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Joe Anderson
ABOUT Joseph

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

Alan Clopine
ABOUT Alan

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

Published On
December 31, 2019

The thrift savings plan (TSP) explained, and the rules around Roth conversions from TSPs. Plus, Joe and Big Al answer your questions about, what else, Roth conversions and Roth contributions: age limits on making conversions, backdoor Roth conversions, Roth contribution phase-outs and recharacterizations, and the pro-rata rules. Plus, Joe explains, again, his distaste for fixed index annuities, and we find out why “Big Al” is called Big.

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Show Notes

  • (01:02) Should I Move Funds From TSP to Roth TSP and How Much Tax Will I Pay?
  • (08:03) Will Converting to Roth from TSP Affect My Backdoor Roths?
  • (18:24) Why Would I Put After-Tax Money in a 401(k)?
  • (22:04) Roth Contribution Phase-Outs for Married Couples Explained
  • (23:38) Can I Recharacterize a Roth Contribution? What About the Gains?
  • (25:51) If I Do a Backdoor Roth, Do I Have to Pay Additional Taxes?
  • (26:57) Can You Do Roth Conversions Over the Age of 80? How to Save on Taxes?
  • (30:28) If I Do a Second Roth Conversion This Year Will the Pro-Rata Rule Apply?
  • (35:26) What Do You Think of My Fixed Index Annuity?
  • (44:12) Why is “Big Al” Big?

Resources mentioned in this episode:

THRIFT SAVINGS PLAN:

FROM TSP.GOV & SEC.GOV: TSP Changes (PDF), 2020 TSP Contribution Limits, Roth TSP for Uniformed Services Members, and Taxes on Your TSP Withdrawal (thanks, listener Dan!)

LISTEN | YMYW PODCAST #220: Here’s How the Pro-Rata Rules for the Thrift Savings Plan (TSP) Have Changed

LISTEN | YMYW PODCAST #251: Should I Convert TSP to Roth? Would I Lose My NY Tax Deduction?

LISTEN | YMYW PODCAST #198: TSP and the Savings Deposit Program for Military

FIXED INDEX ANNUITIES:

READ THE BLOG: Understanding Annuity Retirement Pros and Cons

Transcription

Today on Your Money, Your Wealth®, the TSP or thrift savings plan explained, the updated rules around withdrawals from the TSP, and Joe and Big Al go over the rules around Roth conversions from TSPs. Plus, the fellas answer your questions about, what else, Roth conversions and contributions: age limits on making conversions, backdoor Roth conversions and RMDs, Roth contribution phase-outs and re-characterizations, and the pro-rata rules. Plus, Joe will explain, again, his distaste for fixed index annuities, and we’ll find out why Big Al is called “Big”. As a reminder, rules for stretch IRAs, RMD withdrawals and more are changing in 2020 thanks to the passage of the SECURE Act, which was passed after this episode was recorded! Be sure you have the most up to date information by downloading our SECURE Act guide from the podcast show notes at YourMoneyYourWealth.com. I’m producer Andi Last, and here, on the final day of 2019, are Joe Anderson, CFP® and Big Al Clopine, CPA.

01:02 – Should I Move Funds From TSP to Roth TSP and How Much Tax Will I Pay?

Joe: We got Matt from Carlsbad, California.

Al: Awesome.

Joe: “Good morning.” I guess he wrote this to us- over breakfast. “I have a good sum of funds in my traditional TSP account and a healthy part of this is tax-exempt. I do not have a large amount in my Roth TSP. Should I move a percentage from my traditional to Roth? And if so, how much taxes percentage-wise should I expect to pay? Thanks.” OK Alan, Let’s dissect this or try to decipher what Matt is talking about. So he’s got funds in his TSP. For those of you that are not familiar with TSP, it’s Thrift Savings Plan. It’s a 401(k) plan for government employees. So Matt’s got a retirement account. He’s got a healthy part that is tax-exempt.

Al: So does that mean after-tax money? Got basis?

Joe: Nope.

Al: Ok, what does that mean?

Joe:  I have no idea.

Al: Okay. You are the TSP expert between the two of us.

Joe: I’m saying tax-exempt in regards to the contributions were pre-tax is what I’m thinking. You know how people write things.

Al: Yeah I know. I’m just trying to understand what he’s saying.

Joe: Me too. That’s why I said let’s try to decipher this. So a healthy part of this is tax-exempt.

Al: Tax-exempt. But can you not put after-tax money in the TSP?

Joe: No.

Al: You can’t.

Joe: No.

Al: Not possible?

Joe: No, it’s impossible.

Al: Okay. Can I quote you on that?

Joe: Like Roth- yes you can. I’m sorry. You’re referring to after-tax dollars that would still be taxable on the earnings coming out of the plan.

Al: Yes. That’s what I’m referring to.

Joe: Yes. And the answer is No. Can I put after-tax dollars in the Roth component of the TSP? Yes.

Al: If they have a Roth component.

Joe: They do.

Al: Yes. This one does apparently.

Andi: And he says he does not have a large amount in it.

Joe: The Thrift Savings Plan is a government plan.

Al: Isn’t that a state? Or that’s a federal plan?

Joe: It’s federal.

Al: OK. So all right one plan. So, government plan has the Roth option. So when you put money in you can either get a tax deduction. Right? Or you cannot get a tax deduction by putting it in the Roth side.

Joe: Yes. Correct. So he’s saying a good healthy part of this is that pre-tax. It was tax-exempt from taxes as the contributions growing tax-deferred now is going to be taxable coming out. But then he’s like I want some Roth stuff. Because it was tax-exempt in the old standard definition of tax-exempt. He wouldn’t need to go into Roth because the money was-

Al: It’s already exempt.

Joe: So he’s just confused on some terminology.

