Larry Swedroe

Larry Swedroe is principal and director of research for Buckingham Asset Management, LLC, a Registered Investment Advisor firm in St. Louis, Mo. He is also principal of BAM Advisor Services, LLC, a service provider to investment advisors across the country, most of whom are affiliated with CPA firms. Swedroe's mission is to educate people on [...]


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 [...]

Published On
February 27, 2017

Whether Social Security will be around when you need it – or not. Tax planning if you’re a millionaire or just want to be one. And how to really diversify that investment portfolio. This is Your Money, Your Wealth.

Today on Your Money Your Wealth, Larry Swedroe from Buckingham Strategic Wealth discusses factor-based investing and explains the difference between alpha, beta and smart beta. Big Al lists the 7 tax planning tips for millionaires and those who want to be millionaires. Joe and Big Al talk about Social Security and the often overlooked family benefits. And, the fellas answer emails on SEPP, 72(t), IRAs, 8606’s, 1040’s and other mysterious numbers and acronyms. Speaking of acronyms, here are Joe Anderson, CFP, AIF, and Big Al Clopine, CPA.

:46 – Will Social Security Be Around When You Need It?

JA: All right welcome to the show. We got a lot of things to discuss. I want to get into Social Security Alan. I read an article from our crack research team, they only printed off half of it because the printer ink went dry.

AC: Yes. So how much of the article do you have? Or do you have selected words?

JA: We’ve got bits and pieces but I think you’ll get the gist of this. (laughs) So I was at a junior college and our retirement planning course over the week and I was going through Social Security and this one gentleman just said, “hey don’t you think you’re being a little bit, you know, aggressive with your assumptions?” And I was like, “Well tell me more,” and he was like, “well you know I just don’t know if Social Security is going to be there.” This gentleman was probably in his mid-50s. I usually get that with the younger generation. You know if they’re in their 20s and 30s, maybe 40s even, they’re like, “well, hey, you know what, let’s let’s plan my retirement without it.” And I’ve been doing this close to 20 years. And you know when I started in the business I was 20. And so I was working with people my own age. That’s what you kind of have to do when you first start out right? So that was 20 years ago and they’re like, “No let’s not count it.” And so 20 years later… I think we talked about this in the past with Social Security with your father.

AC: Yeah my dad used to get all mad because he was paying in and his mother in law was receiving payments since she never worked in the Social Security system. And he’s going, “I’m paying her payments, I’m not going to receive a dime.” Now he’s 84, been receiving payments since 65 or whatever the age was when he started taking it. And you know what Joe, I said the same thing in my 30s and 40s and now in my 50s. Yeah I actually expect it to continue.

JA: So when you take a look at the OASDI fund, that’s the trust fund, there’s about $2 trillion. But more money is going out of that fund to pay participants, you know, retirees

AC: And that’s what’s changed. I mean before that, we were taking in more. So the trust fund was building, now the trust fund is shrinking. But the thing people forget is that money is constantly going in there. We’re still paying FICA taxes in our payroll so it’s not going bankrupt. I mean here’s the worst case, in 2034, 2036 we’ll get 77% of our benefits. So that’s not nothing.

JA: Right. Yeah. And if you’re already collecting, what the law states today is that you’re grandfathered in, so they may need to make some changes for the other groups that are coming in behind you.

AC: You bet. And, by the way, they have made changes in the past. They increased the retirement age. They increased the cap, the salary cap as to what they collect. They’ve increased the percentage, and they will likely do those three again. I guess Joe, one thing just really quickly, is means testing is something that could happen. And so if you’re wealthy, you may actually want to not count on it just because you never know.

JA: Or you take it as soon as you can get it.

AC: Take it as soon as you get it, right, that would be true of course. Now if you’re wealthy and if you are subject to means testing, maybe you don’t really need it.

JA: But they put into it, they deserve it Al, right?

AC: They do deserve it. Yeah.

JA: So anyway… wow that went sideways real quickly. (laughs) All right, so this is from Financial Advisor Magazine. Bernie Sanders, you’ve heard of him? So he suggests upping Social Security tax cap on incomes over $250,000. So right now we pay Social Security tax, or FICA tax, into the OASDI fund, up to your first $127,000 of earnings. And after that you don’t pay any more in to FICA. But you do pay into Medicare. So what he’s suggesting is that for income earners over $250,000, that there will be another tax assessed at that income level. So then this is where my notes get a little murky. (laughs)

AC: So you built it up? There’s no conclusion? (laughs)

JA: But I do have some fun facts. So he was saying he was like, well, if Donald Trump made as much money as his campaign says he did, he would have stopped paying Social Security taxes 40 minutes into the year. So, I think they talked about this before too. If you’re single, over $200,000 if you’re married, $250,000 of income, then there would be another tax. Up to a certain dollar figure up maybe another one or two percent or something. So just I guess what I’m trying to say is that there’s workings here to try to fill the gap of the trust fund by taxing a little bit more for higher wage earners. And so with his plan and you can look it up in the Center of Economic Policy and Research.

AC: So that’s the Bernie Sanders plan?

JA: Sure. But what he’s basically saying is that his proposal would fill the gap in that additional money that would go in would only affect 1.6% of workers. So in effect, the top 1% again. Back to that. And so then it’s all solved. But they have made some changes. Just last year they changed the file and suspend, restricted application. So for those of you that are 62 years of age or that turned 62 years of age last year, or full retirement age, those claiming strategies are still available to you. But they try to put this timeframe, it’s like, all right, well here, if you’re close to claiming, or if you’ve already claimed the strategies, you’re locked in. But again, for the younger generation that is coming up to those ages, they can no longer take advantage of those claiming strategies. They could reduce the cost of living. I think we talked about this a couple of weeks ago, is that, what was the cost of living this year?

AC: Well was it was like .01, .001%

JA: Yeah something like that. For the average person I think it was like $300.

AC: It was the lowest increase in the history of Social Security. That’s what the headline said but it omitted the times when it was zero. So it seems like something more than zero at least in my math.

JA: Exactly. Well you are a CPA. (laughs) But there’s different things, so let’s talk a little bit about Social Security because I think there’s still some confusion when you should take it how you should take it. How is it taxed. And then there’s the spousal benefit there’s a survivor benefit and then there’s also a child or dependent benefits.

AC: Well there are Joe, and I guess just the basics. The full retirement age this year is 66 years and two months of age. That’s where you receive your primary insurance amount, your full retirement amount. Now you can take it earlier, you can take it at 62 if you want, but there’ll be a little bit of a haircut. And this year it’ll be about a 26% reduction from your full retirement amount if you take it at 62. And what’s happening currently is the full retirement age used to be 66, last year. It will be 67 in a few years, so there’s kind of a phase in period. So anyway, and then the third thing is you could take it at age 70. And if you wait till age 70, you get quite a bit more. And to put this into real numbers, if your benefit is $2000 at full retirement age, it’s around $1500 at 62, and it’s around $2600 plus at 70. So you can see by waiting just a few years, you get a lot higher benefit.

