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Joe Anderson
ABOUT Joseph

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

Alan Clopine
ABOUT Alan

Alan Clopine is the CEO & CFO of Pure Financial Advisors. He currently leads Pure Financial Advisors along with Michael Fenison and Joe Anderson. Alan joined the firm about one year after it was established. At that time the company had less than 100 clients and approximately $50 million of assets under management. As of [...]

Published On
July 14, 2020

Do you have to transfer from a 401(k) to a traditional IRA before you do a Roth IRA conversion? Does the pro-rata rule apply? Also, the logistics of paying the tax on a Roth conversion. Plus, stimulus package updates around paycheck protection program loans, required minimum distributions (RMDs) and Coronavirus-related distributions (CRDs) from retirement accounts.

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Show Notes

  • (00:58) Will the CARES Act be Renewed or Extended?
  • (04:52) Are RMDs Only Waived for 2020? Can I Put My 2020 RMD Back in My IRA?
  • (07:01) Can I Convert My Required Minimum Distribution to Roth IRA?
  • (08:32) Coronavirus Related Distribution vs. Roth Conversion
  • (15:30) Does the Pro-Rata Rule Apply to a Roth Conversion from a Traditional IRA Rolled from 401(k)?
  • (23:17) Do I Have to Transfer 401(k) to Traditional IRA Before Doing a Roth Conversion? Which of My Roth Conversion Strategies is Better?
  • (31:32) Inter-Plan Conversion: Direct Rollover from 401(k) to Roth?
  • (36:15) Should We Max Contributions to Our Roths or Pay the Tax on Roth Conversions?
  • (39:50) Can I Pay Taxes on a Roth Conversion with My Tax Refund Before I Get It?

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Transcription

Will the CARES Act be Renewed or Extended?

Joe: We got Renee from Los Angeles. LA huh?

Al: Yeah.

Joe: “Will there be renewing or extending the CARES Act?”

Al: “Will they-?”

Joe: Who’s they?

Al: Yeah yeah.

Andi: The man.

Al: The people that do the CARES Act.

Joe: I don’t know Renee. I don’t know what the question is meaning- the CARES Act is a bill, it’s a law.

Al: It’s a lot of stuff. Well here’s what I think Renee is asking. Am I going to get another check? I bet- I’m reading between the lines. Or maybe she’s asking about unemployment being extended. So I would say this, I’ve got an article here Joe, that talks about this. Second stimulus check, will it be happening? How much can you really count on? And it seems like across the board Democrats, Republicans and the president are thinking there’s going to be at least one more stimulus check. How much? There’s proposals between $1200, which is what it was the first time, all the way up to $2000. There’s been proposals from it one more $1200 payment all the way to $2000 a month for up to 12 months, which that would be expensive. Talk about our national debt. I don’t think that one’s gonna pass. But at any rate, Mitch McConnell is saying that sometime later this month it’ll likely be announced and it would probably be in the August timeframe.

Joe: What about- I guess with the CARES Act- a couple of changes- they’re extending the PPP loans. So for small businesses there’s 2 and a half times monthly payroll up to $10,000,000. So they’re extending those loans.

Al: Now that the unemployment I was going to say now that expires July 31st and so far there’s no discussion-

Joe: The kicker, the $600-

Al: Correct. Correct.

Joe: You got the required minimum distributions. So initially if you took your RMD in January you were only eligible to pay it back if you wanted to, with CRD or coronavirus related distribution but they changed that. So now any required distribution from any account. So it could be from the beneficiary IRA. Because before, if you took a distribution from a bene IRA you were stuck with it. So that- they changed that. So that could be renewing the changing CARES Act 2.0. There’s been a little bit more talk about who is eligible for the CRD, the coronavirus related distribution. It was pretty broad brush when they first wrote the bill. So you know you had to have been diagnosed with COVID, a spouse or dependent, maybe you were furloughed, lost your job-

Al: -or even if you’re you lost some work hours so you got less pay. Or if you had childcare situation-

Joe: And then it was like any other thing-

Al: -that we deem appropriate. Which probably is about 90% of all the people out there.

Joe: Exactly. So I think more and more people will be eligible to take the CRD. So stay tuned. Because now we’re kind of getting into some weird territory where we opened up and then now some industries are shutting back down with bars and restaurants. What does that look like for those employers? So there’s going to have to be another stimulus package if they’re gonna try to shut down some of the economy I guess depending on what industry that you work in. So stay tuned. We’ll probably- day by day, week by week, we’ll probably get more information there. So thanks for the question, Renee.