Al: I wonder if he was investing in municipal bonds. You can’t do that inside the TSP.

Joe: It would still be ordinary income.

Al: Right.

Joe: It doesn’t matter. Anything inside a retirement account is going to be coming out ordinary income unless it’s a Roth. So he wants to convert. Here’s a couple of things Matt. You cannot convert- two things, you cannot do an inner plan conversion. So you cannot take your pre-tax and move it into the Roth component of the TSP. And you cannot even convert your TSP to a Roth IRA. You’re going to have to move the money out into an IRA and then do the conversion.

Al: And you would have to be 59 and a half, right? To do that?

Joe: I’m not sure if he’s still working there. I suppose he is.

Al: As an in-service withdrawal. Generally, you have to be 59 and a half and I think that’s how TSPs work. Or separated from service.

Joe: You can do- they’ve changed the laws- we went through this last week a little bit on the more- they’re a little bit more flexible in regards to what you can or cannot do with inside the TSP. Before if you wanted to take distributions, let’s say I’m retired, I want to take $50,000 out of my retirement account per year. With an IRA you can say give me $2000 one month, $4000 the next month, don’t give me anything the third month or whatever. Right?

Al: Yeah.

Joe: But TSP, you had one time and say here’s my election and then you took your distribution. So you’re kind of stuck with it. Now they said we can give you continuous distributions. But how they take the distributions is pro-rata. So it’s still kind of stinks for retirement income.

Al: So let’s say 10% of your dollars are in Roth then it’s going to be 10%- whatever distribution- 10% comes out as Roth or-?

Joe: No it’s worse than that. You could say I want a 100% Roth or 100% pre-tax.

Al: OK.

Joe: But let’s say you have 25% in the C fund, 25% in the G fund, 25% in the S fund and 25% in the I fund. If you want $1 out, you’re gonna get a quarter out of all of those different funds.

Al: Got it. So that’s what that means.

Joe: Pro-rata via funds. Because let’s say the stock market’s down. I want to take it from the government fund, the G Fund, which is a fixed balance, it’s going to be pro-rata. So taking distributions from a TSP is not very efficient. I don’t want to blow up the TSP. I love the TSP because everyone says to love the TSP.

Al: What are the advantages? They’re low cost, right?

Joe:  Oh my God it’s free. That’s it.

Al: That’s pretty low.

Joe: Yes. I mean I think that they basically pay you to hold money in the TSP. No, it’s very very inexpensive. They got 5 funds. They’re index funds. And there’s so much money in the Thrift Savings Plan. Is that you’ve got the power of large numbers where the expense ratios are miniscule.

Al: Got it.

Joe: You got $1,000,000 account in the Thrift Savings Plan. You’re probably paying, I don’t know, $200 a year maybe? So they kind of pound that into these-  oh don’t- because so many people that sell product will go after them.

Al: Yeah.

Joe: You’d sell them a fat annuity.

Al: High commission. High cost.

Joe: High cost. High- versus maybe going can I get some index funds that might be higher. A little bit higher cost but at least you have a little bit more flexibility.

Al: Sure.

Joe: The TSP doesn’t let it stretch to the next generation. The wife can’t- or the husband or the wife, the spouse I should just say, they can’t hold the TSP. That’s kind of weird too. So let’s say if you have a Thrift Savings Plan, if you were to pass away, Annie? They’d be like, “no, get out of here.” So she would have to move it into an IRA. If the kids- let’s say if Annie predeceased you and then now goes to the children, it doesn’t allow a stretch. So they would have to put it into an inherited IRA. So the TSP itself does not stretch, it would be fully distributed. So there’s a lot of nuances that are not necessarily flexible. And I get it because it’s free. There’s no help. They’re not going to staff that thing up and say here, here’s your options, here’s your choices or whatever. It’s all automated. They’re going to make it very very simple for them to administrate the plan. So hopefully that helps, Matt.

08:03 – Will Converting to Roth from TSP Affect My Backdoor Roths?

Joe: We got Chris from Savannah, Georgia. Very beautiful place.

Al: Wow, that’s exciting. We’re all the way on the East Coast.

Joe: “Hi Joe, Al and Andi. I truly love listening to your podcast.”

Al: Not just love.

Joe/Al: Truly.

Joe: This is true love.

Al: This is great.

Joe: Love you Chris from Savannah.

Al: Yes.

Joe: “Thanks for everything you do. I just finished listening to the advice you gave Terri on episode 249-” Of course you remember Terri.  “-on the breakeven point for Roth conversions.”

Al: Oh sure I remember talking about that.

Joe: “And I was pretty convinced that we should start converting our traditional for 401(k)s to Roth’s. Like Terry, we will have more than enough fixed income in retirement to live on. And it’s hard to imagine a scenario where we would need to start tapping into our retirement funds before the MRD payment starts.” or RMD is what we’d say, but mandatory required distribution or required minimum distribution. “I’m 59 and have fully retired from both military and civilian service.” Well Chris thank you very much for your service. “I’ve just under $800,000 in the TSP-” Again TSP, Thrift Savings Plan.”- all traditional. My husband is still working and we are doing Backdoor Roths through Schwab. I know there are new rules for TSP withdrawals. But I’m wondering if those rules would allow me to make conversions without screwing up the ability to do Backdoor Roth. This is the only non-Roth account that I have after having converted other accounts a few years ago in order to start the Backdoor Roth.”  All right. Very good Terri. She’s-

Al: She’s on it.

Andi: No, this is Chris.

Joe: I’m sorry Chris. Who the hell’s Terry?

Andi: She’ referring to a question from 249.

Joe: Terri. That’s old news.

Al: We’re talking Chris now. We like Chris.

Joe: “We make large charitable contributions every year in order to-“

Al: “every other year.”

