Joe Anderson
ABOUT Joseph

As CEO and President, Joe Anderson has created a unique, ambitious business model utilizing advanced service, training, sales, and marketing strategies to grow Pure Financial Advisors into the trustworthy, client-focused company it is today. Pure Financial, a Registered Investment Advisor (RIA), was ranked 15 out of 100 top ETF Power Users by RIA channel (2023), was [...]

Alan Clopine

Alan Clopine is the Executive Chairman of Pure Financial Advisors, LLC (Pure). He has been an executive leader of the Company for over a decade, including CFO, CEO, and Chairman. Alan joined the firm in 2008, about one year after it was established. In his tenure at Pure, the firm has grown from approximately $50 [...]


Andi Last brings over 30 years of broadcasting, media, and marketing experience to Pure Financial Advisors. She is the producer of the Your Money, Your Wealth® podcast, radio show, and TV show, and moderator for the firm's digital events. Prior to joining Pure, Andi was Media Operations Manager for a San Diego-based financial services firm [...]

Published On
July 26, 2022

The time may be right for a giant Roth IRA conversion, especially now while the market is down, to potentially give you more money to spend in retirement. How does that work with long-term capital gains and dividends, and how much should you convert to Roth, and when, and how? Plus, deciding how to invest 529 plan college savings, whether to save to pre-tax or post-tax retirement accounts, and the ever-popular Backdoor Roth strategy. 

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Show Notes

  • (00:48) Retirement Spitball: Long-Term Capital Gains, Dividends, and Roth Conversions (Carl Spackler, FL)
  • (07:17) How Much Roth Conversion? When to Convert, and How? In-Kind, or Sell and Transfer? (Teri, Utah)
  • (14:05) How to Invest 529 Funds? Taxes Will Be High. Should We Save Pre-Tax or Post-Tax Retirement Accounts? (Ryan, Little Rock, AR)
  • (22:24) How To Avoid Double-Taxed 401(k) Withdrawals? With a Backdoor Roth (Jeff, San Diego)
  • (25:50) Backdoor Roth: How Do Roth Contribution Gains or Losses Affect the Pro-Rata Rule? (Kevin, NJ)
  • (33:43) Required Minimum Distributions and Roth Conversions (and Tax on UTMA Accounts) (Jim, Dallas, TX)
  • (40:11) The Derails

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Today on Your Money, Your Wealth® podcast 388, the time may be right for a giant Roth Conversion, especially now while the market is down, to potentially give you more money to spend in retirement. Now, how does that work with long term capital gains and dividends, and how much should you convert, and when, and how? Plus, deciding how to invest college savings, whether to save to pre-tax or post-tax retirement accounts, and the ever popular Backdoor Roth strategy. Visit YourMoneyYourWealth.com and click Ask Joe & Big Al On Air to send in your money questions, comments, suggestions, requests, or stories. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

Retirement Spitball: Long-Term Capital Gains, Dividends, and Roth Conversions (Carl Spackler, FL)

Joe: Got our good buddy, Carl Spackler writes in again. “Andi, thanks for getting my question to Big Al. I guess I goofed in my example because I didn’t take into account that capital gains don’t apply for married couples with income under $83,000. So, with that being understood, I like to resubmit the same question with a different income situation.”
This is called taking advantage.

Al: I think we already answered this, but we’ll do it again. It’s okay.

Joe: “I plan on retiring in 6 years with about $1,500,000 in IRAs, $1,000,000 traditional, $500,000 in Roth, which I wouldn’t need to touch for 10 years. Hopefully it will be $3,000,000 by the time I need it. During those 10 years, I’ll be living off about $1,000,000 that I have in a brokerage account. I have zero income other than the investment income that would be generated. However, I also want to be converting the non-Roth IRAs over those 10 years. I will be fairly young in retirement, 55, so I can spread those conversions out longer than 10 years if needed. However, I like the idea of finishing all my Roth conversions within the 10 year time span because I plan on taking my Social Security at age 65. And I really like the idea of not having to pay taxes on my Social Security. Am I overvaluing tax savings on Social Security by rushing the conversion? Let’s assume my $1,000,000 creates $40,000 a year in capital gains. Could you spitball what my options are? For example, perhaps $83,000 max to avoid capital gains, plus $26,000 standard deduction would give me about $109,000 of room. Assuming $40,000 in capital gain, that leaves $69,000 for conversion is my most favorable option. Again, just spit balling. Thanks, Carl. Spackler.” That’s the old Caddy Shack.

