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
November 10, 2020

When does the real estate depreciation 121 exclusion happen and how do you account for rental property equity, or cap rates, to calculate retirement income? Plus, estate planning beneficiaries and charitable donations, stock market investing in an LLC, understanding the national debt, the differences between Roth 401(k) and traditional 401(k), and of course, Backdoor Roth and Roth IRA conversions.

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Show Notes

  • (00:50) When Does the Rental Real Estate Depreciation 121 Exclusion Happen?
  • (05:58) Cap Rates: How Do You Account for Rental Property Equity to Calculate Retirement Income?
  • (14:06) Investing in the Stock Market Inside an LLC?
  • (19:38) Understanding the National Debt
  • (24:57) Estate Planning: Beneficiaries and Charitable Donations
  • (33:01) Backdoor Roth IRA and the Pro-Rata Rule
  • (36:01) Does a Roth IRA Conversion Count in MAGI (Modified Adjusted Gross Income)?
  • (38:10) Roth 401(k) vs Traditional 401(k)

Free resources:

WATCH | EDUCATIONAL VIDEO: How Do You Start Investing in Real Estate?

LISTEN | YMYW PODCAST #217: How to Use Rental Real Estate to Build Legacy Wealth

10 Tips for Real Estate Investors

LISTEN | YMYW PODCAST #231: Appreciate How Good the Economy Is Now (with Economist Chris Thornberg)

Listen to today’s podcast episode on YouTube:


Your questions are all over the financial map today on Your Money, Your Wealth®, and Joe and Big Al are gonna do their best to explain when the real estate depreciation 121 exclusion happens and how to account for rental property equity, or cap rates, to calculate your retirement income. Plus, naming estate planning beneficiaries and making charitable donations, stock market investing inside of a limited liability company or LLC, making sense the national debt, the differences between Roth 401(k) and traditional 401(k), and finally, the fellas can’t escape the Backdoor Roth and Roth IRA conversion questions, so they’ll answer a few of those too. I’m producer Colossus Andi Last, and here are the hosts of Your Money, Your Wealth®, Giant Joe Anderson, CFP® and Big Al Clopine, CPA.

When Does the Rental Real Estate Depreciation 121 Exclusion Happen?

Joe: “Hi Joe, Andi, and Al. Jim from Santa Cruz ‘calling’.” Did he call?

Andi: No. He put that in quotes because you often say that even though it’s all emails.

Joe: “Joe, did you notice that I listed your name first?” Well, thank you very much Jim from Santa Cruz. “Also I drive a 2013 BMW.” Wow. Jim is snazzy. “I have two questions. My wife and I plan to rent out our home during our first couple of years of retirement. I understand we will take ‘depreciation’-” like he’s seen it in quotes like he’s really not going to do it, Al.

Al: Got it. Yeah.

Joe: “- depreciation during that period but that we will eventually have to give it back. How does that work” When does it happen? So how does the short term rental period affect the $500,000 tax exemption when we try to sell our house in 5 to 10 years?” So let’s start with that one. So he’s got a house in Santa Cruz. He’s going to rent it out for a couple of years. He’s going to cruise around in his BMW or something. And then he’s going to come back and then live in the house and then potentially sell it.

Al: Right. So the rule that he is referring to, it’s a section 121 exclusion. That’s where you get a $250,000 gain exclusion per person, married couple $500,000. So what that means is if you have up to $500,000 of gain as a married couple when you sell your home, you sell your residence, you get that for free. You don’t pay any tax on that. If your gain’s greater than that, then you’ll pay capital gains. Now it gets a little trickier when you rent out your home. So you have kind of a mixed-use property and in a sense, some rental, some residence. It always depends upon, Joe, where you start. If it started as a residence, then you’re much better off than if it started as a rental. So that’s what it sounds like, this is Jim’s residence. So we’ll assume that it was his residence originally, maybe still is. But even then he wants to rent it out and then come back and live in it again. So a couple of things, it doesn’t- in that example, it doesn’t affect the exclusion. You’ll still get the $250,000 or $500,000 full exclusion. But any depreciation that you took during the period of rental, let’s just say that’s $10,000 just to throw out a number, that was a tax deduction that you got. Then you have to record that as income in the year that you sell the property. So you’ll still get the $500,000 exclusion, but you have to pay taxes on the depreciation that you took. Now, in most cases depreciation that you take as a rental for most people, they don’t get to deduct it. Because of the passive loss rules, so perhaps that depreciation would get suspended. And then when you sell it you get to take that, it offsets against the income, so no harm, no foul. But I guess I’m saying a lot here Joe- you’re gonna say I’m saying too much.

Joe: Yeah, I mean I heard Annie in your background doing dishes or something. So I totally lost everything.