Joe: “every other year-” there we go- “in order to bunch our deductions. So we’re in a super low tax bracket those years despite having a high enough age guy to require us to do a Backdoor Roth. My husband’s 401(k) is mostly traditional but we have switched to Roth contributions over the years. Can we make conversions within his plan? Or does that depend on the rules of the specific plan? My third option is to say screw it, not make any changes and push all the RMD amounts to charity when we start receiving them and let the kids pay the taxes when we die.” Well that’s awfully- well jeez- “one option-“

Al: Well it depends on her mood at the time.

Joe: It depends on her mood at the time.  I love it.

Al: Whether the kids are acting nicely or not.

Joe: “Andi, I live outside Savannah, Georgia. I just have a phone number from Virginia. Thanks so much gang.” Because we would probably said Chris from Virginia.

Andi: Absolutely. If she hadn’t told us.

Joe: Then she followed up- She goes “Hey Andi, just submitted a question about Roth conversions and TSP and I realize that I refer to MRD instead of RMD.”

Al: It’s the same.

Joe: Yeah. Same same. “I asked a question awhile back and Al referred to me as savvy.”

Al: Ooh. How about that huh?

Joe: Wow. Oh she can’t let that- that was probably years ago.

Al: That was probably like episode 248 at least, or before.

Joe: Oh man. “I hate to ruin his image by screwing this up.”

Al: No, I still think you’re savvy, Chris.

Joe: “But I can imagine Joe having fun with it anyway.” Yeah. She does know us well. “I love the humor and the advice. Just thought I’d clarify that I’m aware of my mistake.” Well she’s savvy.

Al: She is savvy.

Joe: Because MRD-

Andi: Savvy Chris.

Al: MRD is the same thing as RMD. It’s just said differently.

Joe: Mandatory Retirement Distribution.

Al: Yeah. Required Minimum Distribution. Mandatory Required-

Al/Joe: -Distributions.

Andi: I learned something today. I’d never heard of MRDs.

Joe: MRD.

Al: Yeah. Some people say that. It’s perfectly acceptable. I noticed you translated it when you read it just because we usually say RMD.

Joe: RMD.

Al: Required Minimum Distribution.

Joe: But Savannah, Georgia, they say-

Joe/Al: MRD.

Al: It rolls easier with a Southern accent.

Joe: It just rolls. You know when you got that little roll.

Al: You know by the way that’s- we’re talking about, when you turn 70 and a half, you’re required to start taking money out of your IRAs, your 401(k)s, your TSPs.

Joe: So I don’t know Chris. You might- after what we’re going to tell you- you’re probably gonna say screw it. Because you cannot do a conversion out of your TSP.

Al: No, but husband has a 401(k).

Joe: So he could do an inter-plan conversion as long as it’s-

Al: As long as it allows.

Joe: -as long as the plan allows it. The law allows it. But does the plan allow it? I don’t know.

Al: But couldn’t she, if she wanted to a conversion she could do it, an in-service withdrawal- well she’s not even in-service, she can just do I guess just a withdrawal to a-

Joe: A 60-day roll over it and put it into a Roth and get taxed and then file that BS?

Al: No.

Joe: No.

Al: She could do it a trustee to trustee transfer for a small amount and convert that?

Joe: Okay. She could do that to an IRA and then convert it.

Al: To an IRA. Yeah, that’s what I’m thinking.

Joe: But it would have to go to an IRA first. So let’s say she wanted to convert- You cannot go TSP to Roth. It would have to be-

Al: No I understand. So let’s just say she wanted to convert $40,000. So she does trustee to trustee transfer-

Joe: $40,000 in the IRA, and then 40 converted.

Al: – TSP to IRA. Convert that. And then you still do your Backdoor Roths and it’s all-

Joe: As long as everything’s converted she’d be fine.

Al: Yeah. If you do the trustee to trustee transfer of $80,000, and you keep $40,000 in the IRA, you’ve blown your Backdoor Roth.

Joe: But I think that’s just too big of a hassle. Because the Backdoor Roth is just like a Roth contribution. You know what I mean? Everyone gets so up in arms about these Backdoor Roths. Just convert $6000. It’s the same thing because it’s already after tax. You already paid the tax.

Al: Well and then going back-

Joe: Does that make sense? I mean people just get —-  I was going to say a bad word. I’m not going to say it. But they get like a chub – or happiness.

Al: A chub.

Joe: Can we say that?

Andi: Wow. You actually said that!

Joe: About these Backdoor Roths.  But it’s like I can’t screw it up. It’s not- It’s the same thing. Or am I missing something here, Alan?

Al: No, it’s roughly the same. But I think in this particular case it’s much easier to just- if you want to do a Roth conversion, convert your husband’s 401(k) to the Roth, if it allows it.

Joe: Let’s say she rolls her TSP into an IRA. $800,000 is now in an IRA. So now Chris cannot do a Backdoor Roth.

Al: Yep.

Joe: So what a Backdoor Roth IRA is, is that you have $7000 in your checking account. It’s already after-tax. So let’s say they’re in the 25% tax bracket. They already paid 25% in tax on that money. It’s free and clear from tax. They put it into an IRA. Then they convert it into a Roth IRA. There’s no tax due on the conversion because it’s an after-tax contribution. Right?

Al: Correct.

Joe: But the money was already taxed. What’s the difference if you take $7000 from a retirement account that was never been taxed and you convert it into a Roth IRA?

Al: Well there’s no difference if you’re in the same tax bracket today as you were when you paid tax on that $6000.

Joe: Right. But it’s the same year because they’re doing a Backdoor Roth. Because they got the- unless she’s saving dollars when she was working when she was 12 years old.

Al: I’m saying the $6000 she already had.  She already paid tax on that. I’m saying in another year.

Joe: But a Backdoor Roth you’re doing it the same year. Aren’t you?