Al: That’s right, yeah.

Joe: “Florida. PS. My next door neighbor is Freida’s boss. Small world.”

Andi: Got a movie buff here.

Al: Apparently.

Joe: He likes the old ones. He loves Chevy Chase. Love Chevy Chase. And Billy Miller. Or Billy Miller.

Andi: Bill Murray.

Joe: Bill Murray. Not Billy Miller.

Andi: Who’s Billy Miller?

Joe: Billy Miller. Billy Miller is a portfolio manager.

Andi: Of course. Just right up there with Bill Murray.

Joe: Yeah, Billy Miller. He beat the S&P 500 for, like, I don’t know, 30 some odd years. Now he’s completely washed up.

Al: It doesn’t last, does it?

Joe: It doesn’t. It doesn’t. But it’s a good ride.

Al: Yeah, right.

Joe: While you’re on it. Okay, so to answer your question the same exact way as we did last time, is yeah, just avoid the capital gains.

Al: So here’s how it works. Roughly $83,000 is the top of the 12% bracket for married couples. Now, that’s taxable income, right? Taxable income. And the standard deduction is about $26,000. So you just add that to the $83,000. So in other words, you can produce about $109,000 of income and- of all sources of income and stay in that 12% bracket. If you are in the 12% bracket, your capital gains are tax-free. So let’s just say in your example, $40,000 of capital gains. They’re in the 12% bracket, they’re tax-free. That’s a great deal. So that means then, let’s see, what’s the math here? $69,000. So $40,000 plus $69- $69,000 conversion gets you to $109,000 of gross income. You subtract the standard deduction, you’re at $83,000. Then you’re in the 12% bracket. You will pay 12% tax on the Roth conversions of $69,000, but the capital gains are 100% tax-free.
Love it. Absolutely love it. It absolutely works. Now, for some reason- now I’m going to spitball- first of all, that was fact, what I just said. Spitballing is if you really want to get this done in 10 years, why not do a giant one this year when the market is down? So, yeah, if you do a bigger one, you’re going to be in the 22% or even 24% bracket. But you can probably, instead of $69,000, you can probably get almost $300,000 converted and stay in the 24% bracket. And it’s like, well, yeah, you paid an extra 10% or 12%, but the market is down 20%. So if you think about it that way, if you’re going to supercharge this, you want to do it while the market’s lower.

Joe: Yeah, I like it. $89,000, that will get the whole thing out in 10 years, and that would keep him in the 12% tax bracket, and then he would be in the 0% tax bracket for life. But Carl, what you got to consider here too, is that everything doesn’t necessarily have to be out because how Social Security’s taxed is based on provisional income.

Al: Correct.

Joe: And so what provisional income is that you take a look at your AGI and then add back half of your Social Security. And then as long as you can keep that under roughly $40,000, you’re still going to be tax-free. If- he’s married, right?

Al: Yeah. But it’s going to be hard to do that if in fact he’s got $40,000 of investment income.

Joe: True.

Al: Because you’re already there.

Joe: But he needs to tax manage the non-qualified account. But he’s going to burn through that because he’s going to live off of that $1,000,000. Plus some of that is going to be have to pay for tax along the way. So everything is going to come from Social Security and a Roth.

Al: Right, I would tend to agree with that. Maybe that’s what he’s saying.

Joe: So he might not have to convert it all, is what I’m saying.

Al: Right. So as the numbers you provided, you can convert $69,000. Now, if you tax manage this better and had about a 2% dividend instead of 4%, now you have $20,000 of income instead of $40,000. Now you can convert $89,000. And then you go back to what you’re saying, Joe, is you can get this pretty much converted in 10 years, except as this thing grows, it’s going to get away from you a little bit.

Joe: Right, right, right. I think if you really want to nail this thing down, I would probably run some numbers, but he’s got the right idea.

Al: Yeah, for sure.

How Much Roth Conversion? When to Convert, and How? In-Kind, or Sell and Transfer? (Teri, Utah)

Joe: Go to YourMoneyYourWealth.com. Click on Ask Joe and Al On The Air. We’ll answer them right here. We got Teri from Utah writes in. “Hey, Joe, Al, Andi, longtime listener. Love the podcast. As of a month ago, we’re petless for the first time in 31 years.” Sorry to hear that. “I drive a Jeep and enjoy a nice pinot. Since I last wrote in 2019, we have transitioned into retirement and have not touched any retirement assets. Yoohoo. The basic facts are/were, we are 63, 62. I’m working part-time, just for insurance purposes. We have the following investments. Taxable accounts, $1,000,000. IRA is $2,000,000. Roth IRA, $350,000. Pension plans are right around $100,000 a year. Social Security at full retirement is $64,000 but plan to wait until age 70. Living expenses, $70,000-“ Yeah, well, that math works, Teri.

