement? Today on Your Money, Your Wealth® podcast 406, Joe and Big Al explain how to really think about and calculate your retirement expenses. Plus, if you want to reduce your tax-deferred account balances, does it make more sense to do Roth conversions or reinvest? What about doing Roth conversions to a higher tax bracket than the one you’ll be in during retirement? Also, the fellas explain the alternative minimum tax, how Social Security spousal benefits work, and when in the year you turn 72 you must take required minimum distributions from your retirement accounts. And finally, what should someone with no credit history who hasn’t paid taxes do with a sudden $100,000 windfall? I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson CFP®, and Big Al Clopine, CPA.
How to Forecast Expenses in Retirement (David, Huntsville, AL)
Joe: All right, we got David from Huntsville, Alabama. “Hello, Big Al, Joe, Andi. I have a few questions about forecasting expenses for retirement. If you still have a decent time horizon, 10 years in my case, before you retire, how do you factor in reduced future spending into your plan? For example, my wife and I spend just under $22,000 for principal and interest payments on our home that will be going away in a few years. We also have other expenses for children, food, clothing, family premiums for coverage for health care, dental, vision, et cetera. All of those things will go away when we hit retirement. How do you account for those things when thinking about planning? Also, caught Episode 402, hell of an episode.”
Al: It was, I think.
Joe: What number are we on now?
Al: That was a recent one, right?
Andi: Yeah. By the time this airs, this will probably be like 405. So this is very recent.
Joe: So we’re past 400.
Andi: Oh yeah.
Joe: Did we have a celebration?
Andi: The celebration was answering more questions.
Joe: Got it.
Al: We’re actually waiting for 500, Joe.
Joe: Got it.
Al: Then we’re just going to be all out bash.
Joe: I don’t know if we’re going to be around.
Al: That’s debatable. I agree.
Joe: Just a lot of weeks. Yeah, that’s like two years.
Al: A couple years. You want to do this another two years?
Joe: I don’t think so. Well, it’s up to our listeners if they want us to keep plowing through, I guess we’ll plow through these. I don’t know how many more. I think we’ve answered just about every question in the book. I don’t know, some of them not so great, but we gave it a shot.
Al: We gave it a shot. And we usually say we don’t really know what we’re saying, so take it for a grain of salt.
Joe: So back to episode 402 here. “I heard the Roll Tide Big Al comment. I chuckled as I’m a proud alum of the University of Alabama. Big Al is the name of the mascot for ‘Bama.”
Andi: Now it all makes sense.
Al: I thought it was me. Okay.
Joe: Got it. “I drive an old Toyota truck. And my drink of choice is a large cup of coffee. Thanks for all the comments and suggestions you have for helping me think through the expense consideration for retirement plan. David.” Cool. Alright, I’ll take a crack and then Al, why don’t you kinda wrap it up?
Al: Okay, like it.
Joe: This is what we do for clients anyway, is that you have your standard living expenses and then you have your mortgage and then you have ancillary expenses from there. So let’s say if you have children expenses that, you know, it’s like, hey, there’s sports or there’s daycare or there’s whatever-
Al: – or college.
Joe: College expense. So you kind of line-item that out, put it on a spreadsheet. So your main living expenses, let’s call it, is $100,000 a year. Your mortgage is $20,000 a year and then another $20,000 for kids’ expense or ancillary expense. And then you just take that because you have to use an inflation factor on some of this stuff. Like your living expenses are going to grow with inflation. So you call it 3%, 6%, 2%, whatever you want, and then you run that line item out on your spreadsheet. But the mortgage does not increase with inflation, because that’s a fixed rate and that’s going to drop off. And then your kids’ expense will grow with inflation, but they will drop off at certain times depending on how old your kids are. So then when you’re at retirement, you have just your straight living expenses. So you just line-item it out. You could bucket into like two or 3. Some people go nuts and they have a full line-item of everything that they spend. I mean, depending on how detailed he is, you can do it either way. But I think that’s at first blush, that’s what some ideas that I have.
Al: Yeah, that makes sense to me, too. So using your example, Joe, $100,000 is living expenses. That’s real easy. Just have whatever inflation rate you want. If you don’t know what to pick, maybe pick 3% just as a starting point, 3.5%, 2.5%, whatever you want, but maybe 3% as a starting point. And then you’ve got the other $20,000 for principal, $20,000 for kids, and both of those will drop off. Right. So are the kids going to be out of college by the time you retire? Then great, you can drop that off. Although we do know that kids tend to come back, and there are extra expenses there- from personal experience. And Joe, I’m going to be interested to see how this all works out for you, too, because you gave me a lot of trouble on that. But nevertheless, yeah, that’s exactly what you do to figure out what the expenses are. So once you got that, then you might even take it another step, which is, do I want to spend more in retirement? Less? A lot of times you read financial planning articles and they say, oh, you can only spend about 85% of your income, or whatever. Maybe. In our case, a lot of the people that we help spend more because they have more free time, more time for leisure, more vacations, more- better cars, fix up the house, whatever it may be. Vacation home. So just factor that in. Are you going to be spending more or less, but start with your current spending, inflate that with an inflation rate that you’re comfortable with. I think, Joe, probably a 100-year average is probably between 3%, 3.5%, something like that.