Al: But I go back to another point- and whoever wants to understand this just replay this a couple of times to be able to unpack it. So another point is people say well then I’m just not going to take depreciation because I don’t want to pay it back and that’s not an option. You have to take depreciation. Whether you take it or not, the IRS treats you like you took it. So you might as well take it. You might as well get a tax benefit and then you just pay back that same benefit in the year of sale. If you never sell your residence, you never pay the tax on it. So that’s what I got Joe.

Joe: Got it.

Al: You like that?

Joe: Yes.

Joe: He’s also got a question on a high deductible health plan. So he has an HSA and a high deductible health plan. “But I’m changing jobs in November and my new employer doesn’t have the high deductible health plan. I have contributed $4000 to my HSA during 2020. The family plan contribution limit is $7100. Can I still make the $3100 for 2020 even though I no longer have the high deductible plan? If so, do I need to make this contribution during 2020? Thanks as always for the awesome show.” Well yeah, you need to make the contribution in 2020. If you’re not going to have the plan in 2021, you won’t be able to make the contribution. So I would put- here’s my take is I would just put the $3100 in it and then go from there.

Al: That sounds good. I’ll go with it.

Joe: Because it- I mean splitting hairs now. But I would make the contribution this year.

Al: Right.

Joe: So I don’t know. Hopefully, that helped Jim from Santa Cruz. Thank you very much.

Cap Rates: How Do You Account for Rental Property Equity to Calculate Retirement Income?

Joe: I got “Hello Al, Joe and Andi. Thank you so much for answering my question on rebalancing a stock and bond portfolio in a down market while in retirement. Your answer was direct and will be simple to implement if it makes sense for us to do when we retire. By the way, my wife did not believe Joe was not Big Al. I explained that Al got his nickname from his big brain. But she would not believe me until I showed her the YMYW YouTube video.” This is Tom from Lynwood, Washington. Tom. “I would like to hear your thoughts on how to account for the equity in our rental property to calculate retirement income cash flow.” Okay? Al, you with me?

Al: I’m with ya.

Joe: He’s lookin’ for cap rates I believe here. As a reminder I’m 57, wife is 62 and we plan to retire in 2 to 3 years. We have a globally diversified total return portfolio consisting of pre-tax, post-tax, and Roth accounts.” Tom. Yeah, I think Tom’s got a lot of cash if I remember right. He likes to brag about it.

Andi: You guys get along famously then.

Joe: I don’t have any cash. Big Al, that’s- Big Al’s called that because of his wallet as well. He’s got a big wallet.

Al: That’s what you like to say.

Joe: That’s why you got a big, bad back. “We have owned a rental property for 11 years and we intend to keep it for at least 8 more years and sell it before I take Social Security at 67. The rental property is cash flow positive and I estimate the equity will be about 22% of total cash flow.” So the rental property is cash flow positive and I estimate the equity will be about 22% of the total cash-flow generating assets at the time we retire.” So the cash flow from the rental property, he’s going to calculate 22% of his needed income.

Al: Right, got it.

Joe: “My dilemma, to meet our expenses in retirement we’ll need to draw down the stock/bond portfolio at 6% a year. Obviously, this is too high of a drawdown percentage. However, if I include the equity in the rental property, the drawdown becomes more 4% or 5% or no- 4.5%. Do you think it’s reasonable to include the rental property in the drawdown calculation? Thanks, Big Al, Giant Joe, and Colossus-”

Andi: “Colossus Andi.”

Joe: “Colossus Andi.” Giant Joe. I could say something very inappropriate but I’m not.

Andi: That would be inappropriate.

Al: That would be like you, but you’re very restrained. That’s good.

Joe: Well, so a couple of things Tom, is that it’s okay to take a 6% distribution rate in your early years as you’re letting your Social Security grow. Because there’s gonna be multiple years and multiple triggering events that’s going to happen. So he’s looking at straight I’m bridging this gap to retirement. I’m going to have some retirement income through my real estate. But everything else is gonna have to come from my brokerage account and then that’s going to be a 6% draw rate. And then from there, then his Social Security kicks in and so on and so forth, which would be maybe even a 2% rate. So you’ve got to look at it kind of in a bigger- he’s looking at it in a vacuum I think, year by year which you don’t want to do.

Al: And I think that the way I would say it is I would not include the equity in this calculation because it’s not available. It’s a cash flow-

Joe: He could sell it.

Al:  He could sell it. If you sell it and end up with the liquid cash that you invest then yes, at that point you count it. But in this particular case, you take your spending need and you subtract out your net rental income. And then you have your shortfall and you divide that in your portfolio, which is what it sounds like he’s doing. And I think another point is if you’re eligible for Social Security I would actually plug your- what your Social Security into the computation and see what it is. Maybe it’s 4%, but you’re taking- if you took Social Security early and then it’s like it’s actually not that bad. I can afford a 6% awhile because I’m letting my Social Security grow. So that’s maybe another way to think about it.