Are RMDs Only Waived for 2020? Can I Put My 2020 RMD Back in My IRA?

Joe: Shirley from Irvine, California. “Are RMDs only waived for 2020? I already took my RMD in March of this year. Can I put it back into my IRA?” The answer is yes. So you took a required minimum distribution that is when you turned 72 now due to the SECURE Act is that there’s a certain percentage that you have to pull from a retirement account and pay the tax on that. And what they did is they said because of the volatility and everything else that’s going on in the overall markets for retirees or people that are of required minimum distribution age or reached their required beginning date you don’t have to take it. You don’t have to pull the money out so you can save some taxes there if you choose to. So if you don’t need the money- before you would have to take it out pay some tax and then just reinvest it in a brokerage account. Due to the CARES Act, you do not have to pick the RMD.

Al: And Joe that is only for 2020.

Joe: Correct.

Al: One year. And this is a recent pronouncement that just came out within the last month, I would say, which is now they said that you can put it back if you took your RMD even in January, February, March, whatever, you can put it back. No taxation, no 30-day or 60-day rollover rule. So it doesn’t count as your once a year rollover. So you can just put it back. So anyway that’s different than what we had said in other shows because the law just changed. But you have to put it back in by August 31st I believe. I think that’s the date.

Andi: That is correct.

Joe: If it’s grown in value, no big deal. Because it’s just going to be taxed at ordinary income at that- let’s say you took your distribution of $10,000. And you still invested it. You put the- well I wonder what you put back. I guess probably just that required distribution amount.

Al: I think you just put the $10,000 back and then you have ordinary income. You keep the rest and you just pay taxes on it. I think that’s how they would do that.

Can I Convert My Required Minimum Distribution to Roth IRA?

Joe: OK. I have no idea. How do we pronounce this name?

Andi: Chandrakant.

Joe: Chanderkant.

Andi: Chandrakant.

Joe: Do you know a Chanderkant?

Andi: It’s a very common Indian name.

Joe: Oh. All right. Chandrakant from Atlanta, Georgia. “Can RMD withdrawals be converted to a Roth IRA?” The answer is no. A required a minimum distribution is a distribution. RMDs cannot be converted to a Roth. This year though, there is no required minimum distribution. So if you’re used to paying the tax and the tax rate is low enough, it might make sense to continue to take that distribution and this year you could convert it to a Roth. But you do not have to take the RMD this year.

Al: So instead- in other words instead of taking that the RMDs withdrawal, just take what would have been your RMD and put it in a Roth IRA. It’s the same taxation as what you’re used to anyway and that way you do a Roth conversion. One year only. 2020.

Joe: That’s it.

Andi: Is there any chance that they’re going to extend that?

Joe: Why do you care? Are you 72?

Andi: I’m curious and I think that our listeners would be interested.

Joe: No I don’t think so.

Al: I don’t think so either. But never say never. Right? There’s been no discussion of that. I’ll put it that way.

Andi: Got it.

Joe: You want to ask some Social Security questions too while we’re at it?

Coronavirus Related Distribution vs. Roth Conversion

Joe: All right. We got what-?

Andi: Stop Ironing Shirts is a blogger.

Joe: OK.

Andi: And Josh is a listener of YMYW. And they had a conversation on Twitter. So I shared it with you because I thought you might want to give more information here in this conversation.

Joe: Well please tell me more.

Andi: So Stop Ironing Shirts says “Has anyone weighed the pros and cons of a CARES Act 2202 distribution versus a Roth IRA conversion? 2202 is taking a distribution today and spreading the taxes out-” so, a coronavirus related distribution.

Joe: CRD. This reading stuff isn’t as easy as it looks is it?

Andi: Josh said “I heard @ymywshow-” that’s our handle on Twitter- “talk about this several times in the past few months. Need to be able to demonstrate that you’ve been affected by COVID-19 to be eligible for the COVID-related distribution or whatever CRD stands for. But there is an opportunity there to explore.” So obviously Josh does actually pay really close attention to the show. Stop Ironing Shirts replied and said “Interesting. I’m 61% plus pre-tax accounts and can meet the requirement. My side hustle was terminated due to COVID impacts to their business. Only downside I can find is those investments start kicking off taxable income and aren’t sheltered from liability.”

Joe: But he’s saying he wants to do a Roth conversion with the CRD.

Al: I think what he’s saying and I think he means 2020. 2202 is about 200 years from now.

Andi: But isn’t that the actual name of it?

Joe: A subchapter of the CARES Act of the CRD is what he’s saying.

Al: Oh is it?