JA: But when they talk about the crossover, right? So what’s the breakeven? So it depends on all sorts of different assumptions. It depends on if you take it at 62 and invest it. So if you invest it, and you earn a certain assumption rate or assumed rate of 7% well then the breakeven is going to be fairly far out.

AC: Or if you earned 15%. If you can pull that off, then yeah, you might as well take it at 62.

JA: But I would say the majority of individuals that take it at 62 they spend it. They don’t necessarily save it.

AC: That is true.

JA: Right. If they did save it they probably might make more sense to wait. Right. Because it’s a guaranteed income stream. So you have to take a look at it. In our opinion, as longevity insurance? Right, because it’s going to be a guaranteed fixed payment for the rest of your life, and the longer that you wait, because we are living a heck of a lot longer than ever before, and so a lot higher fixed income payment is probably going to be beneficial for most of us because there’s a lot of uncertainties. And of course there’s uncertainties in the Social Security, but I think there’s more uncertainty in the overall stock market, bond market, and everything else in between as you invest your overall assets. If I can get a guaranteed rate, or increase in my overall benefit, I think people should be taking a look at that.

AC: Right, I agree with that. And I think the key is just what you said longevity insurance. In other words, some of us are going to live into our 90s, even 100s. Do I dare say 110? You know we don’t know. I mean medical advances, people are living longer.

JA: It’s not an investment it’s an income stream.

AC: It’s an income stream and it’s there as long as you’re living. And in fact if you were to pass away your spouse gets your income stream. And, boy, if you do nothing else. If you at least look at you and your spouse, whichever one has a higher benefit, if you can afford to wait at least for that higher benefit individual till age 70 then no matter which of you survives the other one, the survivor will receive that higher benefit for life.

10:09 – Social Security Family Benefits

AC: Our children can get benefits, Joe, and I don’t think a lot of people know that. In fact about 4.3 million children, according to the Social Security Administration, are receiving benefits and the benefits add up to about $2.6 billion per month. And you might think, well all right, I could see where my kids would get benefits if I’m disabled, or if I’m deceased. But what about this, what if you retire, what if you’re at retirement age and you have young children. Could that happen? Yes it could happen.

JA: I think I’m on that path.

AC: This is for you Joe Anderson. So listen up. (laughs) Let’s say you’re age 62, for example, you got a four year old.

JA: Trump,he’s, what, 71, well, the little guy?

AC: Yeah he’s got he’s got a kid under age 18. Right. So he’s a perfect candidate for this strategy. Right.

JA: Do you think Trump waited till 70 to get his benefits?

AC: (laughs) Who knows what President Trump did. That’s a mystery. But here’s what you can do…

JA: Do you think he’s claiming his dependent benefits?

AC: I think he probably is double dipping everything he can. So at any rate Joseph, for our listeners, and perhaps for you, coming down the line, if you have an eligible child, in other words your retirement age, 62 or older, and if you got a child that is your biological child or adopted child or a step child or it could even be a dependent grandchild, so there’s where I come in. Could be me.

JA: Knowing your kids its not gonna happen.

AC: To receive the benefits… By the way let me just acknowledge, I’m going over this topic because a colleague last night asked me to talk about it on the air. So here we go. So if you have a child, the child must be unmarried, under age 18. Or they could be up to 19 years old if they’re a full time student, no higher than grade 12. So I guess if you’ve got a student that still 19 and hasn’t quite gotten through high school, this counts. (laughs) But boy, this is kind of interesting Joe, so you can apply for Social Security benefits for your dependent child if, and this is a big if, if you are claiming your own benefits. So maybe you want to wait till 66, full retirement age, or maybe you want to wait till age 70, because you get a higher benefit amount. But if you have a minor child and your age 62, you might want to redo the math, because if you start taking benefits at age 62, and let’s say you have an 8 year old child. Several years of benefits until they’re 18. They could be receiving a pretty nice benefit, and the benefit, believe it or not, is half of your full retirement age benefit, even if you take it early.

JA: So it’s based on your full retirement age number. So let me just clarify, so let’s say my full retirement age benefit is a thousand bucks. And if I take it early at 62 that’s a 25% haircut, so 750 bucks. So I’m going to take it at 62 because I have a kid that’s 10. So I’m going to receive that 750 bucks, but wait a minute. I’m going to receive additional benefits because I have a dependent child under the age of 19 that’s still in high school. So then that is based on my full retirement age number which is a thousand, so then I would receive another $500 in benefit. So you add the 750 plus 500. Well if you do the math over 8 years, that’s going to be more to you potentially.

AC: And that is the exact math and Joe I got the example of this actually. Your example, times two! 62 year old parent of a 14 year old could wait four years to collect $2000 a month at full retirement age. Or they could receive $1500 immediately, while your child gets a $1000 per month because $1000 is half of $2000. So in other words, you get $2500 for the next four years.

JA: $1000 additional a month, right, so that’s $12,000 a year, times, what, four years because he’s 14?

AC: Yes four years, and so in this example, by the time this individual reached full retirement age, then they go back to their $1500 a month, which, it’s indexed for inflation. But it’s even better if your child is 10, or 8! (laughs)

JA: You know what, if you’re working, if you’re struggling, right, with your Social Security benefits? Just pop out a couple kids! Just adopt some! (laughs)

AC: But there is a limit to this Mr. Anderson.

JA: Yeah, family maximum.

AC: Yep, family maximum, and it’s usually somewhere between 150 to 180% of your full retirement age, and I actually pulled out my statement to see if that was true. And I won’t give you the numbers because that would give away my history of income. (laughs)

JA: Got a big wallet on Big Al… (laughs)

AC: But I will give away the percentage and I looked at it – my full retirement age benefit versus the total family benefits, it was 170%. So 70% higher. So I was between 150 and 180. I’ve no idea how they calculate, how they pick that, but, anyway, we’re seeing that Joe. We’re seeing families with kids and sometimes both spouses are in their 60s but they adopt a kid or they take over care for a grandchild. And this would count. And this is actually, I think hardly anyone ever talks about this. This is a great benefit. And furthermore, Joe, it does not affect your own benefit.

JA: Yeah sometimes people think all right well here if I’m getting an additional benefit because of my dependent, then I’m going to get less for me. And that’s not true.

AC: Now, it is true that you have to be receiving your benefit for this to work, and so if you take it early certainly that affects your benefit. But the fact that your kids, or your kid or kids, could be plural, are getting benefits is not affecting what you’re going to get for you.

JA: Right. I would guess that the Social Security Administration is not asking you, “hey do you have dependent children?” when you claim your benefit.

AC: I would highly doubt that too.

JA: I don’t know, I’ve never claimed for my benefits because I’m 40. (laughs)

AC: Well me neither because I’m in my 50s. (laughs)

JA: So, I guess I will find out in 20 years. Stay tuned. (laughs)

AC: Joe, this is news that I think you can use based upon whatever happens in the Joseph Anderson family down the road. (laughs)

JA: It’s going to be exciting. (laughs)

AC: We’ll keep tabs on that.