Joe: Right. Some people really get in the weeds here. It’s like, I’m going to save money in gas because I’m not going to be driving to the office. Right. You just gonna stay at home?
Al: Right. I’m not going to have suits. You ever going to go to a wedding? I think you probably have a few.
Joe: How about yeah, a couple of others- You’re not going to pay FICA tax, payroll tax. You’re going to save money there.
Al: You’re not going to fund your 401(k).
Joe: Not gonna save anymore.
Al: Right. But I kind of think of your spending is kind of your net pay anyway. That’s kind of your starting point to give you an idea of what you’re spending. And then are you saving more on top of that or spending less? We have to draw on the savings, or worse yet, drawing off your credit card.
Andi: But then don’t you also have to take into account the increase in healthcare expenses in retirement as you get older?
Al: You do. Yes. Especially if you retire before 65 and Medicare.
Joe: Yeah. You got private health insurance. I mean, that’s a killer. I think, like, what Al says, most people spend a little bit more. But I’m glad David is at least doing an exercise because most people have no clue what they spend.
Al: That’s exactly right.
Joe: And they go into retirement completely blind. Yeah, I think we’ll be all right.
Al: Well, I mean, how many times have we had people come to our office? I’m spending $3000 a month. Okay. I think it’s $36,000 for the year. I’m thinking property taxes in California is 1/3 of that already. But you don’t say anything. And then you look at what they’re making, $150,000. Okay, cool. And then you look at what they’re putting in a 401(k), taxes. Maybe they’re netting $90,000 or $100,000, whatever the number is- netting $100,000. Okay, so you got $100,000 leftover, you’re spending $36,000. All right, so you’re telling me you’re saving, I don’t know, maybe $65,000 a year, right? Maybe $5000, $6000 a month. Does that sound right? Well, no, we don’t have any money. OK, well, simple math. You’re not spending $36,000. But usually when that happens, people come to us. They got their mortgage or rent, they’ve got their food and they’ve got their utilities and they forget everything else. Maybe they don’t even have their food. It’s like during the holidays, ever buy presents? Oh, yeah. Ever buy clothes, does that come up? You ever go on a trip? You ever drive your car? Do you have a car? Got to fix it up?
Joe: Do you have insurance?
Al: On and on. You got cable? You got a cell phone? Or is that free?
Learn about 6 common retirement blind spots that can sabotage your financial plan: watch the Retirement Blind Spots episode of Your Money, Your Wealth TV show and download the companion Retirement Blind Spots Guide from the podcast show notes – just click the link in the description of today’s episode in your favorite podcast app, then find all the free financial resources right above the episode transcript. Next, learn to calculate how much you really need to spend in retirement and create a financial plan you can rely on when you click Free Financial Assessment there in the podcast show notes and schedule a free, comprehensive deep dive into your entire financial situation with an experienced professional on Joe and Big Al’s team at Pure Financial Advisors, a fee-only fiduciary. Then, do us a favor and spread the word: share Your Money, Your Wealth®, all the financial resources, and Pure’s financial assessment with your friends and colleagues.
Convert to Roth or Reinvest to Reduce Tax-Deferred Accounts? (Sunny D, AZ)
Joe: “Greetings, Andi. Hello, Dynamic Joe. And Steady Al.
Al: Steady. Steady as she goes.
Joe: “This is Sunny D from Arizona.” I remember Sunny D.
Andi: Sunny D has emailed us before, yeah.
Joe: All right, here’s his question. “Should I transfer funds from my traditional IRA to Roth?” I believe is what a TIRA-
Al: TIRA? I got a TIRA and I want a Roth.
Joe: All right, “Here’s the situation. $250,000 plus dividends plus capital gains, minus standard deduction puts me at the top of the 24% tax bracket. For 3 years, ages 69, 70, 71, my income, excluding dividends and capital gains, will be zero. My goal is to reduce the tax-deferred accounts, and I see two options. Transfer $250,000 a year from my traditional IRA to Roth IRA and use cash to fund 3 years of annual expenses, which are about $150,000 a year. I do have funds, in case there’s a doubt.” Who’s doubting?
Al: Well, he didn’t say what they were, so he’s telling you he’s got plenty of money for his living expense and taxes.
Joe: You think Sunny D is a male?
Al: I did say he.
Joe: Andi, what’s your vote? I think Sunny D is a female.
Andi: I have no idea. It does say we- while my wife prefers H2O- so that seems more likely that it might be male.
Al: I’m right.
Joe: Yeah, you’re right. Okay.
Al: Well, probably not necessarily.
Joe: “Withdraw $250,000 a year from my traditional IRA and invest $100,000 not spent in the market. The two accounts will result in the same IRA balance, which is currently high at the end of 3 years. The advantage of strategy one is that the Roth investment growth tax-free. But the disadvantage is the inherited amount must be withdrawn within 10 years. The advantage of strategy two, is there is no withdrawal time limitation, and the after-tax investments grow in perpetuity, while the disadvantage is there will be capital gains tax at 20%. The assets will be inherited by our 3 children, who are doctors, so in the highest tax bracket and have no need for the funds. It is our high likelihood that the inherited assets can stay invested for longer than 10 years. Would love to hear your spitball on the two strategies. We have a Lexus 350 and a Mazda CX5.” CX5? That must be like a SUV?
