Joe Anderson
ABOUT Joseph

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

Alan Clopine

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

Andi Last

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

Published On
August 2, 2022

Should you save for a house down payment or invest for retirement? How much long term capital gains tax do you pay on a rental property when you sell it after 20 years, and how does a 1031 exchange work? Also, opening a Roth IRA with the Backdoor Roth strategy, and the 5 year Roth withdrawal rules explained. Plus, a couple retirement spitball analyses: are you saving too aggressively for retirement? Can you avoid the Medicare IRMAA, or income related monthly adjustment amount, and high taxes from required minimum distributions?

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Show Notes

  • (00:53) Should I Save for a Down Payment on a House or Retirement? (Abigail Scott Duniway)
  • (08:34) Rental Property Long Term Capital Gains Tax Explained (Juan)
  • (14:39) Retirement Spitball: Are We Saving Too Aggressively for Retirement? (John, Boone, NC)
  • (22:15) 5-Year Clock: Can I Open a Roth IRA with a Backdoor Roth Conversion? (Bobbi, NYC)
  • (29:57) 5-Year Roth Withdrawal Rules Explained (Janie, St. Louis)
  • (37:22) Retirement Spitball: Can We Avoid IRMAA and High Taxes from RMDs? (Wilbur, Nashville, TN)
  • (44:29) The Derails

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Today on Your Money, Your Wealth® podcast 389, should you save for a house down payment or invest for retirement? How much long term capital gains tax do you pay on a rental property when you sell it after 20 years, and how does a 1031 exchange work? Also, opening a Roth IRA with the Backdoor Roth strategy, and the 5 year Roth withdrawal rules explained. Plus, a couple retirement spitball analyses: are you saving too aggressively for retirement? Can you avoid the Medicare IRMAA, or income related monthly adjustment amount, and high taxes from required minimum distributions? Visit YourMoneyYourWealth.com and click Ask Joe & Big Al On Air to send in your money questions, comments, suggestions, requests, or stories. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

Should I Save for a Down Payment on a House or Retirement? (Abigail Scott Duniway)

Joe: All right, I got an email here. It says, “Andi, can you please give me a cool alias?” So what’s the alias of this person?

Al: What’s the name?

Andi: So I came up with Abigail Scott Duniway. Our emailer is actually from Portland, Oregon. So I looked up famous women in Portland and I came up with Abigail. She apparently was one of the first people on the Oregon Trail in 1851. Her husband suffered a farming accident, so she ended up having to support the family. She moved them to Portland.
She started a women’s rights newspaper called the New Northwest. She became the first woman to vote in Portland. So she was a pretty cool chick. So I decided I was going to name our emailer after Abigail here.

Al: Okay, a little history lesson. That’s good.

Joe: Oregon Trail.

Al: Right. You ever been on that?

Joe: No.

Al: I don’t think I have either. Been near it.

Joe: All right. “Hi, Andi. Joe. Al. I’m 40. I’ve spent most of my life-” on the Oregon Trail “- most of my life not really paying attention to money or investments. I’m debt free, but currently only have just over one times my annual income split between the old 401(k) and my TSP. Base salary is $73,000. But I’m currently in a unique position to pick up an extra day of overtime each week, which would almost be an additional $1600 a month. I’m curious about what my best course of action is in regards to this new money. I’m a renter, and I’d really like to use it towards the down payment on my first home. But I also know I’m really behind on my retirement savings. Currently, my work takes a mandatory 3.1% towards my pension. Plus, I’m investing 10% into my TSP. They match 5%. And I’m maxing out a Roth IRA. Based off my current salary, my pension will be around $22,000 a year. Am I too far behind to buy a house? I live in Portland with my SO-“

Al/Andi: -significant other-

Joe: “-SO-

Al: -with my SO-

Joe: -“with my SO and our 15 year old pit bull. We drive a- “15 year old pit bull. They last- they live that long? “ – and drive a 2005 Corolla and I enjoy a hard seltzer from time to time.”

Al/Andi: Cider-

Joe: I like the hard seltzer.

Andi: He just changed it to what he wanted to drink.

Al: You were thinking that was-

Joe: I was being selfish. Sorry. “Thanks for your help.” Okay, let’s see. I can help.

Al: Okay.

Joe: That’s minor.