16:35 – Big Al’s List: 7 Tax Planning Tips For Millionaires And Those Who Want To Be Millionaires

AC: This article is from Motley Fool, I thought it’s pretty good. It starts out with taxes. It’s perhaps the most dreaded five letter word in the English language.

JA: Ooh, that’s good copy right there.

AC: But what about death. That’s another dreaded word. (laughs) But another one is audit. That’s another one that we don’t like. (laughs) So here’s the first one. It’s think long term. Boy we talk about that all the time. And what this is referring to Joe in this particular…

JA: Let me guess, it’s not look at year by year, but take a look at what to expect in the future.

AC: You got it. And if you think about traditional taxes, tax preparation, and even if you’re fortunate to have an account that does some tax planning, it’s usually for one year at a time, but really you’ve got to look at 20-30 years out, to figure out what’s going to be the best moves to take right now. And there are some basic things, and some of us forget this stuff. If you have money in CDs, it’s interest income. Not only they’re not paying hardly anything, but it’s also subject to ordinary income tax. And if you’re a millionaire, you might be probably in the highest tax bracket, 39.6%, you’re losing federal, and then in the state of California, for our Californian listeners on top of that.

JA: Right, I think to piggyback on that too, you have to forecast just a little bit especially when you’re looking at a retirement income strategy, to say, all right, well here, I’m going to create income from my overall assets. I have some savings. Then you have to look at, well, how are those savings going to be taxed as you create the income?

AC: Right. It’s both of those not just not just the investment return.

JA: Right, because we look at everything in a silo. And I think that’s how we were taught. We get the cart….

AC: Cart before the horse?

JA: No. Another one. Anyway. Yeah. (laughs) Investments cause tax. And then if I can reduce the tax then my investments are going to grow a little bit further. It’s going to stretch out that asset a little bit longer for me to create that income when I need it. As we talked about we’re living in a little bit longer.

AC: And this is especially important in retirement, when you’re actually creating a cash flow from your assets. So there are certain kinds of investments that produce ordinary income like interest income, some kinds of dividend income. Short term capital gains. In other words, you buy a stock or mutual fund and you sell it, it’s at a gain, you sell it in less than a year, you’re paying ordinary income tax rate. So what’s the better tax rates? Well of course it’s long term capital gains, it’s buying an investment, holding it for at least a year, and then you sell it, and then that highest capital gain rate is 20%. A lot of us are paying 15%, the wealthiest people are paying 20%. There is the Medicare surtax on top of that, 3.8%, but 20% tax rate versus almost a 40% rate – it’s almost half. It’s almost half. Now California doesn’t have a special capital gains rate, so it is what it is. But federal, boy, you cut your tax in half just by figuring out, all right, what investments do I want outside of retirement versus inside of retirement, or maybe the Roth IRA, you know, and so it’s all about keeping more about what you make. And then related to that, Joe, is gosh, a lot of people have the bulk of their savings in a retirement account that when they take that money out, it’s all taxed at ordinary income rates, and we see this over and over again. People retire they’re in a very low bracket. They’ve got some savings they’re living off their savings. They’re in a super low bracket, in fact a zero bracket. And then they hit 70 and a half, they start Social Security, they have to take the required minimum distributions and now all of a sudden they’re in a 25%, 28% bracket, maybe subject to alternative minimum tax.

JA: Right, because we were told not to touch that money, right? And psychologically when people start tapping into their retirement accounts, it has an effect on people. I can spend the heck out of my mutual funds in savings that are outside of the retirement account. I could go on vacation, I can buy all this other stuff, but as soon as I start tapping into the retirement accounts or taking distributions, then it’s like, oh here we go. This is the last little bit of cash that I got, and I don’t necessarily want to do it.

And now, everything after that’s taxable, so this strategy, if that’s you, you just retired you’re in a lower bracket temporarily, then start doing Roth conversions, start taking some money out of that IRA, that 401(k), converting it to a Roth IRA. Yes, you will pay taxes, but you’re paying taxes at lower brackets. There’s no way to avoid the taxes. But if you can sort of preplan paying lower taxes, you end up with a lot more money that way.

JA: What’s number two?

AC: Number two is to contribute to tax advantaged retirement vehicles like 401(k), 403(b). What about a teacher, Joe?

JA: 403(b), 457?

AC: So they can sort of double up, right?

JA: Yeah that’s key. I mean, I think a lot of times for some employees that they can have two different plans and sometimes they think, well, I can only put up to the maximum of $18,000. If I have a 403(b) or 457 plan, if I’m an educator. Some hospitals, they have multiple plans, so the maximum amount that you can put into a defined contribution plan is about $54,000. It’s not 18 or 24. So if I have a 403(b) and a 401(k), or 403(b) and a 457 plan, I can put in $18,000 in the 403(b), $18,000 in the 457 plan. And then I can do the catch up for both of those plans, and guess what, I can also do a Roth IRA contribution as well, if I’m under the income thresholds.

AC: Right. And on the other side of the spectrum, we see business owners, they’re in their 60s, they’re making a ton of money. They could set up a defined benefit pension plan for their own company. We’ve seen people put away $200,000, in one case I saw $300,000 being put into a retirement account just for the owner, because there were no other employees. And therefore, that’s a tax deduction in that tax year. Now this owner was going to sell his business a few years down the road anyway, and so in the highest bracket now, versus any time in his life, why not take that deduction right now?

JA: Right. So we look at different strategies, let’s say if you make a lot of income, you’re a sole proprietor, and you’re like, man, I’m just getting killed in taxes. Well you can set up this defined benefit plan. It’s fairly complex because the defined benefit plan really bases a benefit amount for you when you retire. So the defined contribution plan is just set. The contributions are defined. $18,000 but the defined benefit plan works completely different. They’re saying, all right, well, you can have a maximum income of 200 some odd thousand dollars. So let’s back it up to figure out how much money that you can fund the overall defined benefit plan to get you to the maximum income stream once you retire. So you can front load this thing significantly, so the older you are, closer to retirement, and the income that you have, I mean you could shelter several hundred thousand dollars. That’s a great tax deduction that given year, then that money grows tax deferred until you pull the money out.

AC: We’re talking about planning tips for millionaires, or for people that want to be millionaires.

JA: All right. Number three.