Al: Be a good guess.
Joe: Yeah. “Enjoy traveling. So the cars are rarely used. The Lexus is 4 years old and it has 7000 miles on it.”
Andi: That is rare.
Al: That’s unusual.
Joe: “My drink of choice-“ that’s like my mother. She still has like a PT Cruiser that has like, 400 miles.
Al: She still has that one?
Joe: I think now the bottom rusted out on it.
Al: Yeah. In Minnesota.
Joe: In Minnesota, the salt. All right, so let’s see. “My drink of choice is a 16-year-old single malt.”
Al: That’s been aged.
Joe: Yeah, like that. So he likes a little splash water with them. “My wife prefers a little H2O. Pets are no longer in the picture due to our travel.” You rather travel and take care of the pets, so let’s go.
Al: Yeah. Pets are gone. “Would not be right if they spend 6 months in the kennel?” I agree. “I’ve been a listener for 4 years, and I’ve recommended your podcast to family and friends.
Andi: Thank you. Sunny D.
Joe: “Great work. The humor and mispronunciation, which, while intentional, is amyousing.”
Al: Yes. It’s spelled wrong.
Joe: Okay, so he’s going to transfer $250,000 a year from his traditional IRA to a Roth IRA.
Al: Yeah, that’s the one choice.
Joe: And he’s going to use cash to fund 3 years of annual expenses. So he’s got a little cash outside of the retirement accounts. He’s got a lot of money in the retirement accounts and he’s thinking a full transfer play to the next generation with some of this money. But the kids are docs. Big stock there.
Al: Yeah, right. Get stock there. But he’s worried about the 10-year distribution upon inheritance.
Joe: So then he’s like, all right, well, I’m going to withdraw $250,000 and just invest $100,000 because he needs $150,000 to live off of. So instead of transferring it into a Roth IRA, he’s going to take it, pay the tax, spend it, reinvest the other $100,000, keep them in the top of whatever 24% tax bracket. Which do you like better there, Big Al?
Al: There’s no choice here, the first one. And here’s the reason why. Don’t worry about your kids not keeping the investments. They can actually do their distributions from the Roth into a non-qual and have it still invested in-kind. You can have the same investments. The Roth just ensures it’s going to be tax-free for quite some time.
Joe: It’s going to be tax-free for all of Sunny’s life.
Joe: There is no required minimum distribution in a Roth IRA. So he’s converting now into a Roth. It’s going to compound tax-free for Sunny’s life. Then it’s going to compound tax-free for his wife’s life because she’s going to live a lot longer. Because she’s like you, Al, drinks H2O. I’m like Sunny and I’m going to start drinking single malt scotch.
Al: Yeah, there you go.
Joe: Is there a double malt? If there’s a double malt, I’m drinking that.
Al: No, but you can have two single malts.
Joe: Alright. So yeah, because then you get the compounding tax-free growth instead of if he takes the money out and reinvests into a brokerage account, there could be capital gains, there could be distributions, there could be all sorts of taxes along the way where he’ll never ever pay taxes on those money again. And then when he passes, or when the wife passes, the kids can still stretch 10 years tax-free.
Al: Right. Yeah. There’s no question. And then it can go out to the non-qualified. They don’t have to spend it, it just has to be distributed. And then you’ve got, let’s see, Sunny is probably 68 or 69. So Sunny, you probably got 25 years or more of your life. And if your wife outlives you right? And then-
Joe: You know the exact date?
Al: I do. You got till 92. I’ll put it this way, you and your wife have a life expectancy to 92. I do know this because that’s the midpoint on couples.
Joe: Got it.
Al: Yup. But then the kids get another 10 years tax-free. Right. So there’s no question here.
Joe: Yeah. Compounding tax-free is a lot better. So, Sunny, thanks for the write-in.
IRMAA: Does it Make Sense to Do Roth Conversions to a Higher Tax Bracket Than in Retirement? (Chris, Straight Outta Austin)
Joe: Keep your emails rolling in, folks. YourMoneyYourWealth.com. Click on Ask Joe and Al on the Air. We’ll answer them at some point, unless they’re a novel.
Andi: In which case, you might anyway.
Joe: We got something special here right now.
Al: I think we got a 4 page-
Joe: We got a little 4 pager. That’s a record.
Al: It’s not our preference, but we’ve got two segments open, so let’s go for it.
Joe: All right. “Hi, Andi, Joe, Big Al. It’s Chris straight outta Austin.” Buddy, Chris, how’s it going, bud? “Still riding around that 2001 lower Dodge Dakota. And I’m not hitting the food truck scene as much as I used to. I find this working from home thing takes more time commuting into the office.”
Andi: More time than commuting into the office.
Joe: Got it.
Al: So he’s spending more hours working at home.
Joe: God, he was a food truck pickup artist. “Don’t think I’ve ever named my choice of poison. Let’s fix that. I like to throw back an Apple beer, the original non-alcoholic, when I special order them. Like them from the heard of the high carbonation-“
Andi: “For the head and the high carbonation-“
Joe: This is going to take forever. I’m nervous about this email, and that’s why it’s blowing up. “I also occasionally enjoy Moscow Mules made from Gosling ginger beer for a nice little burn.” So if he’s going to get funny and sarcastic and all this stuff, then it’s going to all blow me up, because then I’m going to miss the jokes. Let me do the jokes.