Joe: Or another way to look at it too, is that take the rental income out and then put the equity in the equation. So you’ve got to pick one or the other. So he’s using a hypothetical. He’s spending let’s say $75,000 a year and $25,000 is coming from rental income. So a shortfall is $50,000. Makes sense. And he’s like if I pulled from my portfolio I have $800,000 and some odd thousand dollars. So that would be a 6% draw rate. Or you say, you know what? Get rid of that $25,000 of income and put the equity within the asset mix. So you add- let’s say he had $800,000 of assets- you add in the equity there, but you take the income out.

Al: But if you do that, you want to make sure that you’ve got a conservative valuation on the property and add in closing costs and maybe even add in taxes. So anyway, if you’re going to go that route just be I guess be true to yourself in terms of what you really net out of this. If you actually sold it.

Joe: Let’s say it’s $1,000,000 property and then he’s got a ton of equity in there but it’s renting poorly. The cap rate’s terrible because- where the hell does he live? He lives in Lynwood, Washington. I don’t know where that is. Is that-

Al: It’s up north.

Joe: I was going to say- well I don’t know. I don’t know what would properties go for up there. But there are multiple ways that to do the calculation- kind of the back of the envelope type thing, just to see-

Al: I think the main thing Joe, is what you just said, is it’s OK to have a higher distribution rate for a while if Social Security and/or pension is coming later.

Joe: But he’s also might be doing this because- Tom’s writing to us like we remember exactly what his net worth statement is. But let’s say if you have IRAs and 401(k)s. And then he’s got a brokerage account and he’s got this rental income. And he’s like I’m not going to touch my IRAs and 401(k)s. I’m trying to convert those and I think- something like that- and he wants to spend down his brokerage account. And so he’s just looking at that one account and he’s doing the division in the one account. I’ve seen that before- I have this account, I’m pulling 6% out of this one account. I go but you have 3 other accounts that have another $1,000,000 in it. Who cares? You’ve got to take a look at the grand scheme of things. All right, Tom, I appreciate your question. Your dilemma makes our shows come true. So if you’ve got a dilemma you know where to go. Go to YourMoneyYourWealth.com and give us your latest dilemma.

YourMoneyYourWealth.com is also where you can load up on more real estate investing information. Whether you’re just getting started buying rental property or you’ve got some experience and you’re looking for ideas, I’ve put some free resources from Big Al in the podcast show notes to help you on your journey. Check out Al’s video on how to start investing in real estate, and listen to his interview with small apartment building investor Terry Moore on how to use rental real estate to build legacy wealth. Download our free guide with 10 tips for real estate investors as well – it’s all free, just click the link in the description of today’s episode in your podcast app or visit YourMoneyYourWealth.com to go to the show notes for today’s episode transcript, access all these free resources, and send in your latest financial dilemma.

Investing in the Stock Market Inside an LLC?

Joe: Al, I got like 10,000 Roth IRA questions that I’m just boycotting right now.

Al: Well then we’re gonna have a pretty short show, I believe.

Joe: I don’t know how many times I’ve got to tell people to stop with the Roth conversions. All you had to do was listen to one episode and then you’re good to go.

Al: Right. Apparently not because people keep coming back and asking follow-up questions.

Joe: We have 15 pages of Roth, Backdoor Roth, Mega Backdoor Roth. It’s like this is not the Mega Door Back Roth IRA show. Give me something else to talk about. I’m gonna kill myself.

Al: Well apparently we’re not clear at all. That’s why they keep asking-

Joe: Geez.

Andi: You talk in circles.

Joe: Marcus. Marcus saved the day, Al. He asked a question. “Hello Joe, Al, and Andi. What are the pros and cons for an individual investing in the stock market inside a business entity, specifically an LLC instead of using a personal taxable brokerage account? I heard people say this works well for families but haven’t got clear benefits. Thank you. Continue the great work on the show. P.S.” And then nothing.

Andi: He forgot to put his P.S. apparently. Marcus, let us know what your postscript is.

Al: He got interrupted I’m sure. And then he just hit send.

Andi: And notice he didn’t say this time that he’s from Tennessee Alabama. He just said he’s from the South.

Joe: He is from the South. Tennessee Alabama’s the South.

Al: We know Marcus.

Andi: Yep.

Joe: So I don’t know what the hell he’s reading. Some of you guys do out there? You don’t need to listen to every single financial podcast out there and then you come to us for clarification on stuff that you heard a snippet on. So he wants to invest in- well what, a family limited partnership? Or he wants to set up an LLC to invest in stock market funds? Versus- he’s gonna set up a limited liability company and he’s going to invest in mutual funds in the market.