Al: Yeah. But you already paid tax on that $6000 potentially in a prior year.

Joe: But what I’m saying is that let’s just say I did a $6000 conversion each year. It’s going to be the same tax effect.

Al: Yeah overall, over enough years. But see the thing is, if you don’t want to pay tax on the $6000 this year because you’re in a high bracket you’d rather do the Backdoor Roth. That’s why. That’s all. Very simple. Chris, you’re still savvy. My partner, on the other hand- does need some help.

Joe: I’m with you 100%. But what I am stating here is that if this were me- Chris is savvy. She knows her stuff.

Al: Yes she does.

Joe: And so she’s kind of taking a look at things. She’s doing, bunching up some charitable stuff. So she’s in- they’re in really low tax brackets. So those are the years that she wants to do conversions. And maybe she wants to convert to the top of the 22% or 24% tax bracket. And to do that it needs to go from IRA to Roth IRA.

Al: Sure.

Joe: So roll the money into an IRA and just do the conversions whenever you want. Versus then doing from TSP, filling out all the paperwork, going through all that rigmarole, putting $40,000 into an IRA and then from an IRA converting it.

Al: But if you have plenty of time and you want to be like, do this exactly correctly in terms of the best benefit, then you kind of look at it the way she does.

Joe: OK. All right. Well congratulations Chris. We really appreciate your listenership. I’m glad you find us humorous and I think you’re doing an awesome job.

I’ve linked to our previous discussions of Roth conversions from a TSP and the changes to the TSP plan, including info straight from the horse’s mouth, that is, TSP.gov, as well as our brand new guide to the SECURE Act, which changes some of the rules regarding RMDs – or MRDs, as the case may be, Chris, since 72 is now the new 70 and a half. Find all these free resources in the podcast show notes at YourMoneyYourWealth.com. And if you would like more clarification or have a money question of your own, click “Ask Joe and Big Al” in the podcast show notes and send it in as a voice message or an email. You can get there by clicking the link in the description of today’s episode in your podcast app.

18:24 – Why Would I Put After-Tax Money in a 401(k)?

Joe: Back to the email bag. We got Rob from Santa Clarita. Isn’t that where our buddy’s from?

Andi: Yes.

Joe: All right.

Andi: Meir Statman.

Joe: Meir Statman.

Andi: I’m going to get him back on the show just so you can-

Al: Just for that.

Andi: Yeah.

Joe: Yes. “Dear Joe, Big Al, and Andi. Have a couple questions for you. Sometimes I just need to hear some of these answers in a different way or in a different context.”

Andi: By the way, you remember Rob right? He’s the guy that works in Hollywood.

Joe: Oh yeah. Is he?

Andi: Yeah. He’s a big fan of the show. You’ve answered lots of his questions.

Joe: How do you know that this is the same Rob because-?

Andi: Because I know these things, Joe.

Joe: Oh. Wow, she’s like a-

Al: She’s already been emailing back and forth.

Andi: Totally.

Joe: She’s got a little eye in the sky.

Al: And she probably reached out to Rob, ‘Rob we’re a little short this week, we need another question.’

Andi: Yeah because we’re so short.

Joe: Rob’s in like a Head and Shoulders commercial. Andi knows it.

Al: Yeah that’s right.

Joe: OK. So Rob’s he’s got number 1. “Why would I ever put after-tax money into a 401(k)?”

Al: Wow, that’s direct.

Joe: “Aren’t all your gains going to be taxed as ordinary income when you go to withdrawal? I understand that the gains are tax-deferred but if I took that money and put it into a brokerage account and had it my investment for over a year, it’d be taxed at capital gains. I want to have more control over my investments. And I could use tax loss harvesting if I needed to and the money is liquid without penalties. Is this especially true if we think that these tax cuts are permanent? And I could end up going from 22% tax bracket to 35% with AMT?” Look at Rob.

Al: Wow. You’re right on it.

Joe: Look at the big brain on Rob. Jeez.

Andi: Somebody listens to the show.

Al: Another savvy guy. Wow.

Joe: But Rob you’re missing one big huge fat point. Yes, you would absolutely fully want to put after-tax money into a 401(k) plan. But you do not want to leave it in the 401(k) plan for long. You would convert it directly to a Roth IRA as soon as you made the contributions.

Al: If your plan allows it.

Joe: You could- well they’re always at your- after-tax dollars are available. It might take 30 days but in most cases I’ve seen, it’s readily available. Very very quickly. So let’s say you put $20,000 after tax Rob. Then you convert the $20,000 into a Roth IRA. So that’s another $20,000 that you have in a Roth IRA that you never pay taxes on it because it’s an after-tax contribution.

Al: It’s like a way to get a much bigger Roth contribution in, kind of using these rules.

Joe: So I get it. If that wasn’t the case then I would not want to put after-tax money into a retirement account either. Would you?

Al: No. I agree with Rob for that- I mean so this was what, maybe 2, 3 years ago when the IRS came out and said yeah you can take the after-tax money and put it directly into a Roth IRA. Before that, remember the crazy stuff we’re trying to do to work around that rule? Because of the step doctrine rule and all that, but IRS came out and said and in a letter ruling or even I think it’s law actually come to think of it, that you can- in a 401(k) if you have after-tax money- you can put that directly into a Roth IRA. Now you want to do it sooner rather than later because any earnings on that get taxed as ordinary income. So Rob is right in that respect. So the sooner you can do this, the better.

Joe: He’s got part 2 of his question.

Al: It looks like he has 4 questions.

22:04 – Roth Contribution Phase-Outs for Married Couples Explained

Joe: Jesus Rob. “Can you explain the formula for the step down in Roth contributions if you’re married and making between $193,000 and $203,000 of AGI? I looked it up on something like Investopedia or Morningstar and didn’t-

Joe/Al: – seem to add up?”