Andi: That’s alright, we’ll help you.
Al: Yeah, we’ll do our best.
Joe: All right. “So I’m sitting down listening for a few of your edge-of-your-seat thrilling episodes that keep me thinking about retirement planning and readiness, when you made me realize a situation that’s been covered in pieces but has a twist that I’d like to hear your professional spit balling on. I admit this is long because I put a lot of thought into it over a good period of time. So it may not qualify for a YMYW podcast, but I’d still like to hear from your thoughts, even if you rip it a new one.” Rip it a new one. All right. I’m already ripping this thing a new one. “Of course. It’s all about Roth conversions. I’m resurfacing the discussion, Big Al and you. Joe, has mentioned a few times it doesn’t make sense to convert to a bracket that’s higher than you’ll be in retirement. On the surface, that makes sense. But what about those unique cases when you have, let’s say, $3,000,000 in IRA accounts and even aggressively converting into 24% tax bracket for the next few years and still leaves you in a vulnerable high tax bracket for your RMDs? Let me introduce you to the fictitious married couple. One, who is 66, is still working and plans to retire in early 2023. His wife, Twosy-“ Oh, One and Twosy?
Al: I think later he talks about One and Two.
Joe: “-Twosy is older than One, so is already retired and drawing Social Security. Twosy has no 401(k) or IRA accounts, so RMDs are not a concern for her. However, her IRMAA is being affected by One’s yearly Roth conversions.” So Twosy is paying a little bit more in Medicare premiums because-
Al: and One is making money and wants to do conversions.
Joe: Got it. “One has been faithfully making the 401(k)s for years. When he left his job, he’s moved the 401(k) to an IRA after listening to YMYW podcast. One got concerned about taxes in retirement and realized he had incurred $2,800,000 in traditional IRAs and deferred tax 401(k)s. One found out late about contributing to Roth 401(k) at work. So he maxed on Roth contributions and was pissed the match was in Roth as well, but that’s for another time. One and Twosy have about $3,000,000 in tax-deferred accounts, $400,000, a Roth account $650,000 and brokerage accounts, $200,000 in cash.” So they got about $4,000,000. Very good job, One and Two.”
Joe: “One has been also Roth converting $90,000 to $100,000 for a few years with plans to continue converting to 2025.” So another couple of years going to bang out another $100,000 into the Roth. “He’d be able to convert more $250,000 if he retires in 2023. However, One realizes that at this rate, by 2025 he may have knocked out another $700,000 to $900,000 in conversions, but that still leaves close to $2,000,000 still accruing and heading towards RMDs. Did I add that One had invested half of his IRA in some growth stock instead of moderate funds in stock so made the IRA growth crazy worse? Well, he did. He actually learned later that he did and became more conservative. But damage done. Not wanting to lose his position, One wants to continue to convert most of his current IRA growth positions to a Roth.” OK, I’m with him.
Al: Yeah, so far so good.
Joe: He’s got a lot of money.
Al: Most of it in an IRA 401(k) taxable.
Joe: So he listened to our show a couple of years ago and was like, oh, we’re going to have a problem.
Al: Got a tax time bomb.
Joe: So let’s start converting to the top of the 24% tax bracket. He’s like, if I retire next year, at some point I’ll be able to convert more. So that’s debatable.
Al: By the way, one side comment. If you’ve got $4,000,000 and most of it’s in an IRA, you’re going to be putting your growth stocks in the IRA anyway. I’d rather have you have that growth and worry about the taxes than not have the growth. So let’s just be clear on that.
Joe: “One will join Twosy in retirement and begin his Medicare in 2023. One and Twosy plan to live on $80,000 a year with $40,000 of that coming from the total IRA accounts, $8000 coming from stock dividends, $18,000 coming from Twosy’s Social Security and the rest filled with cash before One takes his Social Security 2026, that would be at his age 70. One will begin taking Social Security, which will reduce the amount he can take from the IRA amounts, which leaves more to growth and tax-deferred accounts. And at 72 RMDS kicked in, $2,000,000 is still growing and most likely forces them into the next tax bracket at some point. As mentioned earlier, as long as One is maxing out the 24% tax bracket in conversion, Twosy’s IRMAA premiums is taking it on the chin with an estimated added premium of 4%. This doubles up when One retires in two years. Together, they’ll be paying out a whopping 8% more in IRMAA tax premiums. One sees this as a tax that effectively puts them in the 28% tax bracket now, in the next two years at 32%.” So IRMAA is Medicare premium, and that’s based on income. And so because they are doing Roth IRA conversions, they’re adding income voluntarily to their tax return. And hence, creating higher premiums for their Medicare premium.
Al: Yeah. And by the way, that happens two years later. So there’s a two year look-back. The money that you make this year will affect your Medicare premiums in two years from now.
Joe: “So One starts thinking, wait, why not just nip it in the bud and convert everything needed to get the tax-deferred accounts to a needed level? 0.9 million. So $900,000, leaving $1,000,000 balance to manage for RMD as soon as possible. Then heard Big Al’s voice in my head, but still studied the pros and cons anyway.” All right, we’re going to go the pros and cons of him converting. His wife has got IRMAA issues.