Al: Yeah. So in terms of- let’s just start right there. There’s really no advantage that I can think of, other than it’s a different name than your own and maybe it’s a little easier to hide. But I’ll tell you what, nowadays with internet searches and all kinds of background checks, attorneys can find out what you own and where you own it. So I don’t think that’s that great a deal. So there’s really no specific reason to invest stocks in an LLC. However, I think you hit upon it Joe, which is if you want to do an advanced estate planning technique called a family limited partnership, that is a way to do that, and what you do is you set up an LLC, you contribute stocks or cash and buy stocks or whatever so that LLC owns stocks. And then slowly over time you give $15,000 of value, I guess to each beneficiary so it stays under the gift tax limit and you slowly trickle out some of these assets to the kids. Now as it’s given, they take over the same tax basis that you had. So if there is a sale they’ll pay tax on the sale, but at least you get it out of your estate if you’re up over that $11,000,000 level or $5,000,000 in 2026 so it can be a strategy. But just to invest- just to set up an LLC to buy stocks, I can’t think of really any reason to do that.

Joe: That’s an estate freeze. So if Marcus has a large estate, and was trying to avoid or using some advanced tax strategy to avoid the estate tax or the death tax, there are ways to gift assets outside of your taxable estate into a non-taxable estate so you’re gifting it out of your basically control. You’re setting up a family company and you’re gifting shares of your wealth because it could be more than stocks and bonds. It could be real estate, it could be whatever, into this other entity that would avoid estate tax on your passing.

Al: It’s more common Joe with real estate to do this strategy.

Joe: Yes. Well with an LLC for sure. Like you have rentals; you would set up an LLC to buy- to title investment property because of just the liability of renters falling, tripping, and breaking their legs, suing you or doing whatever.

Al: That’s right. So you’ll have umbrella insurance; you may have liability insurance. But an LLC limits your liability to the equity in that asset or the equity of all the assets in that particular LLC. So that makes sense but you don’t really have liability for owning stocks. It’s just an investment.

Joe: Unless they’re listening to something and saying hey you can get corporate tax rates versus individual but an LLC is a flow through entity.

Al: They’d have to invest in a C Corp which would be the dumbest idea of all. Because now you’ve got double taxation. So yeah don’t do that.

Joe: All right Marcus, hopefully that helps. Let us know what the P.S. you know-

Al: What you think the P.S. was?

Joe: I don’t know. ‘Joe, I think-‘

Al: Andi, do you have a thought?

Joe: ‘Joe, I think you do a great job. Andi, Al, half-ass- at best.’

Al: I thought he would say Andi does a great job and you and I are marginal.

Joe: Well, we are marginal.

Andi: He knows that we already know that.

Joe: I’ve got to pump my own tires here.

Andi: ‘Cause nobody else does it for ya’ Joe. Nobody else thinks anything highly of what you have to say.

Joe: That is correct.

Andi: Right. Yeah.

Understanding the National Debt

Joe: We got Clint. He writes in from Florida. “Hi Andi, Joe and Big Al. Can you help me to understand the huge U.S. national debt currently at $27,000,000,000,000? I remember my high school economics class. The debt has something to do with GDP. However, the only way I can foresee our national debt decreasing is to at taxpayer and/or rise taxes on everything from income to estate.” So yeah we can have a big baby boom, add a lot of people, more people in the workforce.

Al: That’s one way. Or open the borders, get more taxpayers in here.

Joe: And then you got- or you can raise taxes. “How much time do we have before the debt hits the fan?” Oh, look at a Clint with his little clever conversation here.

Al: That was clever.

Joe: “Thanks for the entertaining and informative podcast.”

Andi: Thanks for adding to it Clint.

Joe: Yeah. Yeah. Well I remember when I- I used to say something stupid like that too- one of our workshops? It was about taxes rising. So it was Social Security. It was insecure health care. And then inflation; and then pension plans. S.H.I.P. So I write that out and then I was like ‘when is the ship gonna hit the fan?’

Al: I do remember that.

Joe: Three people laughed out of like 1000 people in the auditorium. That was great.

Al: Stopped doing it.

Joe: After that it was like, let’s not do that one anymore. I stole that too, from Ed Slott.

Al: Oh, you did?

Joe: Yeah.

Al: It works better for him apparently.

Joe: I guess so. Yes.

Al:  Maybe it’s funny for other advisers but not like people that are just trying to listen to the content.

Andi: So now his question is, are you guys are you dragging this out because you don’t really know how to answer the question?

Joe: No. The debt is going to hit the fan and there are a few ways that it’s going to- what will happen- is that we could grow ourselves out of it. That could happen.

Al: If we stop increasing the debt, with inflation it’s- we’re going to pay it back in cheaper dollars. So that is one way to go.

Joe: Another way is probably to increase taxes. And I think that is a very pretty good guess that that will happen.