AC: Number three, we’re only to three. Use your investment losses to your advantage. I bet you know what they’re getting at here. So when you have an investment that’s outside of a retirement account, hopefully that investment goes up over time. But you know how the market is, it’s volatile. Sometimes your investments go down temporarily. Sometimes longer term. But when an investment goes down in value, lower than what you paid for it, there’s a great strategy, it’s called tax loss harvesting. You actually sell that asset on purpose, so that you create a tax loss that you can use on your tax return, then you buy something similar so you’re still invested and your investment portfolio still has its integrity. But in the meantime, you’ve created a loss. Let’s say you have an investment that went down $20,000 for example. That $20,000 loss gets captured on your tax return and is available dollar for dollar against any future capital gain. So in other words, you sell a mutual fund at a loss, $20,000 loss, you sell another one at a gain, $10,000 gain. You don’t pay any taxes on that $10,000 gain because you get the $20,000 loss. Whatever you don’t use in the current year carries over into the next year and you go through the same thing again.

JA: Right, it will carry over for the rest of your life. So basically what I think I understand you’re saying is that, in my overall portfolio, it needs to be in a taxable account, it can’t be in a retirement account, so let’s say I have multiple mutual funds, some are going up, some are going down, it’s a diversified portfolio. Everything can’t go up, that would be at all positively correlated, that would not necessarily be a diversified portfolio.

AC: Right, that doesn’t happen.

JA: Right. Well, it does happen, with people that don’t have a diversified portfolio.

AC: If they pick the one right investment.

JA: So let’s say you have multiple different mutual funds, you have small companies, mid-sized companies, international companies, commodities, whatever, it’s all diversified in that portfolio. But one of the funds goes down. Let’s say goes down $20,000. So what Al is suggesting is that you sell that, buy something similar, so let’s say it’s an international mutual fund. So it’s down $20,000, you sell that, you buy another international mutual fund. It cannot be identical. There’s wash sale rules there. So you got to be careful of what you’re doing, but the portfolio roughly looks the same. So I sold an international fund, bought something similar. So I’m still in that market. So then that $20,000 loss sits on my tax return. So the portfolio looks similar, now as other asset classes move up, and maybe I need to create, that year, $10,000 worth of income from the portfolio. All right. We don’t want you to sell and spend the assets that go down. We want you to sell and buy the same asset class that goes down. We want you to sell and spend asset classes that go up. Does that make sense?

AC: Yes it does.

JA: So now you take $10,000 from the portfolio, and guess what? That $10,000 gain that you just created to create that income, well you have a $20,000 loss, that would offset dollar for dollar so that $10,000 comes to you 100% tax free. So you consistently look at your overall portfolio and the mix of asset classes that you have in that particular account to make sure that you continue to harvest losses so those losses will offset future gains as you’re trying to create income. Those losses will carry over for the rest of your life. But here’s the problem. Most people will never do that. You know why? I think this is why more and more people should have professional management of some sort that looks at tax loss harvesting, because there’s something that’s called anchoring, that is embedded in our mind as a behavior that is so detrimental to your financial health.

AC: Are you saying we don’t want to accept that we lost money?

JA: Well yes and no. So let’s say this. Let’s say I bought a stock or mutual fund at $50 a share. So if I buy XYZ stock, 50 bucks a share it goes down to $30 a share. You and I would sell that and buy something similar to harvest that loss. Because there’s no emotion there. But if I’m that individual, if I’m doing this on my own, it’s like $50, it’s worth $30 a share, do you think I’m going to sell it?

AC: No, you want to wait to get your money back.

JA: I’m going to wait until when it reaches…?

AC: Well at least 50.

JA: At least 50! Right. So I anchored it at that price of $50 a share. If it goes down to 30, if it goes down to 25, it’s like nope I’m not selling them until it goes back to that anchoring price of 50.

AC: We all want to say we never lost money.

JA: The same thing works on the other side of the equation right. I bought that stock at $50 a share. All of a sudden now it’s $75 a share. What am I thinking.

AC: Yeah well you’re thinking you did a great job.

JA: But also, this is getting a little overpriced, maybe, right? I should sell and reap some profits, because I bought it at 50, now it’s at 75, right? So we anchor it at whatever price that we purchase it, which is ridiculous, we shouldn’t be doing that. So when you look at tax loss harvesting, you have to get the behavior and the emotion out of the equation to really benefit you long term. And so you have the emotions in there, you have your portfolio construction, and then you have the tax aspect of it. That’s why everything has to be coordinated, versus looking at things in a silo, like, I have my tax plan over here, I have my investments over here. Like, let’s say if you went to a restaurant and order a burger and fries. Your kids didn’t want the fries to touch the burger. And the ketchup had to be somewhere else, right?

AC: I was the worst when I was a kid.

JA: And you would just eat the fries first, and then you would eat the burger… now, I put my fries in my burger! (laughs)

AC: You’ve gone to the other extreme.

JA: So you got to look at it is not necessarily one thing versus another. This strategy, when it comes to your overall financial wealth, has to be looking at all sorts of different disciplines.

AC: Giving to charity is another strategy that the millionaires do, and you can do yourself, which is obviously when you give to charity it’s a tax deduction. An itemized deduction, of course you have to be able to itemize, you have to have more deductions than the standard deduction. But that’s true of most of us in California that have any level of income, because of the state taxes that we pay, that’s a deduction. But if you’re in the highest tax bracket that’s 39.6%, so you’re saving about 40 cents of that dollar just in taxes and oh, we live in California. That could be another 13%. So you’re saving over 50%, 50 cents on a dollar, on your contributions. And a lot of folks that have money have great hearts, they want to give back to charity. But you get a benefit yourself, and then you think about, are there smart ways to do this? Sure, you can actually give away an appreciated stock, instead of giving away cash, because the way that works is whatever the stock is worth on the day you give it away is your tax deduction and you don’t have to pay the tax on the gain.

JA: Right, if I bought it for a dollar a share, now it’s worth $10 a share, I give that stock to the charity at $10 a share. I don’t pay any tax. They sell it. They don’t pay any tax.

AC: Right, because they’re nonprofit.

JA: You got it. So what usually happens though is that maybe I have some cash, some money market accounts, savings account. I’ll just cut a check, and then I’ll sell that stock and spend it. Well then I’m paying tax while I gave the cash away. No, give the stock away. So you don’t have to pay the tax on the appreciation of the stock. It’s a smarter way to look at it.

AC: It really is. Now don’t do this if your stock has gone down in value. Sell it….

JA: Yes right. And buy some similar.

AC: Or sell it, create the loss and then give the cash away. So you got that loss that you can use against other stuff.

JA: We’re talking taxes.

AC: 7 tax planning tips for millionaires and those that want to be.

JA: Perfect. So, number five.

AC: Number five, Joseph, is consider municipal bonds. And why? Because municipal bonds are generally tax free. In other words, you receive interest income, you don’t pay any taxes on them and if they’re issued in your state of residence, like California, for example, then it’s tax free in the United States, IRS tax free, and California, Franchise Tax Board.

JA: So you gotta be careful here. Couple of things. Bonds versus stocks. First of all. I think people get confused. A bond is an obligation. It’s a note. It’s a loan.

AC: So it’s like you’re loaning your money to the government, or in this case a city municipality, or county, or state, for that matter.