Al: And so the question is, should he convert in a higher bracket today than he’s going to be in retirement? So now he’s going over pros and cons.
Joe: It’s debatable.
Joe: Debatable if he’s going to be in a higher tax bracket.
Joe: All right, “Here’s the pros. No more conversion necessary if they can reach the goal of getting the total deferred accounts down to $1,000,000 and manage it from there. With no more Roth conversions after 2023, they can actually live in the 12% tax bracket as early as 2024. One’s thinking with the value of account positions currently down with the market, this is an opportune time for One to be converting with the ability to reach the conversion goal in two years. They’re paying out an effective 28% rate with the IRMAA hits anyway. So the sooner they stop the bleeding and the sooner IRMAA can get back to the rates of 2025 being the last hit for both of them in helping to avoid or lessen the tax torpedo. Another one here, max out the 2032 32% tax bracket in the remaining of 2023, a 32% tax bracket into Roth conversions. And they can take advantage of the low cost of entry into the Roth accounts growing faster when things begin to turn around.” Right. I like that. “IRMAA premiums will end in 2026 just before Social Security kicks in, putting more Social Security back in their hands. This all helps One and Twosy stay in low enough tax rate to keep the capital gains rate zero as well. Gone as they’re paying more taxes now to get into the lower tax bracket in retirement. Converting that to 32% versus 24% means they convert half of the $9,000,000-“ they got $ 9,000,000?
Joe: Is he bleeding that?
Al: .9million, maybe. Well, he’s got $2,800,000 in IRAs, 401(k)s.
Joe: “-but pay out 29% additional taxes. Converting the remaining .9million at 32% versus 24% means another $29,000 in taxes for a total additional $58,000. Summarizing. One believes that converting $900,000 in a Roth account at the near bottom of the market sooner than later, that there is potential for that $58,000 to be recovered in a tax-free Roth account the next 4 years, assuming the economy recovers in that time. And he and Twosy will be a much better retirement shape going forward. Worst case, it takes a couple of more years. Question-“ finally. I thought the question is convert $900,000. “So that’s the scenario, guys. All this leads back to the question is the scenario that would warrant converting to paying additional taxes at the higher tax bracket to potentially come up financially better later in retirement? Just closing, I would like to think out of the box and leave you some closing thoughts on the question above. I have this crazy thought that once One has recovered the additional taxes paid by converting at 32% versus 24% and they are now paying taxes at 12% rate, then their effective rates should not be looked at the higher rate to get paid to get here. But this is little gem that I introduced to you as the nerd rate.” Okay, now we’re making stuff up here.
Andi: And he admits that.
Al: I’m not sure- do we need to go on or he wants our spitball analysis.
Joe: Okay, here’s my answer to this question. I would absolutely convert the $900,000 or more all day, every day, right now. And here’s my rationale.
Al: In one year.
Joe: Yes. I like his- Because if he’s nitpicking about IRMAA taxes and he’s already done the calculation of the additional tax, the longer that that money stays inside the retirement account. If he could keep himself in the 12% tax bracket. So he converts now- the $900,000 is low, 10%, 20%, 30% lower than it was a year ago because of the markets. He converts into a Roth IRA when values relatively are lower than they have been. And if the market recovers over the next 3, 4, 5, 10 years and back to levels where they were last year, two years, 3 years ago, he’s going to make out. And all of that future growth is going to grow inside the Roth. There’s going to be zero taxes on any distribution from the Roth. If he keeps it in the IRA, that’s going to continue to grow tax-deferred. So every dollar that he earns inside the Roth- or inside the retirement account is going to be taxed at ordinary income rates, right?
Joe: So if he has a recovery inside the retirement account and he’s taxed at 24%, 25%, maybe he goes into AMT or whatever. I mean, I would much rather have the control of paying a little bit more tax today to keep myself in the 12% tax bracket because I don’t know where tax rates are going. Maybe the 12% stays at 12%, but then the 15% comes back, or maybe the 25% comes back, maybe the 28%, AMT, who knows? So he’s taking the uncertainty of taxes off the table, and he’s paying a little bit of premium to do that. Everything good in life costs something. Final comment here is that when he looks at where his income is, if he can control his RMDs even lower- because he wants to get maybe the retirement account to a $1,000,000, because then the RMD there is $40,000. So then he’s got Social Security, but then all other distributions could come from Roth.
And tax rates for Social Security is based on provisional income. Roth distributions don’t count. So he could also get a savings from the taxation of Social Security if he does this even maybe another year, and then you add up all those tax savings over the lifetime.
Al: Got it. Okay. Yeah. I wouldn’t do it in a million years except in one situation, and that is if the market crashes.
Joe: It’s crashed.
Al: Right. So I would at least think about it. I would be hard pressed to do it, because you’re going to be paying taxes in the 32% or even 35% tax bracket to do this, to save in the 12%.
Joe: But he would not be in the 12% tax, he’s saving in the 25% or 24%.
Al: I know. Yeah, well, 22% now, but let’s say 25% later. Right. So do I want to pay tax on the 35%, 32% versus- we’ll go with taxes as they’re supposed to be in 2026. Right. So basically you’re saving from 32% to 25%. That’s 7%.
Joe: But it’s a marginal rate.