Al: When he asks about GDP, gross domestic product, it’s unrelated to the national debt. However, what economists like to do is they like to compare the national debt to gross domestic product. And when it gets too far out of whack- like for example Greece was way out of whack- their debt was way lower than ours but so was their GDP. And we’re not economists- I can’t tell you the magic ratio- but obviously, Italy was another one. Portugal was another one. Spain was another one. But Greece was the worst. It is an issue, it’s actually a huge issue, that we’re going to have to tackle. And at the moment, our politicians don’t seem to want to tackle it. But we’re going to have to have to work on this. But the main ways you work your way out of this is increasing taxes or growth; stopping contributing to the debt and growth which then ends up paying this off in cheaper dollars.

Joe: Yeah. Well, you get an increase in revenue and so you keep the tax rates the same. You get more tax dollars because of the increase in productivity.

Al: Well that’s the idea of supply-side economics.

Joe: Yes. Thank you. Maybe we should get Chris Thornberg back on here.

Al: So we could ask a bunch of dumb questions.

Joe: Oh my God. He makes you feel like a total idiot.

Al: Remember what I said- I remember this question. I said ‘you know now that our national deficit is like- at that point $18,000,000,000,000-‘ He goes ‘Al, that’s the year, this is the year. That’s the national debt.’ I said ‘oh sorry.’

Joe: We were doing a little pre-show. I was like ‘so, what do you want to talk about?’ He goes ‘well ask me anything.’ I go ‘well how about this?’ He goes ‘no that’s the stupidest thing I’ve ever heard.’ OK. Well I’ve got nothing.

Al: Just start talking. How’s the economy?

Joe: How do I know? You’re the economist. He’s a good guy though. I like him.

Al: Yeah, I liked him. But he was- he was direct.

Andi: That’s why we had Brian Perry interview him last time.

Joe: He was on?

Andi: A couple of years ago now.

Joe: I don’t remember.

Al: I think I was on that too and I let Brian ask the questions.

Andi: Yeah I think you were too. Yeah.

Joe: Because I’m not very good at asking economists questions.

Andi: Chris was on- let’s see, actually it was July 2019. It just feels like it was about 10 years ago.

Al: Did you take economics in college? Joe?

Joe: Yes I did. I killed it. Yes. I went to University of Florida. It was mandatory.

Al: I took it too. It was hard.

Joe: It was a toss up to be an economist-

Al: Or this.

Joe: – or whatever the hell I am.

Al: Or a bartender?

Joe:  Bartender, that’s coming up too.

Al: I got it.

Estate Planning: Beneficiaries and Charitable Donations

Joe: We got an estate planning question Al, from CK.

Al: Okay. We’ll do our best. We’re not estate planning attorneys but we’ll do our best.

Joe: She goes “I’m a single old lady. I want to complete my will.” So she’s got a few questions if- well first one- “If I assign beneficiaries on an IRA Roth annuities, can these go directly to beneficiaries without going through probate?” Very good question, CK. And yes, the beneficiary form is one of the most important estate planning documents that most people have. Because yes, this will go straight to the beneficiary without messing around with any attorneys or probate or even go through the trust if you name an individual as the beneficiary of those accounts. So very good there. Any comments on that, Al?

Al: No that’s accurate. To my knowledge.

Joe: Got it. Number two, “If I donate to Silicon Valley or similar companies to make America great or if I donate to medical and educational or qualifying non-profit agencies, which one is more beneficial?”

Al: Sounds like a political question.

Joe: I don’t know what the hell that is all about.

Al: Well let me just say if you give to a charity which is in the tax code it’s got these letters and numbers 501C3. And as long as they’re a charity it doesn’t matter. And from a tax deduction you get the same to that tax deduction in any charity. If it’s a political deduction, you don’t get a tax deduction there. So it has to be to a charity- 501C3. But in terms of which is more beneficial, if you’re saying tax-wise, it doesn’t matter. If you’re asking me which is better to make America great, that’s a personal opinion.

Joe: Which is more beneficial I guess- if you go to a nonprofit, that’s where you want to go. That’s where you get the biggest bang for your buck. So just 501C3- just make sure that it’s a qualifying charity. And yeah you then-so what is the ruling now Alan, in regards to stock or cash gifts in regard to deductions?

Al: It’s a great question, because a lot of times when people think contribution, they think cash only. But you can actually give stock or any appreciated property for that matter. And so at the date that you make the donation whatever the value of that stock is becomes your tax deduction. And so it’s definitely preferable to give your appreciated stocks. In other words, the other choice if you want to give to charity would be to sell your stocks, pay taxes, capital gains taxes on them, and then donate. But you can actually donate them directly without selling. Then you get the full deduction for the valuation. But you don’t pay any capital gains tax. So that’s like- that’s a great way to go.

Joe: And then is there a limitation? Let’s say if I- because there’s a certain percentage of AGI that you can actually deduct on your tax return?