JA: So you have to make sure that you understand what you’re doing, because the higher the interest rate doesn’t mean it’s a better bond, because people will say “look at this interest rate it’s at seven… well, 4% let’s say, versus two. Let’s get realistic here. What year am I in here? 1980? (laughs)

AC: Well yeah but I’ve seen people getting trust deeds now for 10%. Even in this market.

JA: Oh sure. Guaranteed 10%.

AC: Right. Until they default.

JA: Until it is no longer. Yeah. But let’s look at a municipal bond for instance, because the higher the interest rate that you get from the bond, that doesn’t necessarily mean the bond is better. It means it’s more risky. So you have to look at it, and I’m sure a lot of you’ve heard through the media and everything else, as interest rates go up, bond prices go down. And so a lot of pundits are saying be very careful with your fixed income. A lot of you have come into our office and say, “Joe, Al, why would I even own bonds when I know it’s a certainty that I’m going to lose money.” I don’t want any. Everything stocks. Because look at how great the stock market is, until the stock market isn’t.

AC: And then why weren’t we in bonds.

JA Yeah. We always want what we can’t have. So interest rates go up, bond prices go down. So just be careful what type of bond that you own. Now if you own that bond to maturity, then you’re fine. You just have an opportunity cost because you’re locked into that specific coupon. I buy a municipal bond 3%. If I hold that, let’s say $100,000, I get $3,000 of income. If it’s a municipal bond it’s 100% tax free, if I buy it in the state that I live in. And so everything’s great until interest rates go up to let’s say 5%. Hypothetically of course. Your bond price is going to go down if you sell that bond prior to the maturity date.

AC: Yeah and that’s a key point you’re allowed to sell the bond. You don’t have to wait until maturity. It’s a liquid market but, if you sell it and interest rates have gone up, the price of your bond is going to go down because no one wants to buy a 3% bond when they can buy a 5% bond. In today’s market.

JA: No rational individual would do that.

AC: So you have to discount it, and that’s where the losses can come in.

JA: Right. And so if I hold that to maturity then it’s like, I did not receive a loss of principal, if it’s matured. And there’s no default. So now a lot of experts are saying, all right, well, let’s say if Trump reduces the overall top federal rates on the individual side, then municipal bonds are going to get hurt. So there could be some issues there too. I mean Meredith Whitney, when was that, 2009?

AC: Oh gosh. No, I wanna say 2010-11. She predicted it would be just Armageddon in the municipal bond industry and of course it never happened. But that’s what she predicted.

JA: But that doesn’t mean it can’t happen. Because look at Detroit, they filed bankruptcy, Orange County, Stockton, I mean the list goes on and on. So just be careful. There’s pros and cons to every type of investment, there is no free lunch out there. So if you do buy municipal bond, yes it’s going to be tax free to you. As long as you hold that bond to maturity you will not receive a discount. Now, that is if you own individual securities, an individual bought, individual issue, in most cases, it depends on your asset level, but if you don’t got, I don’t know, a couple of million bucks? A bond fund is probably going to be a better option just because of the pricing. You want a little bit more diversification, and then plus, the pricing on individual bonds on those small issues? I mean they will take you to the cleaners because there’s very little transparency.

AC: Yeah because there’s bid ask spreads, and who’s getting all that money? The person that sold it to you.

JA: And the bond market is so much bigger than the stock market.

AC: I know, I think that’s a mystery to most people. The stock market is little compared to the bond market.

JA: Think about it. Countries don’t issue stock. You can’t buy stock in USA. But you can buy a Treasury. There’s trillions in treasuries. So if you kind of think of it like that, the bond market is gigantic and the stock market is tiny. And these bond traders on Wall Street, they don’t want to mess around with, “I got $25,000,” your broker is going to make a mint on that $25,000. I think a bond fund is probably a little bit more better for most of us, but of course every circumstance is different. So you just want to make sure you do your due diligence, get the transparency that you need to make sure that you make the right decisions.

AC: Yeah and Joe, I think something you said right off the bat bears repeating is, if when you look at individual bonds, or maybe even bond funds, the ones that are paying more is not necessarily the better one, because that means they’ll be more risky, and it’s kind of like when you go to a bank to get a loan, what do they ask you for, or what do they get? They want to get a credit report. They want to get your FICO score. And so the higher your score is they know you’re not that much of a risk so they can give you a low rate.

JA: Right. Alan’s FICO score is 800, mine’s 500. So. So that’s why my mortgage is 17%. (laughs)

AC: And Joe is trying to issue bonds right now. So he’s going to have to pay a lot.

JA: So the bank is saying, “All right, well, Anderson here is more risk. So I’m going to charge him more.” So I have to pay a heck of a lot more than Alan because Alan has a better clean track record because we all know the big bucks on Big Al, right?

AC: That’s been well documented in prior shows. (laughs)

JA: Right, so who would you rather loan your money to, Big Al or me? I would imagine most of you say yeah of course, Big Al. But you’re going to say well no. I’d much rather loan the money to Joe because I’m going to get a higher interest rate. But how long are you going to get that higher rate before I stop paying.

AC: Yeah that’s the problem. It’s default risk. So that’s the risk that you’re taking on some of these higher interest rate bonds.

JA: Because people equate bonds to stocks. If I’m looking at my 401(k) plan and I’m saying, all right, well, what type of bond should I buy, because I’m getting closer to retirement? Let’s take a look at the past 10 years of my three bond funds: one bond fund is up 10%, the other one is up 6, and the other one is up 2. Well of course, people are going to select the one that did 10% over the last 10 years because of course that’s a better fund. That’s not necessarily the case. That just means that that bond fund has a lot more risk than the one that was up 2% because it’s a note it’s a loan. You’re not buying into the profitability of the company. So if I buy a Google bond and all of a sudden Google takes over the world, my bond coupon is not going to change in price, it’s not, because it was a contractual loan agreement with that company.

AC: Yeah, you don’t own the company, or piece of the company, it’s a loan to the company.

JA: If I have a piece of ownership such as common stock with that company, yes, then I will see a lot of higher appreciation because I’m an owner I have skin. Because I could lose everything. So just be careful how you’re examining the investments that you put in your overall portfolio.

AC: Joe, another tip for the wealthy is buying health insurance, and you think, “who cares about that.” Well this year in particular, there’s quite a penalty if you don’t have health insurance and the penalty is 2.5% of your income up to a maximum of $13,100. So you might as well just get the insurance because you’re paying for it anyway in a penalty if you’re wealthy. Now I will say if you are on Medicare, well that counts.

JA: Or Tri-care or have your own group policy.

AC: Right, things like that.

40:03 – Interview: Larry Swedroe, CPA: Factor-Based Investing

JA: Larry Swedroe on the line, Larry’s been on the show multiple, multiple times. A good friend of the show, he’s written several books on investing and financial planning. He’s Director of Research of Buckingham in the BAMM Alliance that manages, what, Larry, $16-$17 billion of assets or even more than that?

LS: We’re approaching 28.

JA: $28 Billion! Wasn’t it just like 16 last year?