Al: No, I understand. But yeah, the only time I would ever think about that is the market’s down. And it is down. That’s why I said I wouldn’t do it in a million years unless the market’s down. Then at least I would think about it. But now you’re trying to time the market and which sometimes works and sometimes doesn’t.
Joe: How about if he dies? Then he’s got the widow tax.
Joe: What is the wife going to pay? What is Twosy going to pay?
Al: Well, she can do the same conversion at that point if she wants to. But their income, which is Social Security and the RMD, even at $3,000,000, it’s not huge, right?
Al: Well, yeah, $150,000 after the standard deduction. Anyway, that’s my only caveat. The only time I would ever consider this is when the market is down, which it is.
Joe, I don’t know, I would do it all day.
Al: I know you would.
Joe: You got the money, you’re going to pay the tax regardless. But you’re right. Are you going to pay a little bit extra tax? Maybe. But can you get the compounding of tax-free growth and the control over your lifetime?
Al: Yeah, but you lost the compounding growth on the tax that you paid.
Joe: You also lost the compounding effect of the taxes that I’m going to pay the tax at.
Al: I know, but if you’re looking at fair, you’ve got to look at so I’ve lost the opportunity cost on the money that I paid for taxes to make this a fair calculation.
Joe: But the money he has in the IRA is not all his.
Al: No, I understand that.
Joe: So he’s got to pay at some point. And I see your point of looking at, do I want to pay a 32% to save at 24%? 25%?
Al: Yeah. I mean, right now he paid 32% to save at 22%. That’s only if they extend these tax brackets, which, who knows, right? So there’s a mystery there. What are the tax brackets going to be? Anyway, so it’s like I say, I wouldn’t normally do it, but when the market is down, I would at least consider it. That’s my thought.
Joe: Alright, there it is. That’s the debate.
We’ve got 7 strategies to reduce your 2022 taxes, but you need to implement them before December 31! You already know what they are if you watched our recent live webinar on end of year tax planning and downloaded the companion guide on End of Year Tax Strategies. If you missed the webinar, want to watch it again, or need that free guide, check them out in the podcast show notes. Just click the link in the description of today’s episode in your favorite podcast app to get there. If you’ve got money questions, comments, or stories to tell, click Ask Joe and Big Al On Air in the podcast show notes and send ‘em on in.
Alternative Minimum Tax (AMT) Explained (Smitty from the Villages)
Joe: Let’s go to “Hey, Andi, Joe, Big Al. Can you please explain the alternative minimum tax? Who pays it? I found it confusing. I would like to hear your take.” This is Schmitty from The Villages. Smitty.
Al: Yeah, we know Smitty.
Joe: Yeah, a long time.
Al: How’s that golf cart coming?
Joe: Alright. Why does he care about AMT?
Al: Well, it’s a good question. So let me try to explain alternative minimum tax, AMT. So the idea is that there’s an alternative tax system that was developed, or we came up with that- IRS came up with that- in the 50s or 60s, something like that, when certain wealthy taxpayers weren’t, quote, ‘paying their fair share’ because they were loading up on tax deductions. And the government didn’t like that. So they came up with this alternative tax, which basically is this, everything that’s income in the regular tax system is still income in the alternative. And some things that even aren’t income, like incentive stock option exercise, is income in the alternative minimum tax world. So your income in the alternative world is either the same or higher than it would have been in the regular world. Now, as far as deductions, not all deductions are allowed. And the big one used to be state taxes, but now state taxes are barely deductible, so it’s not that big a deal. But there are other things that are not deductible. If you’re loading up on certain kinds of certain deductions, oil and gas or things like that, it may not be fully deductible in the AMT world. Basically, your accountant, through their software, is computing taxes in both systems every single time a return is prepared, and you have to pay the higher of the two. That’s the point of it. Now right now because as I said state taxes are not deductible for regular tax purposes and they’re never deductible for Altman purposes, there’s very few people subject to Altman right now under our current taxation. But that will come back.
Joe: Yeah, because of the SALT.
Al: Right, because of the SALT. That changed everything.
Joe: So Smitty lives in Florida. There is no state tax in Florida.
Al: Yeah, no state tax. In all likelihood, Smitty is not going to be subject to AMT, ever.
Joe: Very few people today are subject to it. They have to have kind of a unique situation that pushed them into AMT today.
Al: Yeah. Here’s where like people that have very high capital gains, because capital gain rate is the same in both systems. And if you got less deductions, you might have a higher AMT rate. So that’s part of it. Some AMT tax, alternative minimum tax is a reversal. In other words, you get a credit for paying it.
That’s if it’s something like a stock option, which then will reverse out when you sell and you basically get that tax back, probably way more than you need to know. But that’s the point. The simple point is there are two tax systems and you have to pay the higher the two, whether you know it or not. There’s two tax systems and tax software, as well as your accountant, computes both every single year.