Joe: “-seem like you could max out before you hit $203,000.”

Al: I can explain that. So what he’s referring to is when you are married and if you jointly make less than $193,000, we call that the modified adjusted gross income, you can do full Roth contributions. And if you make more than that it starts to get phased out. If you make more than $203,000 you can’t do any. And the math is simply this- if it’s a $10,000 variance which this is and the amount that you can put into the Roth is, what is it?

Joe: $7000?

Al: Yes $7000, if you’re over 50 let’s just say. So then you just use that ratio 7/10. And so basically the math- and I’ll just do a real simple example- if you’re halfway there between $193,000 and $203,000-

Joe: $198,000.

Al: $198,000, you can do half of the $7000. And it’s just pro-rata if it’s higher or lower.

Joe: So yeah. Simple simple. $198,000 modified adjusted gross income. So the maximum allowable contribution let’s say it’s $7000. You can only put in $3500.

Al: If you’re $198,000. So easy enough and if you’re somewhere-

Joe: Don’t go to Investopedia Rob, you know where to go.

Al: Go to Your Money, Your Wealth®.

23:38 – Can I Recharacterize a Roth Contribution? What About the Gains?

Joe: YMYW, right here. Just to clarify. “I cannot re-characterize money that I converted into a Roth from an IRA. But I just opened a Roth and I don’t meet the income requirements by the end of the year. I still have until April 15th of the following year to take it out, correct? And if so what happens to any gains that I made?” All right look at- So Rob’s talking about re-characterizations now on contributions versus conversion.

Al: It’s different rules on contributions. You actually still can re-characterize contributions you just can’t re-characterize conversions.

Joe: The reason for that is because the whole re-characterization law came about for contributions.

Al/Joe: That’s why it was there in the first.

Al: There was another reason because if your AGI was above $100,000 and you couldn’t do a Roth conversion.

Joe: Right. Because the contribution limits were a lot higher than the conversion limits. Because what, 2010, they changed the law. So almost 10 years ago. So you had to have a modified adjusted gross income of under $100,000 to even do a conversion.

Al: And you wouldn’t even know that till you file your return. But you had to do your conversion the year before.

Joe: Correct. You had to do it in the year-

Al: So they had to allow you to undo it which is how the re-characterizations came into being. So now you cannot re-characterize the conversion because- and the reason is there’s no limitation anyway.

Joe: There are no income limitations.

Al: The IRS kind of let us have that free rule for like 7 years, 8 years, whatever it was. But anyway so a contribution, yeah you can re-characterize that. Because you don’t know at the time potentially when you made that contribution if you, if it sticks or not. If you do have gains in it you have to pull that money out too and you have to pay ordinary income on that. That’s just the way it works.

Joe: So you put $6000 in it’s worth $6500. You re-characterized the $6000, the $500 comes out, that’s taxable income.

Al: Taxable income. Exactly.

Joe: Because-

Al: There it is.

Joe: – you’ve got to plan a little smarter.

Al: And actually you don’t have to do a Roth contribution until April 15th of the following year. So why do it early if you’re not sure if you’re going to make it or not.

25:51 – If I Do a Backdoor Roth, Do I Have to Pay Additional Taxes?

Joe: Number 4. “If I do open up a non-deductible IRA and convert it using income that I made, in theory, I shouldn’t have to pay any more taxes as long as there was enough money coming out of my paychecks to cover my income taxes correct? Because I’ve already paid the taxes through my payroll deductions. Right? Again love your show and your sense of humor.” So I don’t understand this question here.

Al: Well he said “can I open a non-deductible IRA and convert it?”

Joe: Yes.

Al: Yes. There’s no tax. I guess that’s what he’s getting.

Joe: “I shouldn’t have to pay any more taxes as long as there was enough money coming out of my paychecks to cover…”

Al: Yeah your regular income tax. In other words, you’re talking about a Backdoor Roth. If you do it properly there’s no addition in taxes. So as long as you have enough withholding to cover your salary as far as taxes you don’t owe any more taxes.

Joe: But according to Andi he’s an actor so maybe he only makes $7000.

Andi: No he works in the film industry.

Joe: Yeah. He’s just Head and Shoulders guy.

Andi: OK. He can hook you up with Charlize Theron.

Joe: Oh that’s right. Thanks for the questions, Rob. Hopefully that clarifies some things.

26:57 – Can You Do Roth Conversions Over the Age of 80? How to Save on Taxes?

Joe: Susan from San Diego. She writes in Alan, specifically for you.

Al: Yeah. “Hi, Al.”

Joe: “Hey Al. I have a question for you regarding my in-laws.”

Al: Wow. There’s some money there.

Joe: Nothing about taxes. “So I got some in-laws, I would like you to take care of them.” “They have a good amount of money in a 401(k). They would like to figure out a way to save on taxes when their sons benefit from their trust. They are in their early 80s and would like to convert it to a Roth but it looks like you can’t do it after 80. Do you have any suggestions for them?”

Al: Well Cindy, since you so nicely-

Andi/Joe: Susan.

Al: Susan. What’d I say?

Joe: Cindy.

Al: I said Suzy.

Joe: Whatever.

Andi: Al, I’m sorry. We’ve got that on tape.

Joe: You’re pretty tight.

Al: Whatever. Anyway, Susan since you asked so nicely, there is no age limitation on doing Roth conversions. So your in-laws can do Roth conversions. And I’ll tell you what if they don’t need the money and they are going to be in a lower tax bracket than their sons then it would make sense for them to go ahead and convert it to Roth. And then when eventually when their sons inherit the money the tax is already paid. So there’s no limitation on age to do a Roth conversion.

Andi: Where would Susan possibly get that idea?

Al: I’m not sure.

Joe: Where did what’s his name get the idea that most of his TSP contributions were tax-exempt?