LS: I think it was a bit higher, but we crossed 10 billion a couple of times in ’08, once on the way up and once on the way down, and we’ve been growing pretty steadily since then.

JA: Well, I appreciate your time. I know you’re a very busy guy. The last time, I think it was last year when we were talking about your last book, but then now, we have another book coming out. Let’s talk a little bit about, A, what’s this new book about, and what made you write another one?

LS: The book is called “Your Complete Guide To Factor-Based Investing.” The academic literature, really since 1992, when Gene Fama and Ken French wrote their famous paper, “The Cross Section of Expected Returns” and added small and value as factors, they call them, that helps explain the returns of portfolios that really changed forever the way we think about investing. We went from thinking about just diversifying between stocks and bonds to now diversifying across asset classes, meaning large cap and small cap, value and growth, made the world much more complex, but opportunities for advisors like you, Joe, to help your clients by adding value through superior design, better diversification of portfolios. But the academic research didn’t end there. And over the last 20 plus years now, we’ve actually had papers published to the extent that John Cochrane, University of Chicago professor, called it a zoo of factors, with over 600 of them identified. So my concern was, how does the average investor figure out which exhibits in that factor zoo should they be interested in looking at and considering. So I thought it’d be a good idea to help provide a framework for people to think about, and we identify eight factors in the book, six for stocks and two for bonds, and we give people a framework that says, “in order for you to consider a factor, it should have evidence of persistence, meaning it exists with a premium above market return for a very long time across economic cycles. It’s pervasive around the globe, meaning we’re not lucky, it was just the US outcome perhaps, even better if it’s pervasive across asset classes.” So for example, the momentum factor works in stocks, bonds, commodities, and currencies. The value factor works the same way across asset classes. So that gives you more confidence it’s not data mining. It should be robust, is the term I use, meaning it can hold up the various definitions. So for example, Fama and French used price to book ratio as a definition of value. But if price to earnings or price to cash-flow, for example, didn’t work, I would be suspicious that it was just the data mining, a lucky outcome. But as it turns out, we can use one of four or five different metrics for a value and the same thing applies to things like momentum and quality and profitability. These other factors that we recommend should also be implementable, meaning it holds up after transactions cost. And lastly, it should have an intuitive reason to believe it should persist in the future, meaning that it should be a good risk-based explanation, just like stocks are riskier than bonds. So we expect that they aren’t guaranteed that stocks will outperform, that we should have a risk-based explanation for these premiums, and/or a behavioral explanation that should hold up. So the book goes through all of these issues for every one of the factors we recommend, and then shows you the historical evidence.

JA: So, looking at the traditional view, potentially, or for lack of a better word, kinda more active-type management to try to add value, so it’s looking at tiny markets, or picking individual securities, or different sectors of the market, that maybe one individual thinks that is going to outperform. Certain advisors are adding value to their clients by looking at these factors, of saying, “hey, it’s difficult to time markets, it’s difficult to predict the future, but if you look at these certain factors and construct a portfolio based on academic science, you’ll have a higher probability of getting that alpha or outperformance than if you use more of a traditional view? Does that make sense?

LS: Yeah, basically you’re on the right line, I want to change a couple of the words.

JA: Of course, you’re a smart guy, I’m kind of an idiot. (laughs)

LS: To make things clear for your audience. So we want to define alpha and beta here. So alpha means that your performance is above the market, but on a risk adjusted basis. So if you buy small cap stocks and you outperform large cap, that’s not alpha, that’s what an academic would call beta, which means simply you have exposure to this risk factor we call small cap stocks. So if you buy emerging market stocks and you outperform the S&P 500, that’s not alpha, that’s exposure or beta to the emerging market risk. Same thing for value stocks, or if you buy long term bonds instead of short term bonds, that’s loading on what’s called the term factor. Each of these factors should have a premium. Often you and I know, active managers claim alpha, when they’re really giving you beta, meaning it’s exposure to one of these common factors that a computer can give you exposure to, simply by buying all of the securities that have that common trait, whether it’s small stocks, or value stocks, which have low prices to earnings. So we want to make sure people are differentiating between alpha which could be skill based, but beta which just is a systematic exposure to a common factor and doesn’t involve any individual stock picking, nor really any market timing either.

JA: Now there’s something that’s called smart beta, what’s your take? That’s just factor investing with kind of a marketing ploy isn’t it?

LS: Well, let me say it this way. 99% probably of what’s called smart beta is nothing more than beta. And what I mean by that is, if you invest in small cap stocks and buy a Vanguard small cap fund that’s based upon say an MSCI index, that isn’t smart beta, that’s taking more risk in small stocks. However, let’s take two similar small cap funds. Neither one of which does any stock picking or market timing. And let’s even assume that both of them use the exact same index but one is a pure indexer which means they slavishly follow the index, when a stock leaves the index, they are forced to trade, when everyone knows they’re going to have to trade. So their cost of trading is high because everyone knows when they’re going to trade and they must pay up to actually keep those straight. They are what an academic would call a buyer of liquidity, and they have to pay up to get that. On the other hand, let’s say Joe, because he’s a much smarter guy, he builds a fund based on the same index. But he says, “You know what? I don’t have to trade on that exact day. I’m going to use a computer program called an algorithmic trading program, and I’ve got these 50 stocks that I need to sell, and these 26 new additions that I need to buy, and I’ll let the computer send the signal to the market that I want to buy 100 shares of this, and I’m looking to sell 100 of that. But instead of taking the offer, I might give an example, say a bid is at $10 and an offer is at $10 and 10 cents, well instead of taking the offer $10.10, then maybe you put in a bid of $10.01 or $10.02, slightly above where the market bid is, and you hope that your bid gets it. But you don’t care, you’ll wait. And so, that to me is smart beta, because it’s patient trading and over time will outperform the index. Let me give you one other example. Let’s say an index includes all stocks, and academic research might show that certain types of stocks have poor returns. We know the research shows that stocks under $2 have very poor returns. IPOs generally have very poor returns on average. So you decide, “I’m going to screen those out, even if they’re in an index, because the academic research says that would deliver higher returns.” That to me is smart beta. Has nothing to do with individual stock picking. You’re not saying, “I want to buy this IPO and not that IPO,” but a systematic replicable approach. So yes, I do believe there is a thing that you can call smart beta, but 98, 99% of what the industry calls smart beta is marketing hype.

JA: That’s Larry Swedroe, folks.

49:49 – Joe and Big Al are always willing to answer your money questions! Email info@purefinancial.com – or you can send your questions directly to joe.anderson@purefinancial.com, or alan.clopine@purefinancial.com

JA: So what is the best method for me to receive separate equal periodic payments, Alan. SEPP, you know what that means, right? Summary: I would like to roll over $100,000 into an IRA and receive separate equal periodic payments. SEPP. I’m 55 years old and my wife is 46 years old. I would like to receive payments for five years from this. Is that acceptable under current tax law?