Al: Sure does.

Joe: “-living Expenses $70,000, pensions, $90,000-“

Al: I can see why you haven’t touched your investments.

Joe: “- haven’t touched my investments.”

Al: Cause the math works.

Joe: “I’ve already converted $20,000 this year, which makes me $50,000 shy/short of the IRMA trigger in the 22% tax bracket-” I’ll come back to that “- which allows for an extra $85,000 in the 22% tax bracket of $247,000 if I go to the top of the 24%. A couple of questions. How much do you convert? I hate paying NIIT and IRMAA but wanted your opinions. I know the big picture versus short-sightedness, so I ask.” Well, do you?

Al: Well, they want to see what we say.

Joe: Well, he knows what’s coming or she knows what’s coming.

Al: Probably she.

Joe: “Feel like the investment company prefers I keep it all with them and don’t convert. Hmmm.”

Al: We’ll comment on that too.

Joe: Okay. “Also, when I convert, should it be done when the market is low or high? And should it be done in-kind or sell or transfer? I can’t figure out which method is the most advantageous for getting money over to the Roth. I appreciate good discussion on that. Thanks. Look forward to the spitball. Teri from Utah.” Okay, Teri, your pension is $90,000 a year. You’re going to wait till age 70 to take your Social Security, which is probably going to be another $80,000, $70,000 a year?

Al: Yeah. $64,000 at full retirement, it’s going to be $75,000. Easy.

Joe: Okay. So call it you have an income of $160,000. That’s going to put you firmly in the 22% tax bracket.

Al: Right. No matter what you do.

Joe: No matter what you do.

Al: And that’s before your other investment- investable income.

Joe: Right. You have $1,000,000 in a taxable account. You have $2,000,000 in a retirement account, and they are 60. So they got 10 years. That $2,000,000 by RMD age is going to turn into let’s call it $4,000,000. Now your RMDs are going to be like, another $150,000.
So now you’re close to $300,000 of income. What do you think your IRMA is going to be?

Al: You pay through the nose.

Joe: You’re going to pay through the nose.

Al: Yeah. Forever.

Joe: Right. So you probably want to try to even it out as much as you can. So you know it’s coming. But if you want to save a couple of bucks today to pay a heck of a lot more in the future is kind of what you’re doing. So you’re going to be in the 24%, which probably would be in the 28% tax bracket later. So does it make sense to convert to the 24%? Probably, yes.

Al: I think so, too. I think you got two things going for you. The tax rates are scheduled to go up, first of all. Secondly, the market is very low. So you kind of maximize the conversion probably to the top of the 24% bracket this year. You can evaluate other years, but the extra money that you get to the Roth now while the market is low is going to be something you’re going to be very pleased on years down the line.

Joe: Yeah, later. But then you’re talking about NIT. So let’s explain real quick is net investment income tax. So that’s an additional tax that is on a capital asset. So let’s say Teri’s trading the account, if there’s capital gains, then additional 3.8% is going to be added to the capital gain. So you want to be tax efficient with the other $1,000,000 that you have in your brokerage account. IRMA what that is that depending on what income shows up on your tax return is going to determine what your Medicare payments are. It’s a two year look back. You’re 63 and 62.

Al: So one of them-

Joe: So maybe you do one and it’s not going to affect your Medicare premiums until you’re 65 because it’s a two year look back. So at 62, that might work.

Al: And by the way, that kicks in when married couple makes over $182,000 modified adjusted gross income. Net investment income tax kicks in at $250,000 of adjusted gross income for a married couple. That’s an extra 3.8% on interest, dividends, capital gains, rental income.

Joe: It depends on your investment. If you like your investment, let’s say you want to convert probably the most volatile investment, the one that’s down the most. And then I would just convert in-kind. So you have an IRA at Fidelity. You open up a Roth IRA at Fidelity, and then you just basically move the money from the IRA to the Roth IRA in-kind, pay the tax and you’re good to go.