Joe: He’s trying to be a little fancy pants.

Al: Got it: See that was over my head.

Joe: See I’m tight. I like memorizing the code.

Al: I know you do. See I’m smarter.

Joe: You can convert. So he wants to take a COVID-related distribution. So you can pull money out of a retirement account up to $100,000 and you can either pay the money back over a 3 year time period or he could pay the tax over a 3 year time period. So what Stop Ironing Shirts- what the hell’s that all about? Who’s-?

Andi: It’s something to do with the fact that he’s retired early so he doesn’t have to iron his shirts anymore.

Joe: Oh okay. Got it. Cool. So he’s thinking, “I’m going to take the $100,000 or some amount no greater than $100,000. I’m gonna convert it and then I’m gonna pay the tax over a 3 year time.

Al: Which sounds like a great deal.

Joe: And so our buddy Josh- he’s an avid listener- gave us a little props and aid you know what, hey be careful with that because you need to be affected by COVID. And the Stop Ironing Shirts person said well hey my side hustle- FIRE movement- blew up, so I qualify. So be careful about converting. In the law, it does not say you cannot. We believe that that’s not the intention or the spirit of the law. But it still makes sense to take the money out of the retirement account potentially; pay the tax over a 3 year depending on what your tax bracket is. So let’s say if you get your side hustle back in the next few years, you could potentially- or how much money that you have in a retirement account- what tax bracket that you’re in. So there’s a lot of pros to take it. But the con is, you’re right, is that now the interest in income and dividends that are sitting in a non-qualified account will be taxable. But when you sell those assets it’s going to be taxed at capital gains rate versus at ordinary income. And yeah from liability, so let’s say you get sued or not sued- but maybe you file bankruptcy you will be protected under the retirement accounts but not necessarily protected in a non-qual.

Al: Well it depends. Because some IRA money depending upon-

Joe: Well no, if he does a CRD it’s in a non-qual account.

Al: I understand. But if he converts it.

Joe: So if he converts it, it’s still in a retirement account; it’s growing tax-free. But I don’t think that’s-

Al: Well if you listen to Jeffrey Levine, who we’ve had on our show, probably one of the smartest guys in our industry about taxation, what he says is that it doesn’t really say you cannot take the Coronavirus distribution and convert it. But his strong belief is don’t do it. That was not the spirit of the law and probably or at least that’s his opinion, that the IRS will at some point come back or the government will come back and say no, this wasn’t allowed. You’ll have to undo it and have penalties. And so I personally wouldn’t try that. I think the decision is either make a normal Roth conversion from your IRA to a Roth and just do it normally. Or take the coronavirus related distribution. The plus side of that is a lot of people that we end up talking to don’t have hardly any non-qualified, non-retirement money. And this is a good way to get some out, not have any penalty and pay the tax slowly over 3 years. So if that’s your situation I think that’s not a bad way to go really.

Joe: But he’s only got 61% of his money in pre-tax accounts. It’s not 95%.

Al: That’s true too.

Joe: So he does have some diversification in regards to the taxation of the dollar.

Al: Good point.

Joe: He stops ironing shirts.

Andi: So actually I’m at stopironingshirts.com right now. They’re a mid-30s couple who achieved financial independence at 34 and retired at 36. So they’re out. They stopped ironing their shirts a while ago.

Al: For the FIRE movement, for those that are going to need an income until they turn 59 and a half, here’s a way to get money out without paying a penalty. So you got $100,000-

Joe: Most FIRE people, especially in the 30s, they hate retirement accounts because you can’t spend the money until you’re 59 and a half.

Al: Right.

Joe: So he could take a CRD and put it in a non-qualifying account. Buy a business. Buy some real estate. It’s like your boy Cubert or whatever his name is.

Andi: My boy.

Joe: Well there you go. We haven’t talked FIRE in a while.

Al: No we haven’t.

Joe: So congratulations to Stop Ironing Shirts and thanks Josh for the little plug.

Does the Pro-Rata Rule Apply to a Roth Conversion from a Traditional IRA Rolled from 401(k)?

Joe: We got Miss M, Al.

Al: Miss M. That’s cool name. What do you think, Mary?

Joe: I don’t know. I like Miss M.

Al: Madeline?

Joe: Madalena. Sacramento, California. She writes in ‘Hi Joe, Al. I truly enjoy listening to your podcast this year so far.” Oh.

Andi: It’s all downhill from here, Miss M.

Al/Joe: So far.

Al: I’m reserving my judgment until I listen to a 2nd one.