AC: SEPP. So that’s referring to 72(t). So you have an IRA. Typically with an IRA you have to wait till age 59 and a half before you take the money out without penalty, if you do take it out before then, you’ve got to pay a 10% penalty. And so you have an IRA, at age 55 you’re still allowed to take the money out without penalty, as long as you do this 72(t) election, which means that it’s a separate periodic payment, I forget what the other E stands for.

JA: Separate Equal Periodic Payments. You just have to take the same amount of money out of the account for five years or 59 and a half, whichever whichever is longer.

AC: So if he’s 55, that’s perfect. So he can do it in essence until he’s 60, which is just about right.

JA: So yes, under current tax law you’re still good to go. But this is the little catch here.

AC: Yeah I knew you were going to go there, which is good.

JA: Because he said he’s rolling over $100,000. He didn’t he didn’t specify 401(k), but I’m guessing he’s rolling over from a 401(k) into an IRA.

AC: That would be my guess. So what’s a better strategy?

JA: Keep it in the 401(k) plan because at 55 if you separate from service from that employer, you have full access to the 401(k) plan at 55, not 59 and a half. You don’t have to dink around with SEPP 72(t) tax elections.

AC: Yeah, and I don’t think a lot of people know that, Joe, it’s like, you have an opportunity to retire at 55, let’s say, and you can pull money out of your 401(k) without penalty. Of course, you do have to pay income taxes on it, you don’t avoid that, but you don’t have to pay penalty. Now if you roll that over to an IRA, you can’t take it out till 59 and a half without penalty, unless you do the 72(t) election.

JA: Look at the big brain on Big Al.

AC: And I wasn’t even hardly listening to the question.

JA: I know you weren’t. You’re just still wrapped up in Larry Swedroe’s factor talk.

AC: I’m still getting my arms around it. I know our listeners are too. It’s fascinating.

JA: You’ve got a profitability factor.

AC: I mean that’s the new one, right? I mean, it makes sense.

JA: You’ve got small, you’ve got value…. I mean there’s hundreds of factors now. I just read something too, Rob Arnott was saying be careful of smart beta, ‘cause he came up with, it’s basically factor investing, but he calls it smart beta. I mean that I think that’s kind of a beta’s risk. So you take smart risk?

AC: Yeah, I suppose, that’s snazzy.

53:14 – JA: Yeah. Well speaking of Larry, we’ll end the segment with this question, Al. Do I reinvest my dividends or hold onto them and save them in case of a market dip? What do you think?

AC: Do I reinvest my dividends or save them in case of a market dip. Well, so I guess what he’s suggesting is, if he if he keeps his dividends, he’s probably going to put into cash. And we get these questions kind of in a vacuum. You’ve got to look at a much broader holistic picture. (laughs)

JA: Please don’t hold us accountable for this advice. Here it is. This is not advice. How about that. We are just chatting. Just a couple kids having a couple of beers. (laughs)

AC: It’s a chat. But really, the answer is, what is the right investment strategy for you, and what else do you have? Maybe it would make total sense to reinvest your dividends because of whatever your goals are. I mean, we don’t have enough information.

JA: So, I kind of like his concept here, because it depends on how many other asset classes that he has and everything else, is it individual stocks, does he have mutual funds, and how much dividends are kicking out, and how much money that he has, and I think that’s what you were trying to say? But, let’s say if you do this, instead of reinvesting that dividend back into that particular security, you just hold it in cash, right? And then you take that cash to help you rebalance. And maybe when other asset classes are low, you take that cash to buy the asset classes that are lower, so you’re not necessarily selling any securities, you’re just taking the dividend and holding that in cash, either to take distributions for income, or to help you with the overall rebalance.

AC: And maybe it’s like a poor man’s way to rebalance. Because you’re basically taking money out of the stock market and going into a safer asset class.

JA: Right. So it depends too on how much cash that you have in the overall portfolio, because let’s see if we have a ton of dividends, how long are you going to save? If you want to buy on the dip, I mean that’s market timing. So we don’t believe in that as a great strategy, because it’s very difficult to time. I mean, you might be able to get lucky once, but to get lucky twice, it’s challenging. Like, you might be able to say, “hey this is not feeling good, I want to get out of the overall market.” So you get out right in 2007. But when do you get back in? A lot of people did sit in cash. I mean, look at the beginning of this year. At the end of last year, during the election. A lot of you got into cash, you were like, “This is too spooky for me.” Brexit was another example. “Hey, let’s get in to cash. The market’s going to freefall, it’s going to blow up.” So you got out, but was that the right time? Probably not. Now when do you get back in? So you missed the run. Holding onto to cash to buy on the dip? What dip are you going to buy on?

AC: Well, because it’s only clear when you should have bought, after it’s already happened. And it’s too late.

JA: It’s after the fact. Then you have to have a true process on when you buy. With a rebalance strategy, you already have that in your processes. It’s like this asset class, when it gets to this bandwidth, I’m going to buy more of it from that cash. Versus saying, “hey, when the market drops, it’s at 23,000, when it goes down to 18, that’s when I’m going to buy.” Well how about the next day? Goes down to 16. So you missed the right dip. I guess the only dip in this conversation is me.

57:03 – JA: Full disclosure, Advisor Insights Investopedia sends me these e-mail questions once a week and Al and I answer them on the air. Can I open an IRA in 2017 and deduct it on my 2016 tax return, Big Al. I’m retired and took out a 401(k) but did not roll it into an IRA in 2016. Can I open one now, before filing my tax return, and take a deduction?

AC: I’ll answer two ways. If you worked in 2016…

JA: So he’s thinking he gets a deduction by rolling his 401(k) into an IRA, it sounds like.

AC: Well maybe, I don’t know. That would be a crazy question. The answer to that is no. (laughs) So he didn’t, maybe he just worked part of the year 2016, can he take a deduction on his IRA? All the way till April 15th of this year, and the answer is yes as long as his income is low enough. And let’s say if he didn’t work a full year and I don’t know whether he’s married or single, so there’s different limits here, but let’s say single for example. Then if he made, let’s see, less than $62,000 he can take a full deduction, or $72,000, then he can’t take any. But he also may have retired years ago. You can’t do a currently deductible IRA unless you have earned income and you’re below the limits. Now if you didn’t contribute to a 401(k) or didn’t have a pension plan, you’re not subject to these limits. So there’s a ton of things we don’t know.

JA: Yeah. You need earned income. Earned income would be self-employment income, schedule C income, or W2 wages. Your pension does not qualify. Social Security would not qualify. Interest in dividends does not qualify as earned income.

AC: Yeah I think another thing that gets confusing sometimes is is the concept of a calendar year. So most things, when it comes to taxes, have to be done in a calendar year. There’s a couple exceptions to do a deductible IRA or IRA contribution, you can do that all the way till April 15th of the following year. But you have to have earned income in the last calendar year. If you didn’t have any, you couldn’t go out before April 15th and get some earned income and deduct it. It would only apply for 2017 in that example.