Al: Yes. So for a cash donation, it’s cash or check I should say, it’s 60% of your income. If it’s appreciated stock, it’s 30%. So in other words, you make $100,000 a year, you can give away $60,000 if you write a check; you can give away $30,000 if you give appreciated stock. And the way it works if you want to give $60,000 and still deduct it which would be an awful lot but let’s just say you did. Then you give away $30,000 of appreciated stock and then you give the rest in cash and you still get the full $60,000 deduction.

Joe: If I give $60,000 in stock, so that’s 60%, but I am only able to write off $30,000, I can still carry over that $30,000 loss or the $30,000 the following year?

Al: You can. And so you go through the same computation again in terms of the ability to deduct. And it carries over for 5 years. Obviously, you can deduct it in the year you make the donation, but then it carries over another 5 years. So you have 6 years to deduct it. So unlike a capital loss carryover, which is indefinite the rest of your life, a contribution carryover only lasts 5 years.

Joe: See how I’m just dragging him along here, Andi? It’s like, wow.

Andi: I do. I noticed you’re just feeding him the questions and letting him go.

Joe: I go let’s go here bud. You get a tax deduction. OK. All right. Thanks, Al. You’re high-value today.

Al: Big time man.

Joe: “As a single person, no taxes on $5,000,000. I need a good strategy. Please advise me. Thank you very much.” Not sure what that question means either, Al.

Al: Well I think she’s talking about the estate tax exemption which right now is what, $11,200,000 or $11,300,000 something like that, per person. It’s scheduled to go back to that $5,000,000+ level in 2026. So maybe her assets are in excess of that. I don’t know if she wants it to go to beneficiaries. If that’s her question, then there are all kinds of strategies in terms of setting up advance planning and trusts and family limited partnerships and that’s more than I want to get into right now. But-

Joe: Yeah because you’re barely hanging on with just talking about the charitable contribution on your tax return.

Al: Well it’s- as we record this- it’s early morning in Hawaii, so I’m still drinking coffee, Joe. Give me a little break. So don’t you think that’s her question?

Joe: I think so. I don’t know, what people write us, Al is- sometimes is-

Al: That’s half the fun, trying to figure out what they’re really asking. I got a question from a client yesterday about giving their IRA to charitable remainder trust. And I said ‘no you can’t do that’. And she said ‘well you said a year ago that we could do that’. And so then I’m just trying to think what, now what is she really trying to say? And I think what she was trying to say was the qualify charitable distribution- giving money directly from your IRA to a charity. But she said charitable remainder trust and the item that we were talking about was a beneficiary IRA which you can’t even do that. So anyway, that’s part of our activity which is trying to figure out what people are really asking.

Joe: But you could name a beneficiary of the charitable remainder trust to kind of preserve the stretch IRA. That’s a strategy that we did talk about in a tax seminar a few years ago.

Al: You can. I agree with that.

Joe: But you can’t gift an IRA into a charitable remainder trust.

Al: And that was the question that was posed to me yesterday.

Joe: Got it. There’s a lot of terminology that goes out.

Al: I know. Right. I just have to back up and say what could she be thinking?

Joe: What’s the actual question?

Al: Right.

Joe: Got it.

If you’ve got some complicated money questions, it’s a good idea to get some help with your financial plans before you put them into play so you don’t screw something up and cost yourself or your family a bunch of time and money. Click the link in the description of today’s episode in your podcast app to go to the show notes at YourMoneyYourWealth.com and sign up for a free financial assessment, but do it now – as we approach the end of the year the calendar is filling up. While you’re in the show notes you can also download our estate plan organizer. Just fill it with all of your financial information and give it to your family to make it that much easier for them to manage your affairs or settle your estate when the time comes. And, you can listen to that interview with Big Al, Brian Perry, and economist Chris Thornberg on the state of the economy in July 2019 – remember way back then, before COVID? Check it all out now in the podcast show notes at YourMoneyYourWealth.com, and yes, you can even send in your Roth conversion questions.

Backdoor Roth IRA and the Pro-Rata Rule

Joe: Jason writes back in from good ol’ St. Paul, Minnesota. He goes “Thanks for responding to my question on show 295.” That was great show, Al.

Al: I think that’s one of our best. Once we got to 300, we fell off the wagon.

Joe: 300, don’t listen to it.

Andi: 300 is gonna be all derails, by the way.

Joe: Got it.

Al: Oh perfect.

Joe: “Hi Andi and Big Al. You were right, it is me more than my wife that is into the whole FI and financial planning thing. I was running an errand when I heard the podcast. Hi Joe. Once I got home, my wife and I had dinner, playing the podcast on the speakerphone. You all made her belly laugh.” Well that’s good. I like making bellies laugh. Love it. “I want to clarify my question and add a little bit more detail.” All right. Let’s see what you got Jason. “My wife started a new job and contributed to a 401(k) there. She kept her previous 401(k) RSP from the previous employer, at Fidelity. We each want to start doing annual $6000 Backdoor Roth contributions. Does the RSP need to be rolled into her new 401(k) to avoid the pro-rata rule? Or is it excluded because it’s still a 401(k)? I wasn’t sure if it changed when she left the previous employer. Thanks again for making a show about personal finance entertaining and always educational.” So yeah, you could keep it in the RSP. It’s fine. That would still qualify for the Backdoor Roth.