Joe: “You guys are not only funny but also give honest suggestions and I appreciate that you try to answer a question in many different ways especially when information needed is missing. Thank you for being fun characters on the air.” All right cool. “We all need a good laugh especially during times of adjusting to a new normal.”

Al: Especially during this time. Adjusting to normal.

Joe: Yes. It’s a new normal. “Andi, you are the best podcast producer.”

Andi: Dang. I wonder how many of them she knows.

Joe: I think Andi just kind of popped that in.

Al: Well I was wondering- like if that would have been like a different type, like a different font.

Joe: I thought it would be bold, underlined.

Al: I know Andi had something to do that.

Joe: “I have a question I’m hoping one of you can answer. I searched all over the internet but can’t find a clear answer. I’m asking for a friend-” Of course you are, Miss M.

Al: They always ask for a friend.

Joe: Right, exactly.

” -Fran, 74 years old, who rolled over all of his 401(k) to a traditional IRA account upon his retirement and has been taking RMDs every year since he turned 70 and a half. The traditional IRA has a zero balance-”

Andi: “had,” key word.

Joe: I’m sorry. “- had a zero balance at the time of the 401(k) rollover and no new contributions have been added to the IRA account since. If he converts some of the IRA money to a Roth IRA account this year or any future years, does the pro-rata rule apply? Thanks, Miss M.” All right Miss M, a few things here. So the pro-rata rule- lets kind of talk about what that is, is that this is- the pro-rata rule only applies if there is basis in the IRA. And what that means is that- did your friend-

Al: Your 74-year-old friend.

Andi: I can see the air quotes.

Joe: -like make after-tax contributions? Because what could have happened Al is this, and we’ve seen this mistake in the past. Is that I have a 401(k) plan. I have after-tax contributions in the 401(k) plan. I have pre-tax contributions in the 401(k). When I say after tax, it’s not Roth; it’s after-tax, where the earnings of the after-tax earnings will grow tax-deferred and be taxed at ordinary income rates. He could have rolled everything into an IRA, including after-tax. Then yes, the pro-rata rule would apply. But they made a huge mistake in the rollover. Because the after-tax money from the rollover should never have gone into the IRA. It could have gone directly into a Roth IRA.

Al: And that’s a relatively new rule, what 5 years ago? Something like that?

Joe: Something like that.

Al: We had kind of a-

Joe: -a work-around.

Al: -a funny way that we and some other advisors did sometimes but it was not a sure thing. So we kind of used it cautiously. But that would have been the miss, and just so people understand, after-tax money in a 401(k), how do you get that? Well typically a 401(k) is either a traditional 401(k) or a Roth 401(k) and it’s $19,500 per person this year; $26,000 if you’re 50 and older. But some plans, not all, some plans allow you to put more money than that $19,500 on an after-tax basis, meaning that you take money that has already been taxed; in other words, it’s taxed on your paycheck. And then you put that into your 401(k). That gives you basis so that when you withdraw that money later you don’t have to pay tax on it, because you already paid tax on it. That’s what after-tax money is. And so some plans and some people have tax basis in their 401(k)s and if that’s you then instead of rolling it all to an IRA, you roll the after-tax part directly to a Roth, you’re allowed to do that. You roll the rest to a regular IRA. Then there is no basis in your IRA and you don’t have to worry about any of this pro-rata rule.

Joe: And the pro-rata rule works like this, is that let’s say there is $100,000 but under the $100,000 or- is 10% of it’s after-tax. So 90% of $1 that you withdraw would be taxable, and the 10% would be tax-free. So that’s how the pro-rata rule works. So every $1 that comes out it’s pro-rata from after-tax to pre-tax depending on the tax treatment. However since she applauded us on trying to figure out what the hell they’re actually asking us, here’s another thing, another thought, that maybe she’s asking, is that because the IRA had a zero balance they took a 401(k) and rolled into an IRA. And- well, 74, you think a 74-year-old still working?

Al: They’d have to have like a side gig.

Andi: It does say he rolled it ‘upon his retirement’ which implies that he is not working anymore.

Joe: Okay.

Al: But I get what you – like let’s say he had a side gig. So I know where you’re going with this.

Joe: Then maybe he wanted to do a Backdoor Roth. And so since the IRA balance was zero. Put a 401(k) into that IRA. I open up another IRA and then I put after-tax dollars into that IRA and then try to convert it to a Roth IRA. Then the pro-rata rule would still apply there. Because you look at the aggregate of all IRAs and then you say, what is pre-tax? What’s after-tax? And so to figure out what’s pro-rata.