How Much Social Security Benefit Will My Spouse Receive? (Gus, Philly)
Joe: Let’s go to Philadelphia. Phillies. “Hi, Joe and Al. My wife and I have decided to begin taking Social Security benefits when she reaches her full retirement age at 66 and 6 months, I will be 69 and 3 months. Our plan benefit start date will be January of 2024. She is extremely- I’m sorry, she has an extremely low individual benefit. So she’ll opt for the spousal. My understanding is that the spousal is one-half of what my benefit would have been at full retirement age. My question is, since my full retirement age will have been over 3 years ago, when we start benefits, will she get one-half what it was then, or does it increase from what it would have been 3 years ago based on a COLA or any other mechanism? I know my benefit keeps growing until we start taking the benefits, but I’m not sure if they adjust hers or is it frozen at one-half of the value that was at my full retirement age. Thanks for your help.”
Al: And he says “I never miss your show as this is my favorite podcast.” This is from Gus. So, Joe, I’ll take a stab at this. Great question, first of all, and great insight, Gus already. Because your spouse can receive half of your benefit as long as you’re claiming and receiving your benefit, can receive half of your benefit. But it’s not half like if you wait till 70, it goes back to your full retirement age. So you’re right, it’s what your benefit would have been at full retirement age, half of that. However, it is adjusted for inflation. So in other words, had you start taking that benefit at full retirement age, let’s just say you are 66 or 66 two months, whatever it was, then as if you had been taking that benefit, it would have increased every year with cost of living adjustments. And so therefore, when she starts taking it, it would basically be what your benefit would have been with cost-of-living adjustments at 50%. Because that’s the spousal benefit.
Joe: Yeah, I know why he’s asking this.
Joe: What’s the COLA on Social Security?
Al: It’s high. It’s very high. Yeah. What was it, like, 9% something?
Joe: 8%? Something like that.
Joe: I remember when we were doing this, the COLA was like a can of red, white and blue or can of Pabst Blue Ribbon.
Al: You’re right. And there was a few years where the COLA was absolutely zero. Big goose egg.
Joe: So yeah. So Social Security people are getting a sizable raise. Gus is thinking, hey, wait a minute-
Al: – come on, I should get some of this.
Joe: Yeah. Do they just freeze my benefit? Which is a really good question and good insight, so no, they would get the increase on the COLA. For other people that are looking at their Social Security benefit statements, a lot of times they’re not including the COLA as well. So your benefit may or may not be a little bit different depending on how old you are when you’re looking at your statements and so on.
When in the Year You Turn 72 Must You Take RMDs? (Ricky, AL)
Joe: We got Ricky writes in from Alabama. All right, “I know RMD’s start at age 72, and you can delay the first one until April 15, the following year. But in the year you turn 72, must you be 72? Or can you take it at any time during the year, i.e., before your birthday? And for Joe, life certainties are death, taxes, and Florida losing to LSU.” Wow.
Al: Oh my. That could be quite a debate there. Depends on the year.
Joe: It does depend on the year. It does. It does. It does. Ricky, Ricky, Ricky. Why would he even write that? Ricky doesn’t know what he’s talking about. No, the RMD is calculated on December 31st the year before you turn 72.
Al: Yeah, that’s right. And it doesn’t matter as long as you do it within the year you turn 72. You can do it on January 1st if you want to.
Joe: You can do monthly installments.
Al: You can do whatever you want. So you don’t have to wait till your birthday. That’d be tough if your birthday was December 31st and everything is closed. It’s like, what do I do? No, you can do it any time of the year that you turn 72. And also if you’re taking money out anyway, right? You took some money out in January for living expenses. You don’t have to take another one later. That would count towards the RMD.
No Taxes Filed, No Credit History. What Should Son-in-Law Do With $100K? (Karen)
Joe: We got Karen writes in, and she goes, “Hello. A few years ago, your office helped me with a real estate sale question and answered it on one of your podcasts, as well as reply personally back to me in an email that I sent. I have been bragging about Pure Financial ever since and have many friends now watching Joe and Big Al on Sunday mornings. I’m hoping to receive once again your gracious guidance for another financial decision.” Okay. Big Al, you ready for this?
Joe: “My 55-year-old son in law is self-employed, unlicensed contractor the last 15 years.”
Al: How do you really feel about it?
Joe: “He hasn’t filed taxes in just as long. Credit report is empty. No credit, no negative remarks. He will be receiving approximately $100,000 from the proceeds selling his mother’s mobile home that is titled to him. Questions. What do you recommend he do with the funds?” Maybe get his license or pay some back taxes.
Al: Do the right thing. Have an emergency fund, pay off credit card debt and invest the rest.
Joe: He doesn’t have credit. The guy’s a ghost.
Al: Well, good point, but maybe his wife does, I don’t know.
Joe: “I bought a condo for him and his wife in June of 2020. It is now valued at $700,000 with a $490,000 mortgage. I’m about to put him on title. But rethinking that decision since he doesn’t file taxes. His wife is already listed as joint tenancy with me. What’s your opinion on putting $100,000 towards that mortgage?” Yeah, I like that.
Al: I would not put him on title. I don’t see a benefit there.
Joe: No, zero benefit. The wife and Karen are on title.
Al: I think that’s fine. I don’t think he’ll do that, but you never know. I’m guessing he doesn’t have a lot of savings, although I don’t know that for sure.
Joe: “I have a feeling more options would be beneficial for him if he starts filing taxes, since he’ll be back to earning self-employed income for the next 11 years until he turns 66. Maybe he should deposit the funds in some kind of retirement account, especially now that his mother had passed and he’s no longer her live-in caregiver. I told him maybe he should just start a W2 job at Home Depot so there’s no red flags from the IRS by all of a sudden filing self-employed taxes after 15 years. Hope your upcoming holidays are bright. Curious, is Andi Last still the producer/announcer? Is she female? Male?”