Andi: What does that stand for again?

Joe: It’s a retirement account through her old employer.

Andi: Oh okay. So you don’t know what RSP stands for?

Joe: Yes I do. But it’s early in the morning in Hawaii. And I haven’t had my coffee.

Andi: Got it.

Joe: Retirement Savings Plan, I’m guessing. I don’t know.

Al: That’s probably a good guess.  So here’s your clue on this pro-rata rule. If it doesn’t say IRA in the account name, it’s probably not included in the pro-rata rule. So 401(k)s, 403(b)s, 457s, TSPs, those are not included in this pro-rata rule for IRAs which is important when you get to Backdoor Roth.

Joe: So you could roll it into her new 401(k) if they allow and that would make things consolidated and easier or you can just keep it in the RSP there at Fidelity. Either way-

Al: Either way, you don’t need to but you can.

Joe: And then I guess Jason, I believe the other questions then for you as well is, how much is in the overall account? You know since you’re doing- I think if I remember right Jason’s a little bit younger- but I could be just making this stuff up. He can’t be that young if he’s sitting there listening to us at dinner.

Andi: You’d be surprised.

Al: You know some of these FI people, they’re really into it.

Does a Roth IRA Conversion Count in MAGI (Modified Adjusted Gross Income)?

Joe: OK we get set Sid from Kansas. “Does a Roth conversion count in MAGI? I want to convert $140,000 from my IRA to a Roth IRA. My income this year will be at around $100,000. My wife doesn’t have any income and we file jointly. I’m able to do a Roth contribution this year. Or does a $240,000 of income make me ineligible for a Roth IRA contribution?” Good question Sid. Great question actually. A Roth IRA conversion does not- is not included in the modified adjusted gross income in purposes for you to be eligible to contribute to a Roth IRA. So if your adjusted gross income is under what, $196,000 I’m guessing- $196,000 to $206,000 I believe it is-

Al: I think that’s what it is for 2020. Yeah.

Joe: So he’s at $100,000, he’s like well if I do this conversion, now it’s at $240,000, so that puts me over the limit. But they take the $140,000 conversion out of the computation. So you’re still eligible to do a Roth IRA contribution. Your wife would still be eligible to make a Roth IRA contribution and you can do the conversion of $140,000. So you’re good to go there Sid from Kansas. We’ve been getting a lot of people from Kansas.

Al: Yeah we have. I was going to say the other thing is a Roth contribution does not count either. So if you did a Roth contribution that put you into where you couldn’t, your wife could still do one. Because that doesn’t count either in terms of this computation.

Joe: Roth contribution’s not gonna add income to your tax return.

Al: True. Nevermind that part.

Andi: It’s early in Hawaii. You can be early in Hawaii for the whole show.

Al: The coffee has apparently not taken hold yet.

Joe: What, did you have some Mai Tais last night?

Al: I had 2 Maui Big Swells. They’re really good. I did.

Andi: Explains a lot.

Joe: Okay. You know if you do a Roth IRA contribution that won’t affect your MAGI. All right, good point Al.

Al: Movin’ on.

Roth 401(k) vs Traditional 401(k)

Joe: We got Jeremy, the supply chain manager from Cookerville, Tennessee.

Andi: Cookeville.

Joe: Cook- Cookeville. Yes. I’ve never been there and I remember Jeremy that he doesn’t care for his wife that much.

Andi: That’s not true. He just figured that they should have been saving into his accounts instead of hers because he’s so much older than she is.

Joe: Yeah, by like six months or so. “Andi, Joe, and Al, my company will be offering a 401(k) with a Roth option starting in 2021. Currently, we just have a regular 401(k) option. I often have a hard time articulating the benefits of a Roth IRA versus a traditional 401(k). Can you help me out with how to explain the benefits of a Roth 401(k) over traditional 401(k) to my co-workers who may ask me what my option is?” Well so-

Andi: “- what my opinion is on it.”

Joe: “- what my opinion is-” I’m sorry. “Here’s what I would rattle off if someone asked me right now-”

Al: So he’s kind of the go-to guy in his company.

Joe: Oh yeah. He’s a supply chain manager. He’s the advisor to other supply chain managers.

Al: He looks to YMYW so he’s tight.

Joe: We’re going to send him a T-shirt.

Andi: We need to have some first. I want one.

Al: We do need one. What color is it going to be? Green.

Joe: Oh, it’s gonna be blue and white.

Andi: It’d be the blue and the gold.