Between market volatility, and inflation, and whatever the future holds for taxes and Social Security, it’s hard to know what money moves you should be making now to be retirement ready later. Download our Retirement Readiness Guide for 7 plays that’ll help you get there, despite all the uncertainties. Learn to make the most of your investments, control your taxes in retirement, and create income to last a lifetime. Go to the podcast show notes for a whole host of free financial resources, including the Retirement Readiness Guide, the Complete Roth Papers Package, and the full transcript of today’s episode, all free. You can also watch our latest market outlook webinar in the podcast show notes for money moves to consider making now. And watch Joe and Al answer your questions daily, along with the YMYW TV show, on our YouTube channel. Click the link in the description of today’s episode in your favorite podcast app to get started, and hit the share button to spread the love and share the knowledge. 

How to Invest 529 Funds? Taxes Will Be High. Should We Save Pre-Tax or Post-Tax Retirement Accounts? (Ryan, Little Rock, AR)

Joe: Ryan writes in from Little Rock, Arkansas. “Absolutely love your podcast. I love the spitballing. But more importantly, your methodology when it comes to financial advice. I drive an F150 2017. Enjoy any Mexican beer with a lime on a hot day. I currently am saving for children’s college through 529 plans that I’ve been funding over the last few years. I have about $90,000 and feel like I’m on track to reach the $300,000 total I will need to fund my children’s schooling. I am aggressively invested with these funds. At what point do you recommend being more conservative with these investments? I understand these funds act as one large fund as they can be transferred to the next child, but do I pull money into a safer investment a couple of years before they start school? When do you recommend? What do you recommend? Also, my 529’s are not through a state plan, but through Merrill Edge. I was told the investment options provide a better return. However, I forfeited some state tax relief. Did I mess up here?” Oh boy.

Al: What do you think about the Arkansas tax credit?

Joe: It’s like “oh, go in this one.” So we could talk about that. Yeah, let’s answer this first.

Al: Yeah, for sure.

Joe: Okay. A 529 plan really quickly is a state sponsored plan that you can invest in that gives you tax-free growth if used for higher education. Each state has their own plan. Each state picks a provider, a custodian to hold the funds. And so if you pick your state’s plan, like Arkansas’ state plan, there’s tax benefits if you use their plan.

Al: Right. If you go to college in their state.

Joe: I’m not sure what that is.

Al: And that’s not all states, by the way. California doesn’t have that. So it depends upon your state.

Joe: So if he would have used Arkansas’ plan, he would get some state tax benefits.

Al: Potentially.

Joe: But the broker goes, hey, we have better investment options in ours because the broker is not going to get paid on Arkansas’ plan because he probably can’t sell it.

Al: Yeah, I would tend to agree with that.

Joe: So did he mess up here? Yeah, you messed up a little bit.

Al: Well, we don’t know that. Maybe.

Joe: In most 529 plans too, they have like- what’s that stupid saying? The glide path.

Al: Oh, yeah, yeah, right.

Joe: So as your children get closer to college, to college age, the funds could automatically become more conservative. So I’m not sure what the Merrill Edge plan is.

Al: I don’t either. Apparently Ryan has 3 kids, age 13, 10 and 5.
So absence of a glide path, I would personally, spit balling, would say I would be getting more conservative on my investments when my oldest got to probably, I don’t know, 16, maybe, something like that.

Joe: And then also you have the Great Recession. The $300,000 is now worth $150,000.

Al: That’s right. So it’s tricky. And plus it depends upon how much you’re going to use for this kid and whether it’s going to be used. I mean, it’s really hard to have a generalization on this, but I think maybe a general answer would be, yes. You want a little bit more conservative investments when you need the money.

Joe: Right. He’s 13. So you got 4 years, 4 or 5 years?

Al: Yeah, before it’s needed.

Joe: So I don’t know, if I were looking at a financial plan and someone were to come to me and say, Joe, I need this money in 5 years, how should I be invested? The stock market is probably not the answer I’m going to give them.

Al: But if you look at this as one fund, as Ryan is, because it can be transferred from kid to kid, maybe think about it differently.

Joe: But then I’m looking at, okay, well, the 13 year old, I want to make sure that I have enough conservative growth there to at least pay for that person’s education. And then the 10 and 5 year old, I’m going to be more aggressive. So you have to do the math to kind of back into the equation.

Al: And the other part of this is you don’t need all the money when they’re 18. You need maybe a quarter. Because it’s 4 years or maybe even 5 years of college. So there’s a lot of ways to think about it. But the general answer is yes. As you’re closer to needing the money, you want to get more conservative because if the market nose dives, then you’re kind of stuck.