Al: We have a few retired folks that have a side gig and- that’s profitable- it has to be profitable to do this. And then we have them set up a Solo 401(k) or individual 401(k) they roll their pre-tax money from the IRA into the 401(k) and they’re left with an IRA with after-tax money that then you can convert that and then continue to do Backdoor Roths. So we have done that before.

Joe: Well wait a minute. I should have read it more clearly because she says- Miss M says- well no, there’s no- there haven’t been any future contributions.

Al: I know but you kind of went down the path of, what if there was? But you’re right, it was kind of a fork in the road that didn’t really matter. Maybe for some of our listeners, maybe not for Miss M.

Joe: Maybe they can apply that knowledge to their own situation.

Al: That’s what I was thinking. It’s very clever.

Joe: I don’t know, Miss M. If they roll after-tax dollars from a 401(k) plan into the IRA and they do the conversion then yes, the pro-rata rule still applies. But the pro-rata rules- maybe she’s confused on what pro-rata means. Pro-rata is after-tax versus pre-tax and if you do a conversion of X amount of dollars, some of that’s going to be tax-free from the conversion share via pro-rata, what’s pre-tax and after.

Al: So here’s the question is Miss M- is ‘M’ a first name or last name, do you think?

Joe: Miss M? I would say first name.

Al: First name?

Joe: What do you think?

Al: Well that’s what I’m thinking. But then I start thinking maybe it’s like Manchester or something really cool like that- Miss Manchester.

Joe: That’s really cool. Manchester?

Al: I think so.

Joe: Ok.

Al: That’s the name I wanted.

Joe: Got it.

Al: Alan Manchester.

Joe: Got it. Hopefully that makes sense.

Do I Have to Transfer 401(k) to Traditional IRA Before Doing a Roth Conversion? Which of My Roth Conversion Strategies is Better?

Joe: Our boy Smitty.

Al: Smitty. From Oregon?

Joe: Yeah. Where’s he been? Roseburg. Was he on a webinar that we did?

Andi: Not that I’m aware of.

Joe: I don’t understand. So these guys keep asking us questions and we throw a webinar for people that like to ask multiple questions and then they no-show us.

Andi: We may have to do it on the weekend because a lot of people work.

Al: But we do it at lunchtime.

Joe: Yeah. And it’s a zoom meeting. They could pretend it’s a very important zoom meeting.

Andi: Oh I’m gonna remember that next time I wanna do something like that.

Al: Everyone relies on zoom right now so it’s to be expected that you’d be on a zoom meeting.

Joe: Of course. What are you doing? I’m on a zoom call.

Al: Leave me alone.

Joe: Get out of my bedroom. “Hello, Andi, Joe, and Big Al. I have a mission for you if you choose to accept it.”

Al: Oohs. It’s like Mission Impossible. “I’m age 64, filing jointly, making $150,000 bucks a year. I’m thinking about doing a rollover from my tax-deferred 401(k) converting it into my Roth IRA. I’d be paying all the taxes via my brokerage account and I’m aware of the capital gains tax associated with doing so. It’s my understanding that if I do a 401(k) rollover that it would first need to go into a traditional IRA before can go into a Roth IRA. It’s also my understanding that if I do Roth IRA conversion and some of the money is left behind in the traditional IRA, then that money would be- would also be calculated in taxing of my Roth IRA conversion. So this gives me pause on what would be the proper steps and timeline to eventually get all of my 401(k) money into a Roth IRA while staying in the 24% federal tax bracket. Let me give you two scenarios and maybe you could give me an idea which scenario will generate the lesser amount of tax. Scenario 1) 401(k) equals $700,000. I roll over $700,000 from my 401(k) to a traditional IRA. Then I convert $100,000 of it to a Roth. I will continue to convert $100,000 per year until all of the money has been converted into my Roth IRA. In the end, the total tax would be X. Scenario 2) 401(k) equals $700,000. I roll over $100,000 from my 401(k) into a traditional IRA. Then convert $100,000 to a Roth IRA. I would continue the scenario every year until all the money in the 401(k) has been rolled over to the traditional IRA then convert it to my Roth IRA. In the end, my total tax would equal X. Keeping in the 24% tax bracket, which scenario do you think would create the less amount of tax in the end? Or would it all work out to be equal in the end? Thanks.” Smitty, you’ve got to start watching our webinars bro, because I don’t know what he- so it’s the same.

Al: The answer is equal.

Joe: Equal. Your tax is X and X. You’re right on there.

Al: First of all you do not have to take your 401(k) money to an IRA to do a Roth conversion.