Al: Got anything to add?

Joe: I would look at in-laws’ tax return.

Al: Look at the tax bracket.

Joe: 80-years old, big amount 401(k) plan. What do you think? They probably have pensions.

Al: It may just be-

Joe: I bet they haven’t touched the 401(k) plan or only except for-

Joe/Al: – required distributions.

Joe: Right or mandatory required distributions.

Al: Sometimes Joe what happens when parents get older they go to nursing homes or long term care facilities which generally are fully deductible as medical expenses. So whatever income they have they’ve got more deductions than income. They end up with negative taxable income. Then they’re in a perfect situation to do conversions because they’re in very low brackets maybe even some of it’s tax-free.

Joe: All you have to do is just get the in-laws in a nursing home.

Al: I’m just saying if they are-

Joe: They get giant deductions. And then you do fat conversions and then hopefully you inherit the money soon after that.

Al: Or it’s already there for them if they need it.

Joe: I think this strategy is missed often. Mom and Dad have some money in retirement accounts. We’re going to inherit it. They’re not spending it. They’re probably not doing any type of financial plan. We don’t get that many 85-year olds in here.  Recently though there are some older clients who have come in which has been nice. Because then there are cool strategies that you can actually do just like this. So convert Mom and Dad’s retirement account. A lot of times we would say have the kids pay the tax. Because they’re going to inherit a tax-free asset that right now will continue to grow tax-free and they’ll just have to take a required distribution based on their-

Al: And sometimes we have the parents, they got big fat pension plans, they saved a lot. They got a lot of money in 401(k)s or whatever.

Joe: Yep.

Al: Their kids are deadbeats. So it’s like they’re in high tax brackets. The kids are low tax brackets. So no that would be the opposite. In that case, you would not convert. So it just depends. Parents’ tax brackets versus kids’. If in fact, they don’t really need the money.

30:28 – If I Do a Second Roth Conversion This Year Will the Pro-Rata Rule Apply?

Joe: Okay. We got Dora. Dora the Explora. Boston, Massachusetts.

Al: I like Boston.

Joe: Hey can I park your car? “Hi, Joe and Big Al. I recently discovered this awesome podcast and love it.” Boom. Thank yo,u Dora. “Thank you for putting on such an informative program. I have a Roth conversion question.” Imagine that.

Al: Here we go.

Joe: “In February of this year I had converted my traditional non-deductible IRA to Roth IRA.”  Backdoor conversion. “The traditional IRA at the time was the only traditional IRA with any value. After the conversion, I had no other value left in my IRA. Since this IRA was funded with non-deductible funds this conversion should result in very little tax consequences. I am also retired now so I would like to take advantage of this small window of opportunity to do more Roth conversions before RMDs kick in. I decided to do a rollover of a portion of my 401(K) to a traditional IRA with plans of doing a partial conversion to Roth IRA over the next few years. If I do another conversion for this year will this affect my first conversion that was done in February, i.e. will the pro-rata rule apply as now I have an outstanding value in a traditional IRA? I’m thinking the pro-rata rules should not apply but wanted a second opinion. Looking forward to hearing your answer. Keep up the great job. Thanks again.” Dora you’re not going to like the answer. Yes, the pro-rata rule does apply. It’s the balance of the IRA at the end of the year.

Al: Yeah that doesn’t- that’s never seemed quite fair to me because you do the conversion properly. And then all of a sudden later on, can’t you roll this money out and it blows the whole thing up. So you gotta be careful. You’re right that it’s your IRA balances at year-end that control what the conversion pro-rata rule looks like the rest of the year.

Joe: So you do a conversion in February you didn’t have- so she put money into an IRA. There was no other IRA. She converted it. She’s all good. And then now December she’s like I want to do a little bit more of that conversion. I’ve got the bug.

Al: Here’s a workaround. You could take what you rolled into the IRA and roll in back into the 401(k) as long as it’s not there by year-end. How about that?

Joe: Get rid of it. Get it back into the 401(k) plan and you’ll be fine. So or convert it all.

Al: Strange rules. Convert the whole thing.  That’d be another approach.

Joe: Then you’ll be all right.

Al: Then you blow up your tax bracket.

Joe: Because you know what we used to do back in the day is that we used to do double Roth IRA conversions when there was the re-characterization rule. So before when you did a Roth IRA conversion you moved money from a traditional IRA to a Roth. You had the opportunity to move it back into the IRA if you didn’t want to keep the conversion. Or if you made a mistake, like Dora did here.

Al: All the way till October of the following year as a matter of fact.

Joe: So let’s say we did 2 Roth conversions. So now that money was out of the account. So let’s say it was $100,000 conversion. We would convert 2 of them. And then we would invest them differently. One would be fairly safe. One would be fairly aggressive. So the person would have $200,000. We would see which Roth performed the best. We would keep that one and recharacterize the other one.

Al: It was a great stretch-

Joe: Brilliant.

Al: It worked for like 8 years, 8 or 9 years.

Joe: But what happened though is what we found is that let’s say if someone was 70 and a half and taking required minimum distributions and then you did the conversion. So $200,000 was out of the IRA. And so we were like can we take the RMD based on the account value? But then that didn’t work either.

Al: The answer is no it is. It has to be anticipated, the re-characterizations back in. So it got complicated.

Joe: It did get complicated.

It got very complicated, and now with the new SECURE Act going into effect at the start of the year, strategizing your retirement is a little more complicated – Roth conversion strategies may play an even bigger part in your plans. Let’s face it, YMYW is a great resource for general information about planning for retirement, and while I have posted links to download our SECURE Act guide and Roth IRA basics guide in the podcast show notes at YourMoneyYourWealth.com, for time-sensitive decisions and strategies that are specific to you, your life and your circumstances, the best thing you can do to start 2020 on a good financial foot is to make an appointment with a qualified financial advisor, preferably a CERTIFIED FINANCIAL PLANNER who is a fee-only fiduciary – that means they’re legally required to act in your best financial interests. To sign up for a two meeting financial assessment with one of our CFPs here at Pure Financial Advisors either in person or via video web meeting, click the Free Assessment button at YourMoneyYourWealth.com. We’ve got time for just a couple more questions before the end of 2019:

35:26 – What Do You Think of My Fixed Index Annuity?