Joe: Yep. “Lastly, I’m 40 with 3 kids and my wife has just returned to work. Next year we are entering the 32% tax bracket. I currently have about $300,000 in my 401(k), only about $70,000 in Roth, since my company only started offering the Roth 401(k) a few years ago. At this point, everything I save is in Roth. Should I switch next year to save taxes since my taxes will be so high? Also is it good advice to just keep fully maxing out retirement accounts? With her 401(k) and mine, and the IRAs, that’s close to $50,000 a year. Is it wise? Or should I do a split between retirement accounts, taxable accounts and real estate?” All right, good question. I’m allergic to this microphone. My nose is just-

Al: It’s like going off, right?

Joe: – like just flaring up, man. It’s like itching. Sorry. All right, here’s the rule of thumb that I would do. First thing, you want to invest in your 401(k) plan to the max. So they’re matching. I would start there. And I think he’s doing that. He’s 40 years old, 32% tax bracket. I would go full Roth. Just Roth it up.

Al: I know you would.

Joe: I don’t care because you’re not going to miss the taxes.
You’re 40 years old. In 25 years from now, you’re going to call me and thank me because all of your assets are tax-free.

Al: Okay. I may disagree, but that’s okay. Keep going.

Joe: So go there, Roth and then keep funding. Go to the Roth IRA. I’ll just Roth the hell out of this thing. He’s got $300,000, $70,000’s in Roth, that $300,000 is going to continue to compound. I don’t know. I might switch it up a little bit, but I really like it- 40 years old with the amount of income that they’re making, with the amount of assets that they’ve saved. But ideally, you want to be diversified from a tax perspective. So what that means is that you want to have money in tax-deferred. You want to have money in taxable, and you want to have money in tax-free. Because then you can really control your taxes in retirement. But if you have the opportunity to have everything tax-free in retirement, I would much rather have that. But it really depends on your goals and liquidity needs and when you want to retire and things like that.

Al: That it does. And so maybe a balance is to do half of each. You’re in a high tax bracket, so maybe you want the tax deduction. But I will tell you this. You’re talking about next year. The market is still down next year, Go Roth. Right. Because all that growth is going to come screaming back and be 100% tax-free. If the market, on the other hand, has come roaring back, then maybe you pause a little bit. Maybe you do half and half. That’s my thought.

Joe: Or maybe you look at it- okay, now you’re in the 32% tax bracket. That is taxable income of what-?

Al: Well, it’s-

Joe: – $340,000.

Al: Yeah, right, exactly.

Joe: Big Ry from Little Rock-

Al: Making some coins-

Joe: Making some fat cash. Jeez, a little Mexican beers. Where’s the Dom Perignon?

Al: I think you can upgrade to IPAs.

Joe: Yeah. Something. Wow. All right. So he’s making some cash. So then it’s like, all right, well, maybe I go pre-tax to get me in the 24% tax bracket. So maybe him and his wife’s income is $360,000 of taxable. So he’s $10,000 into the 24% tax bracket. Maybe you put $10,000 in pre-tax to get him to the 24% and then everything else go Roth.

Al: Yes, that would be ideal.

Joe: I would just look at the tax brackets and see where you fall and then that could gauge your pre-tax versus Roth.

Al: Okay, agreed.

How To Avoid Double-Taxed 401(k) Withdrawals? With a Backdoor Roth (Jeff, San Diego)

Joe: All right, let’s keep moving here. We got Jeff from San Diego. “Hey, Joe. Big Al. Andi. Enjoy the podcast very much, and I’ve been listening to it for the last two years or so, typically while I’m walking my white Maltese mix, Fluffster.”

Al: That’s a mouthful.

Joe: Yeah it is. “My wife and I have retirement savings in our current job, 401(k)s, as well as several IRAs. Some of these IRAs were rollovers from past workplace 401(k)s. However, we have also made after-tax contributions to these IRAs, meaning some of the contributions were pre-tax from the traditional 401(k)s that were rolled over, and some were after-tax. We haven’t been tracking the already taxed contributions very closely and are now concerned that we may be taxed again once we start making withdrawals. Is there a form that we need to fill out with the IRS? How do we fix this? Thank you for your input and keep up the great work.” Very good. The form’s 8606, Jeff.