Joe: You can go 401(k) directly to a Roth IRA.

Al: Yes. So keep that in mind. You don’t have to go through this step if you want. But I don’t care whether you go directly from the 401(k) to a Roth and do that over 7 years or you roll the whole thing out to an IRA and you do that sequentially over 7 years. Or if you do $100,000 a year from one to the other, which you don’t need to do. But it’s- it works out the same.

Joe: So if I were Smitty, I would roll the $700,000 into the IRA and then do the conversions there, is just easier. Because then you can just transfer shares from one IRA to the Roth.

Al: You’re not having to request the money out of the 401(k), which is a hassle.

Joe: You got to do rollover paperwork and transfer paperwork.

Al: I do agree with that. But here’s the concern I have and that is it sounds like he wants to convert his entire 401(k) which I’m not necessarily against. But here’s what sometimes people do is they end up converting everything in a higher bracket like 24% and then by the time they get to retirement they have no required minimum distributions. And if they don’t have much other income now they’re in basically a 10% bracket. So you converted and paid at 24% while you- if you pulled it out with RMDs you would’ve been at a much lower bracket.

Joe: Smitty, you make $105,000 a year. So with $105,000- well his taxable income is probably $80,000.

Al: Depends on whether he’s married or not.

Joe: Did he say he’s married? “filing jointly.” He’s married.

Al: Oh Ok. Very good.

Joe: Do you know what that means?

Al: I do know what that means.

Joe: So $80,000- you’re at the top of the 12% at $80,000 of taxable income. So if you want to convert $100,000 then that’s going to push you into the 24% you’re going to take it all with a 22%. So if your taxable income is $80,000, the top of the 22% is $170,000, so maybe you convert $90.000 to keep in the 22% tax bracket. You don’t even touch the 24%. So just kind of like look at the brackets again and look at your taxable income. So I would do an IRA rollover from 401(k). Put it into the IRA. Open up the Roth with the same custodian whatever, Vanguard, Schwab, Fidelity. I don’t care. And then just max out that bracket. I think that 22% tax bracket is okay. If he’s got $700,000, the top of the 22% is probably the right answer. I would not probably touch the 24% because he could- I’m not sure how long he’s going to continue to work either. Because if he’s 64, I don’t know maybe he works until when? Let’s just say the next 4 or 5 years at $105,000, you could still convert like say, half.

Al: You could convert a lot. All I’m suggesting is it depends upon- like let’s say Smitty’s got a lot of pension income then he’s going to be in a high tax bracket, I totally agree with this. But let’s say he’s got no pension income and he’s got no rental property income. He’s got very little other income except for what’s in his 401(k) and his Social Security. Then I would not necessarily convert it all because now you’re paying in the 22% bracket when you put it-

Joe: Then in the future, he’s gonna be in the 0%.

Al: -0% or what will be the 15%- 10%, 15% bracket. The other step in this, I agree with everything you said Joe, but you also want to look at what tax bracket you think you’re going to be in in retirement to help you with this decision.

Joe: And then you want to make sure it’s strategically balanced. There is a formula but it’s not as easy as saying you want 1/3 in a Roth and 1/3 in a brokerage account and 1/3 in a retirement account. It’s really looking at, if I did nothing with all my other income sources and assets, when I retire, what tax bracket potential am I going to be in? And then you look at if you’re going to retire prior to 72 now then you look at age 72 to say, what is this do when RMDs hit? So then you could kind of guesstimate what tax bracket that you’re going to be in. So then that’s kind of the easy step to say well if I’m going to be in the 24% it makes sense for me to pay 22% because I know the 24% is going to 28% in a few years anyway. So then you’re paying less tax. But I also agree that you don’t want to overshoot this thing and blow your load and all of a sudden you’re paying a lot more tax than you needed to.

Inter-Plan Conversion: Direct Rollover from 401(k) to Roth?

Joe: We got Zisi from Washington State.

Al: It’s quite a name.

Joe: I love it.

Al: You know I think if you’re a parent goin’ you know what I think I want to name you Zisi because I want you to be dead last in everything that ever happens in school because it’s all alphabetically.

Joe: Why would anyone want their kids to be dead last in anything?

Al: That way they can not have to go first. They can watch everyone else. Get schooled by everyone else.

Joe: Got it. Everything that you said there was very negative. Get schooled. You should say you can learn from- get schooled is like you’re getting schooled. Like I’m gonna school this question here. “Hello, Joe, Al, and Andi. This is my 2nd e-mail to the podcast.” Well, there you go, repeat listener. “Tax year 2020, I have been contributing to an after-tax in my company 401(k) administrated by Vanguard. The plan does not allow for in-service distribution conversion. However, they allow direct rollover and I want to take advance of that. Here’s what I’m planning to do-” okay so I think she’s getting confused with some terminology here.