Joe: So this is going to be Jeremy’s advice. So we’ll role-play this out. Let’s say my name is Kenneth. And I’m gonna go to Jeremy because I’m a supply chain manager and I’m like ‘Hey Jeremy. ‘You know I heard about this Roth 401(k). What do you think?’ Jeremy is going to say ‘Roth grows tax-free forever. No required minimum distributions. If taxes are high in the future you win by doing the Roth now. With a Roth, you could take contributions out any time without penalty which could come in handy to bridge the gap for someone to retire before 59 and a half. Shifting retirement dollars to Roth may be able to assist with tax bracket management when you start drawing down your retirement. These are the talking points-‘ So that’s- how was my Jeremy impersonation? Pretty good?

Al: It sounded a lot like you. But outside of that-

Joe: It was dead on. It was perfect. “These are typical points I talk about with the normal Roth IRA. But would also add that there are typically more and better investment options in a Roth that is not managed by my company. If someone asked you guys ‘why should I switch to Roth?’ What would you tell them? Thanks for all you do.” Couple of things Jeremy, I like where your head’s at, Roth IRAs do grow tax-free forever. There will never pay taxes on those again given current law. However, in a Roth 401(k) there are required minimum distributions. So you would just roll that into a Roth IRA. Roth IRAs do not have required minimum distributions. Roth 401(k)s do have a required minimum distribution. The biggest thing I think is that you have to look at what tax bracket that someone’s in and how much that they’re planning on saving long term. If they’re probably in the 22% tax bracket or lower, or even maybe the 24% tax bracket given where tax rates are probably going to go, the Roth 401(k) in my opinion is probably a better bet. Because you get the taxes off the table now, you’re jammin’ into the 401(k), and it grows compound tax-free. It’s a pretty good deal. So yeah Al, what’s your two cents?

Al: I do agree with his points as well. And I would say you don’t necessarily need to have 100% of your retirement in a Roth or Roth 401(k) because what tends to happen when people go that route- and it’s a great idea- but when they go that route, then they’re generally- they’re paying higher taxes now because they’re not getting a tax deduction in exchange for paying zero taxes later. I’d actually rather have some income in retirement to fill up a 10%, 12% bracket maybe the future 15% bracket. So I think a balance is in order. But all the points are right. The Roth grows tax-free forever and it’s not just the contribution; it’s the principle, interest, growth. All that’s tax-free. And it’s tax-free for you and your beneficiaries. Now there’s a new rule when you pass away that there is a required minimum distribution for your beneficiaries and they have to drain that account within 10 years, so just be aware of that. But as long as you and/or your spouse are living, there is no RMD. We think it’s a great way to go because you get a lot more tax diversification, a lot more control over your taxes in retirement. But just be mindful of how much tax you’re paying now in exchange for what you’re gonna save later.

Joe: And it’s impossible to know that, because you’re predicting the future of what you believe tax rates are going to be. This is a great strategy if you don’t- you’re like you know what? I just want to get the uncertainty of taxes off the table and just put it into the Roth, out of sight, out of mind. You pay a little bit of tax. No one saves the tax deduction anyway. So by all means, I think if someone says ‘no, I want my tax deduction’ just say ‘well then that’s going to grow- think of it like this- so if you have $50,000 and you get a tax deduction for that $50,000- and I’m running out of time but I’m gonna do it anyway. Let’s just say to make the math super simple. So let’s say you have $100,000 that you contribute, hypothetically, into a retirement account you get a tax deduction for that. So $100,000, you save $25,000 in tax if you’re in the 25% tax bracket. So Jeremy’s a younger guy. And then so let’s say over 30 years that $100,000 turns into $1,000,000 and you take the $1,000,000 out. So you get a $25,000 tax deduction, hypothetically, $100,000 grows to $1,000,000, then you take the $1,000,000 out at 25%. What do you pay in tax? Like $250,000. So you’ve got a $25,000 tax deduction to pay $250,000 in the future. So you could say $1, you could use $100, you could use $1000, you could use $10. I like $100. I like the bigger numbers Al, it makes a bigger impact.

Al: You do. I’m with ya.

Joe: Or you could say, you know what? I’ll forego the $25,000 tax deduction today and let the $100,000 grow to $1,000,000 and I pull $1,000,000 out all tax-free. I save the $250,000 on the back end. So, a lot of ways to slice this thing. But if you want to take the uncertainty of taxes off the table in the future, the Roth IRA is the best way to go.


Got a few Derails for you at the end of today’s episode, and next week, as I mentioned, to celebrate episode 300 of Your Money, Your Wealth®, it’ll be a whole show of Derails, outtakes and the funniest moments from the YMYW podcast. Join us, won’t you? Make sure you’re subscribed on your favorite podcast app so you don’t miss it.

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Pure Financial Advisors is a registered investment advisor. This show does not intend to provide personalized investment advice through this broadcast and does not represent that the securities or services discussed are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast in the process of making a full and informed investment decision.