Al: That’s right. So on that form, you separate any basis in your IRA so that when you do pull out of the IRA, you basically get a pro rata share. So some of it is non-taxable. If you don’t know what the amount is, here’s my suggestion. Do your absolute best to figure this out and sort of err on the side of the IRS. In other words, take a conservative approach. If you think the basis is $40,000, maybe you make it $35,000, whatever. Just kind of err so that the IRS gets the benefit if they ever check. I’ve actually never seen the IRS check this. But form 8606 is a form that should be on every single tax return every single year. But then the question is, well, I’ve never done it. And the answer is that’s okay, just go ahead and start doing on a go-forward basis. Do your best guesstimate of what it should be, put that on the form, and then just continue that each year.

Joe: Here’s a way to isolate the basis, too. You could roll your old IRAs,
because all of these are 401(k)s and after-tax IRAs and things like that. If you’re still working, take the IRAs and roll it into the 401(k). The 401(k) cannot take the after-tax dollar, so it isolates the basis. So then what do you do? You just convert the basis into a Roth IRA and you don’t pay any tax on it, right?

Al: I like that.

Joe: All of you people love the super backdoor BS, this is the best way to actually do that. So hopefully that helps.

A spitball on YMYW is a great first look at your big financial decisions, but it shouldn’t be your only look before you leap. Schedule an in-depth review of your entire financial situation with an experienced financial professional on Joe and Big Al’s team at Pure Financial Advisors You can meet in person at one of Pure’s 6 offices in Southern California, Seattle, or Chicago, or via Zoom right from your couch, wherever you may be. Find out how much if any you should convert to Roth, how you may be able to pay less tax, and whether you can collect more Social Security benefits. Make sure your investments align with your risk tolerance and your retirement needs and goals. Don’t worry about paying commissions, because Pure is a fee-only fiduciary. They don’t sell investment products, so there are no commissions, and the law requires them to act in the clients’ best interest. Click the get an assessment button in the podcast show notes at YourMoneyYourWealth.com and schedule your free financial assessment.

Backdoor Roth: How Do Roth Contribution Gains or Losses Affect the Pro-Rata Rule? (Kevin, NJ)

“Dear Joe and Big Al. I love listening to your show. I just discovered it a few months ago and found both the information and entertainment off the charts.” Wow.

Al: Who knew, right?

Joe: Jeez. Off the charts. “Laugh and learn. Doesn’t get much better that. Now for my question, you guessed it Roth conversions, this time specifically to the pro rata rule and non-deductible contributions.

Joe: All right, this is from Kevin from Jersey.
“For the first time, my wife and I will have too large of income to contribute directly to a Roth IRA. In looking into the backdoor Roth, I found the pro rata rule will affect me as I had to start the year around $100,000 in pre-tax IRA from a previous 401(k) rollover. My wife has no pre-tax IRA funds, so we can do a simple backdoor for her, full contributions here.
My $100,000 became $80,000 in the market downturn. My goal was to convert up to the 24% tax bracket to the Roth and complete the rest next year. Probably $50,000 this year, $30,000 next year. So far, I have converted $20,000 of the $80,000. My question is, if I contribute the full $6000 as a non-deductible contribution now, how do any earnings or losses on that portion affect the pro rata rule? Does it not matter when I convert during the year compared to when I contribute? Only the balance remaining at the end of the year? The total converted funds in the $6000 contribution? If I wait until after I convert all the funds in March of 2023 to contribute for 2022, would that make any difference? I drive an ‘09 Infusion and love great Kentucky bourbon. Thanks for all you do, Kevin from Jersey.”
All right, so he’s looking at the pro rata rule. And what the pro rata rule is, is that if you have pre-tax IRA dollars and you have non-deductible IRA dollars, well, the non-deductible IRA dollars or the after-tax contributions are never going to get taxed again. But your pre-tax are going to get taxed. And so he wants to do the backdoor Roth. And what the backdoor Roth is, is that you can make a non-deductible IRA contribution, then you can convert the non-deductible IRA contribution since it’s non-deductible, and after-tax, there’s no tax on the conversion. The IRS came up with a rule that said, hey, wait a minute, if you have other IRAs, you will have to take a look at all of the IRAs together. So the aggregation rules-

Al: – as if they’re one account, aggregation rule. So far, so good.

Joe: And then the pro rata rule is then you take your non-deductible and you divide it into the total balance of all of your IRAs to get a certain percentage. And then that will determine what percentage is taxable, what percentage is tax-free.

Al: Sure, makes sense.