Al: Little bit.

Joe: “Number 1) Vanguard will liquidate the funds purchased with my after-tax money. Total proceeds are $2100; $2000 is my after-tax basis and $100 gain. Step 2) Vanguard will move $2000 to my Roth IRA, $100 to my traditional IRA. No, I’ve already contributed to my 2020 year non-deductible $6000 IRA and converted that to a Roth IRA earlier this year. Here’s my question: Can I convert the $100 from my traditional IRA to my Roth IRA?” Would I be breaking any IRS rules by doing so?” The answer is no. Because what she’s thinking is that- she’s thinking of contributions versus conversions. And if that extra $100 was classified as a contribution then the answer would be no. But as a conversion, there is no limit to how much money that you can convert as long as you pay the tax on $100.

Al: Absolutely. Yep.

Joe: “How many times a year can I move this after-tax money?” Well as many times as the plan allows.

Al: There’s no limit there.

Joe: “Can I repeat the same process next year and not violate any rules?” Yes. It all really depends on the plan document but if you’re looking at IRS rules, no, you’re fine. “Question 4) Is there anything else I should consider? Thanks for your taking my question.” So what she’s doing is she’s got a 401(k) plan and she’s- there’s after-tax dollars that can go into the 401(k) plan. So $19,000 is the most that you can put in the plan; $25,000 if you’re over 50. Is it $19,500 and $25,500?

Al: $19,500.

Joe: $19,500 and $25,500. Or is it 26? I don’t know how, it just-

Al: It’s $19,500 and $26,000. Sorry.

Joe: $26,000. See? I knew it would come back. Just a little brain fuzz.

Al: Now that you’re getting older.

Joe: So she’s asking, can I put more money into the plan? If the plan allows, the answer’s yes, up to $50,000 some odd. So let’s say she’s putting $25,000 in, she can put in another $25,000. The other $25,000 is after tax.

Al: You have to subtract out your employer’s contributions. So that gets taken off of that. But yeah. Some plans allow you to put after-tax money in and you should because you can take that after-tax money and have that sent right directly to a Roth IRA. It’s a great way to go.

Joe: So when you say how “the plan does not allow in-service distribution or conversion”. Oh it’s- your words are wrong here. So it’s like an inner plain conversion is what she’s talking about.

Al: I think so.

Joe: So taking pre-tax from the 401(k), moving into the Roth side of the 401(k); but it allows it in-service distribution because that’s what you’re doing. You’re taking the after-tax dollars out of the overall 401(k) account and you’re moving those after-tax dollars into a Roth. Any earnings then, you’re pushing those into an IRA. And then you’re converting the earnings into the Roth and paying the tax on the earnings. You could do that, that way is fine, or you could put the whole after-tax plus earnings into the Roth and pay the tax on whatever the earnings are. So what you’re doing is fine. Keep doing it and maximize that as much as you possibly can.

Al: Yeah I agree. It’s up to the plan. If the plan lets you do it every month or quarter. Go for it.

Joe: That’s just a lot of hassle, paperwork, gotta do it annually.

Al: Me too.

Joe: So just maximize it and then each year you just pop it out and put it in the right accounts.

Should We Max Contributions to Our Roths or Pay the Tax on Roth Conversions?

Joe: Adam from Pennsylvania. Imagine this, we got another Roth conversion question.

Al: It’s amazing.

Joe: “Joe and Big Al. Roth conversion question from a couple in their early 30s. Should I focus on maxing out our Roth IRA accounts, $12,000 cumulative each year or is that $12,000 better used to cover the taxes on Roth conversions of our existing $170,000 pre-tax 401(k)s? Both of our employers offer Roth in-plan conversions. Our income puts us in the middle of the 22% tax bracket; 3% state tax bracket. We have cumulative pre-tax 401(k) balances of roughly $200,000; Roth balances of $20,000; we have $150,000 mortgage 2% on a $200,000 property; $15,000 auto loan; no other outstanding debt; fully-funded emergency fund.” I like this question but the only thing he left out- he’s in a 22% tax bracket. I’d like to know what his income is in regards to- what’s he saving in the 401(k) plans? Because he’s probably making $100,000 to $170,000 a year.

Al: Somewhere in there.

Joe: He’s early 30s. He’s already got $200,000 saved. It’s pretty impressive.