Joe: Let’s go to Stewart from San Diego. “Hi. Andi. Al. Joe. LOVE your show!”

Al: In capital letters. “LOVE your show!”

Joe: Love.

Al: Exclamation point.

Joe: “I actually prefer to read the podcast transcripts-“

Al: Because she can’t understand a thing we say.

Joe: Stewart is a male. Would you agree with that?

Al: I don’t know. Keep reading. I’ll tell ya.

Joe: Have you ever met a female Stewart?

Andi: You know an Andi.

Al: This is the 2019s, anything’s possible.

Joe: He reads the transcripts because he just can’t stand to hear my voice.

Al: So how many guys put LOVE in capital letters?

Joe: Well people that love-

Andi: Notice Stewart put my name first, so maybe that’s why he said love your show.

Joe: Yes he loves Andi. “Background, 50 year old, married, desire to retire in 10 years, didn’t get to earn income until age 30 due to extensive education.” Stewart’s very educated. “401(k) was burned badly by the lost decade of investing 1998 to 2008 essentially got zero net return during those 10 years.” Because you were just in the S&P 500. Guaranteed.

Al: Should have had international funds.

Joe: Yep. You should have been globally diversified. But that’s spilled milk. “Predictably got conservative. So now have majority of the 401(k) getting 3.5% return and CDs, which I’m fine with because a 401(k) will grow to $2,000,000 in 10 years when I’m 60.” Wow, good for you Stewart. “Wife and I make just too much to contribute to a Roth and seeking safety for accumulation again this time with after-tax savings. Six months ago purchased a $250,000 fixed indexed annuity-” Oh boy.

Al: Here we go.

Joe: Here we go.

Al: Let’s see if you get Joe worked up.

Joe: Let’s go Stewart. “-with an A to AA rated company. I know that from previous shows and podcasts, in general you guys don’t favor these products but I think I got a decent one.” Of course you did, Stewart. “No fees, no guaranteed income rider, the usual 10% free withdrawal if necessary the first 10 years, 25% benefit base bonus-” wow “-175% interest credit applied percentage, no caps, no spreads, allocations in 4 indexes with participation rates of 50%, 85%, 90%, and 130%. So far it’s keeping pace with or outperforming up 5.6%, the S&P 500 index up 2.7% since I purchased it 6 months ago. In other words, I’m okay losing a point off and index gains each positive year. See the participation rates they averaged 90%. So that I essentially have no chance of losing anything in negative years. You know a very small cost of doing business in order to provide me safety and accumulation so I can sleep at night.” How much time we got here? “My plan is to continue to purchase what I think high quality fixed index annuities with after-tax savings for the next 10 years. Will continue to max fund the 401(k) when I retire in 10 years. My grand retirement plan is to keep half my money in fixed indexed annuities in the other half in index funds gradually converting the 401(k) to a Roth most likely. My retirement income plan when the market is up, then I’ll take the profits from the index funds and let the FIA scrub when the market is down. I will let the index funds recover while taking withdrawals from the FIA. This will minimize losses for my retirement portfolio in down years while getting excellent combined returns in up years all while 50% of it is still safe accumulating during retirement. What do you think fellas? The math is pretty simple and I’ve run the numbers several times. It works even in historically bad timeframes. The Great Depression, Great Recession, Lost Decade, with a slightly mathematical advantage. It works better than the usual retirement portfolio makes up stocks, bonds, CDs, ladders, etc. Love your show, Andi, Al, Joe. Keep fighting the good fight.” Okay I got a few comments here for Stewart. Stewart the fixed index annuity is a- It’s not a good one.

Al: Why?

Joe: Because there is no such thing.

Andi: As a good fixed indexed annuity? There’s no such thing as a good fixed indexed annuity.

Joe: There is a- buy a fixed annuity. The problem is this. So how a fixed indexed annuity works is, it is sold that you can receive market participation with no downside risk. OK?

Al: That sounds good.

Joe: Part of that is true. He will never lose a dime in this product. It’s guaranteed by the insurer by the AA or A-rated- You should go with AAA-rated company. But he’s saying I’m fine with giving up a point to keep my safety. It’s going to be a lot more than a point. Because the underlying product is that they are buying bonds. The insurance company is buying a bond. It’s either a long term zero-coupon bond, or it’s a long term government bond or whatever who knows, whatever’s in that portfolio of the insurance company. So he’s invested in bonds. Then they’re buying call options on the S&P 500 index or the Russell 2000 or he said he’s got 4 different indexes here that he can choose from. So there’s a bond yield that he’s going to receive plus the call option. If the market goes down they’re not going to exercise the option. If it goes up, they’ll exercise- it’s a derivative. What he’s missing is that there is no dividends involved in any of his payment. It’s an option. That’s what he’s receiving. There’s a cost to the option. As markets get volatile, do you think option pricing gets more expensive? Or cheaper? It gets more expensive. So that spread is going to increase with the- and the insurance companies realize this. So each year they can change their spread. They can change their caps. They can change their participation rates. So what a participation rate is, is that you can only- let’s say the market does 10%. You have an 80% participation rate. 8% is what you’re going to get. Plus they put caps on top of it. Then they’ll say you can only receive 2% per month. But let’s say the market does 8% in one month you get capped out. You only get the 2%. So there are so many different things that they have to look at. So they backtest the hell out of them. If you backtested in bad years, of course it’s going to look good because you don’t lose a dime. The market is losing its ass and it takes forever for the market to catch up. You could build these things and make them look like a beautiful sunshine. But it’s not. It’s not at all. You have to understand the product before you get into it and you’re going to put in half your money. You’re going to have $2,000,000. You’re going to make this person rich. Plus you’ve got a 25% bonus. This whole thing sounds like horse manure. Sorry, I don’t think he loves the show anymore.