Joe: So he’s trying to figure out when do they do that calculation? Because he’s like, if I do a conversion this year and I do a non-deductible IRA contribution, when do they take a look at the balance of the account to determine the pro rata rule?

Al: Yeah. And so it’s the balance at year end. Right?

Joe: So if he converts-

Al: – now- well, if he does the non-deductible now and converts- but then he rolls back into 401(k), then there’d be no IRA, right? And so I believe it would be then tax-free because it’s the balance of all IRAs at year end that determine that. On the other hand-

Joe: For the next year or for that year?

Al: For this year. The reason I’m thinking this is because remember, when someone takes their 401(k) right at year end and rolls to an IRA, they’ve already done the backdoor Roth it screws that whole thing up because it’s the balance at the end of the year.

Joe: Yes, I agree. But I’m also trying to think of- because I could see his point here. So let’s say if I did a backdoor Roth IRA, January 1, I didn’t have any other IRAs and I said, all right, I’m going to do a non-deductible IRA and then convert it into a Roth. Now, that’s satisfied.

Al: Because I’m good right then.

Joe: I’m good right then, right? I satisfy the pro rata rule and I satisfy the aggregation rule because I have no other IRAs. But then in June, I roll my 401(k) of $100,000 into an IRA. So does that backdoor Roth that I did in January- the rules all of a sudden change?

Al: They do change. Because it’s the balance at year end and then in this case the end of December 31, 2022, even though you did the backdoor Roth in January of 2022, it doesn’t matter. It’s what your IRA balances are at year end. And maybe it’s in reverse. I’ve never even thought of it. But it should work in the reverse, right? In other words, you did the back door Roth when you had IRA, but then by year end you rolled it into 401(k). So it’s not there. And by the way, the 401(k) does not count towards this aggregation role. It’s only IRAs. So I think that would- if you end up rolling, if your new employer, if you end up rolling it in. I think that does work.

Joe: Yeah. No, without question, it’s at the end of the year. Because I was just thinking, well, wait a minute, how about if he converted $30,000 and then did the non-deductible IRA contribution, and then did the backdoor? His aggregation or the pro rata percentage would be different, but he still has to pay the tax on the $30,000 that same year anyway. So it’s all going to work out.

Al: Yeah. If you convert everything, it doesn’t matter. Right?

Joe: No, what I’m saying is that if he has $100,000 in an IRA, January 1, he converts $50,000. And then in June, he does a $6000 non-deductible IRA contribution. So the balance of his IRA is $50,000. So $6000 into $50,000 is what-?

Al: Call it 12%.

Joe: So 12% is the pro rata rule. Do you agree with that?

AL: Yeah.

Joe: So then if he converted the $6000, 12% of that would be tax-free.

Al: Yes, I agree with that.

Joe: But the pro rata rule should have been $6000 into $100,000, which is 6%. But he already paid tax on the other $50,000, so he still thinks it washes. Right?

Al: I think, but I’m not 100% sure, that’s my best hunch.

Joe: Okay. We’re just totally in the weeds here. And that’s exactly what I didn’t want to get into.

Al: I know. Me neither. I was reading this question. It’s like, how are we going to take this?

Joe: So next year, he converts everything and then he does a non-deductible IRA and then converts that. He’s fine.

Al: Yeah. So if you want to be 100% safe, do it next year.

Joe: Yeah, convert whatever you want to convert this year. Don’t do a non-deductible- or you know what? Do the non-deductible IRA contribution anyway.

Al: Yeah, but then convert it next year.

Joe: Then convert it next year. And then you convert everything next year, and then the both non-deductible IRA contributions for this year and next year will be converted and you won’t pay tax on it.

Al: I like that. That’s a safer bet.

Joe: All right. Look at that. See, we finally got there.

Al: Yeah. And you can do two backdoor Roths next year, right? Yeah. Because you can do one till April 15. You could do it right now and then convert it next year. Or you could do two, one for 2022 and one for 2023 in January, February, March, April 15-

Joe: Yeah. Because you’re making two contributions, one for both years.

Al: Right. And then convert it. And you’re converting everything. You’re good.

Joe: Yeah. If you’re converting everything, then yeah, you’re all set. Wow. Like when a plan comes together.