JA: OK. I have a question for you, a personal question

AC: Oh good. So this is Joe Anderson. You’re thinking about Social Security and the kid benefit aren’t you? You got an angle there.

59:32 – JA: Yeah right in 20 years. (laughs) All right, let’s say I do a backdoor Roth IRA contribution, so that means that I have an after tax IRA contribution and I convert that to a Roth IRA. Let’s say I do that in 2017 for 2016. So I make my 2016 IRA contribution in 2017. So I put my $5500, in and then I convert it. And then I put another $5500 into an IRA for 2017, and then I convert that. So I got $11,000 converted into the Roth. Do I have to file two 8606 forms?

AC: Two 8606 forms. No, you would just file one, they’d be added together.

JAL But they both would be on that same 8606 form in 2017, and that would show the 2017 and 2016 conversions.

AC: That’s right. An 8606 form is when you have an IRA contribution where you didn’t get a tax deduction, it gives you tax basis, is what we call it. So that’s one reason you do that form, another reason you do that form is if you do a Roth conversion, you put the conversion on that form.

JA: So Roth conversion is taking money from your retirement account and then moving it into a Roth IRA. If you don’t have basis in that, you would pay tax on it. But then that would show that the money went into the Roth. So what the IRS is just tracking how much money that went into the Roth via the 8606 form? Because you still get the 1099 from the custodian.

AC: Yeah it doesn’t really matter which year the non-deductible IRA was, it’s the year of conversion that gets on the 8606, and you could theoretically also convert from another existing IRA that you have in the same year. And then that all goes on that same form. The only reason you’d have two form 8606’s is if you’re married and husband and wife both did one.

1:01:37 – JA: All right I am 50 years old, and plan on using the 401(k) catch up provision. $24K for 2017. When I retire, what is the contribution limit for a rollover to an existing Roth IRA? Can I roll over “backdoor” my 401(k) (spouse is retired) into both Roth IRAs, mine and spouse? Even though our joint AGI, line 15 of 1040, will exceed the IRS annual limit for IRAs? I have had the two Roth IRAs for more than 15 years. Jeez, that’s a mouthful. (laughs)

AC: Well, there’s a few misconceptions there. I guess this individual has a 401(k). He’s going to be taking advantage of the catch up, which means instead of putting $18,000 in, he can put up to $24,000.

JA: Yeah, let’s kinda break this thing down sentence by sentence. So the first one is he’s 50. He’s got a plan, 401(k), catch up provision $24,000. All right. So $18,000 is the max. Then he gets to catch up to 24.

AC: As soon as you’re 50 years old, then you can put $24,000 in.

JA: So then the next question he asks is, when I retire, what is the contribution limit for a rollover to existing Roth IRAs?

AC: There is no limit whatsoever, so what he’s thinking of is, there’s a limit for making contributions to a Roth IRA, but any kind of Roth conversion, or in this case a Roth conversion rollover from a 401(k), there is no limit, and that’s a huge misconception that people have it doesn’t matter if you make $5 million bucks, right? You can convert your $3 million IRA if you want to, of course you’ll pay taxes at the highest rate. So you probably don’t want to, but there is no limit.

JA: Right. He’s thinking it’s the contribution limits. And then, so, to follow this up, all these different terminology gets out on the airwaves and it blows people up, because then he says can I roll over “backdoor” my 401(k). Well, there is no there’s no such thing as- what, get the barn door. Open the front door. Let’s do straight front door. (laughs)

AC: Go through the skylight. Well here’s something you can do though.

JA: No, let me finish here. Because he’s saying “Can I roll over my 401(k) into both Roth IRAs?” So he is thinking, OK, well, now I’ve got this 401(k), I’m maxing this thing out to $24,000, I’m 50, when I retire, I’m going to have all this money, I want to get money into a Roth IRA. So he might be assuming that he has to be retired for him to do a conversion, and then he’s thinking the conversion dollars is the same as the contribution limits of $5500. He’s like, “well I got all this money and I wonder if I can split it up and put it into mine and my spouse’s.” No, you cannot do that. If you have a 401(k) you have to move it into your own individual IRA or own individual Roth IRA, if your spouse has a 401(k) she would have to move her money into her own. You cannot commingle. You can’t take spouse’s and move it into your own or vice versa.

AC: Well there is one way to do that. You have to die. (laughs)

JA: Yes you have to die. There’s a strategy for ya. (laughs)

AC: Well, one thing quick quickly Joe. So it could be that maybe there was some nondeductible, some after tax money in his 401(k), when he retires he’s allowed to send that after tax money directly to a Roth IRA. The pretax, he rolls into an IRA, there’s no tax consequences for either one. And he got some money into Roth IRA. So that’s possible.

JA: Yeah. You just have to understand the rules when it comes to these plans. The conversion is unlimited, the contributions are based on income. So then you can only put certain dollar figures into it, where the conversion is unlimited.

AC: The contribution is $5500 per year if you qualify, or $6500 if you’re 50 and older, that’s a contribution based upon current earned income. A conversion, I don’t care if you’re working or not, and I don’t care what you make. Anybody can do a conversion for any level.

JA: Right. But then I guess another caveat on that is that, let’s say if I’m 40 years old, I have money in a 401(k) plan. Then it’s up to the plan document, if that’s my only money. Because I think sometimes people hear us and say, “hey, you know, what I’m 45 years old, I love the conversion idea, I want to convert it.” OK, well where is the money coming from? “Well my own 401(k) plan.” OK, well then you have to do an inter-plan conversion instead of taking the money out of the 401(k) into a Roth IRA, because the likelihood of you doing an in-service withdrawal is probably nil. You could do a conversion in your 401k plan, instead of going to the Roth IRA, you would go to a Roth 401(k). Yeah but then that’s irrevocable and you have to have the provision in the plan anyway.

AC: Right. And that’s a huge point, because when you do a regular IRA to Roth conversion you can always re-characterize, up to the filing date of your tax return in the following tax year. Whereas a 401(k) you can’t. In-plan, 401(k) conversion is a one way street.

JA: That’s it for us today, for Big Al Clopine, I’m Joe Anderson, show’s called Your Money Your Wealth.

So, to recap today’s show: Yes, Social Security will still be around when you need it, and there may even be a benefit available to you that you aren’t considering. Using investment losses, giving to charity and buying health insurance are good tax planning tips for millionaires and wanna-be millionaires. Special thanks to our guest Larry Swedroe, author of “Your Complete Guide To Factor-Based Investing,” for telling us how to really diversify our investment portfolios.

Subscribe to the podcast at YourMoneyYourWealth.com, through your favorite podcatcher or on iTunes, where you can also check out our ratings and reviews. And remember, this show is about you! If there’s something you’d like to hear on Your Money Your Wealth, just email info@purefinancial.com

Listen next week for more Your Money Your Wealth, presented by Pure Financial Advisors, 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.

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