Al: That’s good. I think I would answer it this way. I mean if it’s 22% federal and 3% state, that’s 25% tax rate. So if he- if you save $1 to do a Roth conversion, you’re going to be able to get $4 converted and pay the tax with $1 or if you do a Roth contribution, $1 equals $1. So I’d rather save the money if I have a choice- I’d actually like to do both. But if there’s a choice, if there’s only one choice, I’d rather do a conversion because I can get about 4 times as much money into a Roth by paying the tax with the $12,000 than I can doing a contribution.

Joe: I would disagree with that. I’m going to go the opposite here. I think what he should do is put- he’s 30 years old. He’s got $170,000 in a 401(k) plan, switch all of your contributions to Roth because it’s the time value of money that matters the most. So that $170,000- if he takes the $12,000 that could be contributed to a Roth or his Roth 401(k) plans, that’s less money that he’s potentially saving. But if he’s maxing out- that’s why I was thinking if he’s maxing out his 401(k) plans and how much is he actually saving? And where’s he saving it? My answer might change.

Al: I’m- and I get your logic. But here’s another angle- which is he’s in the 22% bracket which we know is going away in 2026. So we got 4 years of lower taxes and being in their early 30s their incomes probably going to go up and they’re going to be in higher brackets. So what better time than to get more money converted than today? So anyway you can play that either way.

Joe: Adam, take that. Do what you want with it. I would- I’m a big- at 30- you got $170,000. I would- all future savings go Roth, for sure. And if you want to convert, convert.

Can I Pay Taxes on a Roth Conversion with My Tax Refund Before I Get It?

Joe: We got Brent from West Texas. “Greetings from the oil field in West Texas.”

Andi:  Do you think his name is really Brent?

Joe:  Why not? Why would he lie?

Andi: West Texas Crude? He’s talking about the oil fields?

Joe: Am I missing an inside joke?

Andi: Brent Crude Oil?

Al: Never heard of that.

Joe: Not Brent, Bent. Brent?

Andi: Brent Crude, right now. $26.69.

Joe: Oh.

Al: Okay, well there you go. See, we get educated on this show.

Andi: Anyway.

Joe: I thought his name was Brent. I don’t know. What- did you write this question yourself? Did you make it up? Trying to make a little joke here?

Andi: No.

Al: She changed the name.

Joe: Got it. Well anyway, Brent Crude Oil-

Al: He loves the show, 5 stars.

Joe: “Can I calculate my tax return and use the projected refund amount to pay the taxes on a Roth conversion before the conversion deadline. Let’s say it’s March 2021. I’m in the 22% tax bracket. I’ve submitted all documents and completed my tax return with Turbo Tax but have not filed. I am projected a federal return of $10,000 for 2020. Before I actually file I convert $45,000 from a traditional IRA to a Roth IRA, since 22% of $45,000 is $10,000. I update Turbo Tax with the conversion amounts and my refund is now zero. Since I will owe the taxes from my conversion which was- which wash from the refund. I sent my taxes go on with my life. Does this all sound good to you guys?” Brent, no.

Al: You got your years mixed up.

Joe: Yeah. Because the conversion needs- here’s what you do. You could do this I suppose- so he’s doing a conversion of $45,000 and say I’m gonna get a refund of $10,000. I want to do the conversion and just kind of update my tax return and I got the $45,000 in the Roth and you know what IRS, just keep the $10,000. In theory it sounds good but the Roth needed to be done in the previous year.

Al: Right. So if you’re doing a 2020 return I guess that’s what you’re talking about. So in 2021 if you do the conversion in 2021 it’s a 2021 income. What you could do though in 2021 when you file your return and there’s a $10,000 refund you could just apply it to next year’s taxes and then it’s already in next year. Or if you thought you were going to get a $10,000 refund before you could do that conversion in December, let’s just say. It’s a fine idea. You just have to make sure your years are right.

Joe: Brent. We probably should have known that.

Andi: I was surprised.

Al: There’s a lot that you and I don’t know. It’s because we’re so laser-focused on our craft.

Joe: I did know Brent Crude Oil but I thought it was Bent for some reason. It’s been a while since I’ve looked at crude oil, to be honest with you.

Andi: Got it.

Joe: That’s Brian Perry’s job anyway.

Al: It is. We don’t get involved in that.

Joe: We’re having cocktails. That’s it for us folks. Bring in your questions, we’ll answer them if you want really bad advice, you know where to go. Your Money, Your Wealth®. We’ll be back next week. The show’s called Your Money, Your Wealth®.

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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.