Al: That’s the last question we get from him.

Joe: You gotta understand the product moving forward. The backtesting, the numbers that you’re running and everything else doesn’t mean anything because they consistently change the product on you depending on the environment of the market. Just realize you are buying a bond with an option on it. And then sometimes they will then sell a put on that same option to make money to cover it. It’s a complex derivative that they’re investing in. And so if you don’t understand anything that I just said get out of the product. Stewart. Thank you so much for listening to the show. Hopefully, I didn’t deter you too much from our show, but hopefully, it deterred you from your strategy.

44:12 – Why is “Big Al” Big?

Joe: Peter from San Diego. He goes “An off the cuff question. Big Al is a vegan-” I didn’t know you were a vegan. Did you?

Al: Sure.

Andi: Man, you got a short memory.

Al: That’s because he’s in his mid/late 40s.

Joe: “- who are not known for high caloric intake and doesn’t appear Big. Joe actually appears a bit stockier-

Al: from the pictures.” Oooh.

Joe: “But it could be the lighting.” What the hell does that mean, Peter? Stockier? Do you mean that I’m fat? I’m 6′ 4″. I weigh 217 pounds.

Al: What’s your BMI?

Joe: I have 14% body fat.

Al: No no, your body mass index.

Joe: I have no clue.

Al: I bet it’s a bit it’s over 24 and a half. Which means you’re overweight.

Joe: Oh. “So why does Al have the ‘big’ handle and not Joe. I’m sure other curious listeners would like to know. Thanks and happy holidays.” Well Peter, there is a very good reason that Big Al is called Big Al.

Al: What’s the reason, in your opinion?

Joe: Well it’s not my opinion.

Andi: Who came up with Big Al?

Joe: His wife. And that’s all that needs to be said.

Al: I used that at a seminar. It didn’t go over well.

Joe: That was so awful when he did that. You can’t tell that joke for yourself, Alan.

Al: Well I learned that.

Joe: People wrote in comments were like ‘that pervert’!

Al: I didn’t understand how to do comedy yet. But I will tell you the real answer if you want to know. The real answer is we had a- it was a picnic. What do they call that?

Joe: It’s called a picnic. Where they have a basket?

Al: Where we get together in the front yard. Whatever. Anyway, all the neighbors get together and there was-

Andi: Block party?

Joe: Barbeque?

Al: Yeah there’s a name for it.

Andi: Block party.

Al: Block party. Thank you. See you didn’t even know-

Joe: You said block party. He goes, no there’s a name for it.

Andi: He was saying no to you. He was ignoring me.

Al: I didn’t- I can only hear one at a time. I am older, by the way.

Joe: Got it. And larger.

Al: So at this block party we had a neighbor who’s no longer there, but we had a neighbor at the time who was named Albert, also known as Al, and he was about your height, 6′ 4″. Much bigger. And as a joke, Ann started referring to me as Big Al because he was actually the big one. You know some big guys are named Tiny.

Andi: That’s what we’re gonna start calling Joe. Tiny Anderson.

Al: I am a fit vegan but I still have the name Big Al.

Joe: So Peter’s calling me a fat ass.

Al: He just said you’re a bit stockier.

Joe: Stockier. Stockier is short and stocky. I’m 6’4″, lean, mean fighting machine.

Al: So we’ll compute your BMI index for the next show next year.

Andi:  That’ll be part of your New Year’s resolution.

Joe: I guess so.

Al: I’ll let you know where you stand.

Joe: I used to be fat. Remember Fat Joe?

Al: I do remember you-

Joe: That’s when we started the company.

Andi: I’ve seen video.  It was shocking.

Joe: Because when you’re working 90 hours a week. And then you drink a couple Coors Lattes on the weekend and you don’t work out and you become a little bit overweight.

Andi: Stocky.

Al: So now you work out and you eat better.

Joe: Yeah I work out 6 days a week. Play some golf and I still drink those Coors Lattes.

Al: Yes.

Joe: Well, 2019 has been one heck of a year for us at Your Money, Your Wealth®.

Al: It has.

Joe: We appreciate all of you hanging out with us, listening to us, having fun with us, giving us your comments and questions and suggestions.  And a few complaints.

Al: Yeah, we got some.

Joe: I don’t mind complaints.

Al: No. I don’t either.

Joe: It only makes this better.

Al: Keeps us sharp.

Joe: Or just gives us something to talk about.

Al: That’s the main reason.

Joe: So sometimes we are hurting for content.

Al: Cause we like to complain about your complaints.

Joe: It’s like what does this guy know?

Andi: Happy New Year.

Joe: Happy New Year. We’ll see you next year folks. The show’s called Your Money, Your Wealth®.

_______

For our New Year’s resolutions, we resolve to keep giving you the best personal finance and retirement podcast we possibly can each week, and in return, we would love it if you would keep sharing the show with your friends, family, neighbors, and acquaintances. Your Money, Your Wealth® is on all the usual podcast apps like Apple Podcasts, Google Podcasts and Stitcher, as well as Spotify, Pandora and YouTube, or you can subscribe to our podcast newsletter and get a link to the show delivered right to your email inbox each week. Thank you so much for being the most important part of the YMYW podcast.  Ask your questions for 2020, financial or otherwise, by clicking Ask Joe and Big Al On Air in the podcast show notes at YourMoneyYourWealth.com.

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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.