Required Minimum Distributions and Roth Conversions (and Tax on UTMA Accounts) (Jim, Dallas, TX)

Joe: Got Jim from Dallas, Texas, writes in. He goes, “Hi, Joe and Al. I’m hoping you can assist me with the below questions. If I were to delay my first year RMD until April 1 of the year following I turn 72, should I still do a Roth conversion in the year I turn 72? For example, if I were to turn 72 in 2022 but wanted to defer my RMD until 2023 and take two in that year, would I still be able to do an RMD in 2022? My guess is no.”

Andi: I think he means would I still be able to do a Roth conversion in 2022.

Al: That’s what I think too. I think that’s what he meant to say.

Joe: That answers a bunch of different questions. Okay, “Second question, completely unrelated. Who pays the taxes on a UTMA account?” All right, let’s go back to the Roth conversion. RMD, Required Minimum distribution. So he’s talking about a required beginning date, and what that means is that you don’t have to take the RMD at age 72.

Al: Yeah. That’s when you’re supposed to. But you can actually push it to April 1 of the following year.

Joe: So you’re 73 is your required beginning date. It’s like, well, I thought RMD- because people might forget.

Al: Yeah, that’s why they did that rule, because I’d say a lot of people don’t realize they’re supposed to do it, so they let you do it next year till April 1, but you have to take the one for 2023 when you’re 73. So you have to take two of them in that year if that’s what you do.

Joe: You’re making up for the one in 2022, and you’re taking the one for 2023-

Al: But at least you don’t get penalized, and the penalty is pretty steep, 50%. 5 – 0 %. So you don’t want to miss it.

Joe: So Jim, he wants to delay his RMD till age 73. Can he still do a Roth conversion at age 72? And the answer is yes.

Al: Of course. You can do it at 73. You can do it at 80. You can do it 105. I don’t care what your RMD is. You can always do Roth conversions any age, working or not.

Joe: But the RMD has to come out first.

Al: True. Good point.

Joe: You cannot convert an RMD. So sometimes people will be like, well, my required distribution is $40,000. I don’t need the $40,000. It’s a mandatory distribution where I have to pay the tax. Can I just convert it to a Roth? And the answer is no, an RMD is a full distribution. The reason why the RMD exists is that they want to recycle the money because it’s been growing tax-deferred for how many years that it’s been in the account. And so at 72, they’re like, okay, well, now it’s time to take the money out to pay the tax. And they don’t want that to go back into a retirement account. They want that to go into a brokerage account. So they can continue to tax it on an annual basis, depending on how it grows. Or that you actually take it out and spend it or do something with it instead of putting it in a tax-deferred vehicle where you’re still deferring tax year after year after year. So that’s why RMD is a full distribution. Pay taxes on it. You cannot convert it. If Jim wants to do a conversion in 2023, he can, but he has to satisfy the RMD first.

Al: And in this case, both of them.

Joe: And if you don’t do that, it’s an excise contribution to the Roth IRA.

Al: Don’t want to do that.

Joe: Yeah, because that’s a 6% penalty per year that those dollars are in there.

Al: Right. So I think that’s a really good point. So when you have to take an RMD, required minimum distribution, because you’re 72 or older, you can still do Roth conversions, and it all happens in the same year, you just have to take your required minimum distribution first, then you can do the Roth conversion after. So don’t do your conversion first and then do the RMD second, because that screws this whole thing up.

Joe: Yes, because I was going to get in the weeds. I’m not going to do that.

Al: Really? Okay. Usually that’s my job.

Joe: Yes. Who pays the taxes on UTMAs?

Al: The kids. So here’s what happens on UTMAs. This is a-

Joe: – unified transfer to minors.

Al: So this is a kid’s account, but the parent is on there. So the kid doesn’t really have access to the funds till 17? 18? Something like that. But the kid pays the tax, and here’s how it works. The first $1100 of income is tax-free. The next $1100 of income is taxed at the kids rate, which presumably is low, unless they’re child actor or something like that. Everything above the $2200 is taxed at the parents maximum rate. That’s the so-called kitty tax. So that’s how that works. But it does happen on the kids return. You can do a special election to pay the tax on the parents return. It’s just a special form. But in essence, it’s the kid paying the tax.

Joe: Even though the money could come from Jim.

Al: It definitely would come from the parents. Yeah, for sure. But that’s how mechanically, the kid is supposed to pay the tax. So that kid better get a paper route. Cause they gotta pay this tax.

Joe: Alright that’s it for us. Hopefully you enjoyed the show, we’ll see you next week. Show’s called Your Money, Your Wealth®.

The Derails


Joe and Big Al experience Mexican beer deja vu in the Derails at the end of the episode, so stick around. 

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