Andi: Yes, and female. Yes.
Joe: Isn’t there an email that asks you that?
Andi: She emailed afterward, I emailed her, and I said that yes, we would answer this question on the podcast. And then she replied to me and said, “I don’t mean to be insensitive, but A N D I, are you male or female?” So I replied back and I said, “yes, I am indeed female. Thank you.”
Al: Got it. Okay. Should the son of like, get a job at Home Depot?
Joe: But you have no red flags. Hey, you haven’t been filing taxes in 11 years.
Al: I got a W2.
Joe: And then all of a sudden a) you got some money, you want to start a retirement account?
Al: Well, it could have been a stay-at-home dad.
Andi: Well, he was an at-home caregiver for his mother.
Joe: Okay, well, if he wasn’t working, didn’t get any income, I’m fine with not filing taxes.
Al: Yeah, but I don’t think that’s the case.
Joe: I don’t think so either.
Al: I think-
Joe: Well, here, why don’t you go to Home Depot, get a job at- like a W2. Because if you go right away to self-employed-
Al: They’ll wonder what’s up with that.
Joe: They’ll be like what did you do the last 11 years? You just say I’m a caregiver.
Al: Yeah. You don’t need to work at Home Depot. He doesn’t need to work at Home Depot, but he does need to get his license. He needs to start doing this right. The $100,000 is his, right? I’m guessing. But I don’t know your daughter, his wife, I don’t know their financial situation, but just generally, if they don’t have an emergency fund, then create one. If they’ve got credit card debt, not him, but maybe her, maybe pay that down. And the rest you’ve got to put in a non-qualified trust account. You can’t put it in a retirement account unless you have earned income. Maybe she’s got earned income, so maybe that’s possible. But he doesn’t have any earned income.
Joe: So he was on title on this home. Mom dies. So we need to know what the cost basis is of the home because there’s not a full step-up. It’s half. If he sells, there could be some tax due, but he doesn’t have income. But he probably-
Al: – will have to file.
Joe: -file a tax return because you deposit $100,000 at the old credit union or bank, they’re going to be like, where does this money come from? This reminds me of our good buddy from Orange County. He wants all legit.
Al: I remember that. Joe Al. He lived right on the water in Orange County. And it’s like, I’m not comfortable carrying more than $10,000 to the bank to pay the mortgage every month.
Joe: He had like $1,000,000 in cash in his trunk selling fireworks in Nevada.
Al: We can only help you if you go legit and we never heard from again.
Joe: Well, I think I want to go to legit, guys. I want to go legit. But I do got this suitcase. Do you think I could deposit that?
Al: How do I invest that?
Joe: How do I invest this thing? Alright, that’s it for us today. I’m done. My voice is shot. Thanks for putting up with us. We’ll see you again next week. Keep your questions coming in, folks. The show’s called Your Money, Your Wealth®.
Andi: Joe’s life with kids, soft drinks going against Big Al’s code, single malt vs blend, Joe’s surprising data on the Villages, and Ricky in the third person in the big ol’ Derails at the end of the episode, so stick around.
Listen to the YMYW podcast:
Subscribe on Android
Subscribe by Email
Pure Financial Advisors is a registered investment advisor. This show does not intend to provide personalized investment advice through this broadcast and does not represent that the securities or services discussed are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast in the process of making a full and informed investment decision.
• Investment Advisory and Financial Planning Services are offered through Pure Financial Advisors, LLC, a Registered Investment Advisor.
• Pure Financial Advisors LLC does not offer tax or legal advice. Consult with your tax advisor or attorney regarding specific situations.
• Opinions expressed are not intended as investment advice or to predict future performance.
• Past performance does not guarantee future results.
• Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.
• All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.
• Intended for educational purposes only and are not intended as individualized advice or a guarantee that you will achieve a desired result. Before implementing any strategies discussed you should consult your tax and financial advisors.
CFP® – The CERTIFIED FINANCIAL PLANNER™ certification is by the Certified Financial Planner Board of Standards, Inc. To attain the right to use the CFP® designation, an individual must satisfactorily fulfill education, experience and ethics requirements as well as pass a comprehensive exam. Thirty hours of continuing education is required every two years to maintain the designation.
AIF® – Accredited Investment Fiduciary designation is administered by the Center for Fiduciary Studies fi360. To receive the AIF Designation, an individual must meet prerequisite criteria, complete a training program, and pass a comprehensive examination. Six hours of continuing education is required annually to maintain the designation.
CPA – Certified Public Accountant is a license set by the American Institute of Certified Public Accountants and administered by the National Association of State Boards of Accountancy. Eligibility to sit for the Uniform CPA Exam is determined by individual State Boards of Accountancy. Typically, the requirement is a U.S. bachelor’s degree which includes a minimum number of qualifying credit hours in accounting and business administration with an additional one-year study. All CPA candidates must pass the Uniform CPA Examination to qualify for a CPA certificate and license (i.e., permit to practice) to practice public accounting. CPAs are required to take continuing education courses to renew their license, and most states require CPAs to complete an ethics course during every renewal period.