Al: That’s yours. Couple of comments. 3.1% towards pension, 10% plus they match 5%. So you’re already about 18%. We tell folks they ought to try to get up to 20% of their savings. So that’s actually pretty good. You might be a little bit behind. I’m not sure you’re that far behind.

Joe: No, I don’t think she is. Because, let’s say- I bet she’s spending $60,000 a year. Because if she’s got $73,000, you pay the tax, plus you put the 10% into the TSP, plus you’re already taking money out for the pension and whatever benefits, I bet it’s like, I don’t know, $55,000, $60,000 a year?

Al: Yeah, $55,000, $60,000, exactly.

Joe: Okay, so let’s use $55,000. And she is 40, and she wants to retire at what, 60?

Al: Yeah. Call it 60- 20 years.

Joe: Okay. Present value- So we got $50,000, and then we got 20 years. And we’ll use 3.5% percent inflation. Okay, so she needs $100,000. Her living expenses will be roughly $100,000 in retirement.

Al: Yeah. With inflation. Okay.

Joe: She’s going to get a pension of $22,000. And that’s probably not adjusted for inflation. But it probably would be. But let’s just say straight $22,000. Maybe that’s today’s dollars. I don’t know if that’s future dollars. So she needs $75,000. You’re good with that number?

Al: Yeah. Social Security would probably be $30,000 at least.

Joe: Yes. Or let’s call it $20,000 even.

Al: Okay. Just to be conservative.

Joe: Yeah. So now that’s $55,000. So she needs about $1,000,000. Call it that.

Al: In that range.

Joe: In that range. So she’s got $100,000 roughly saved, and then she’s got 20 years. And let’s say she gets 7% on her money and she’s saving, with the match, $10,000.

Al: Yes. At least, yeah.

Joe: That gets her to $825,000. Super close.

Al: Yes, close. It depends on Social Security, though, because if it’s only $20,000, her fixed income is $40,000, and she needs $60,000. So she need $1,500,000, with that math. But-

Joe: I’m assuming that the pension- she’s got a TSP, so she’s a federal employee. The pension is going to have a cost of living on it, potentially.

Al: Yeah, potentially.

Joe: Social Security is going to be a little bit higher than that. And then if her income is going to continue to increase and she’s going to probably continue to increase her savings as that increases.

Al: Oh, you know what? She’s also maxing out a Roth. So you’ve got to add that in.

Joe: So she’s really close.

Al: Yeah, I think so, too. I think you know what? Use the extra money for a house if that’s what you want to do. Maybe your significant other can help, too.

Joe: Yeah, your SO.

Al: Your SO.

Joe: Get SO on board. So $1600. But the problem is that she’s going to have to figure out a down payment.

Al: Yeah, true.

Joe: Because I think she could cash flow if she could get a note.

Al: Well, she could. That’s why she’s thinking she’ll save the extra $1600 a month before that. But it’s gonna take awhile.

Joe: Yeah, it’s going to take a few years.

Al: Right.

Joe: So what’s that, $20,000 roughly a year.

Al: You can do what I did. I borrowed money from my grandma for the down payment. Or maybe your parents or your rich brother or whoever.

Joe: Or you could maybe, depending on what she does for the government, there could be some loan programs, maybe 2% down or 3% down. We’ve seen some of them.

Al: Right. Well, that’s true.

Joe: But yeah, I like the $1600 month. I think if you continue to put what you’re putting in the 401(k) with the match, with the Roth IRA, and then now you have this extra cash of $1600, and if you really want to get a house, yeah.

Al: Go for it, I think you can do it.

Joe: Yeah, I think so, too. I don’t know what segment we’re on.

Andi: You’re in segment 4, so you’ve got about a minute left.

Joe: We got to keep going. I can’t break early, is what you’re saying.

Al: Anything else to say on that one? Personally, I think if people want to own a home, that’s an important thing. And homes tend to appreciate over time. You’re living in Portland, Oregon, which is on the West Coast. The Coasts tends to appreciate a little bit more than the center of the country, not the slam anybody, but it’s just historically. Nevertheless, all properties have gone up in all areas over the past several years, and that tends to happen over the long term.

Joe: The biggest thing is that if you’re going to continue to rent all the way through your life, it’s going to kill you.

Al: Yeah. So you kind of want to lock in the housing. If that’s your goal, and it sounds like it is, yeah, go for it. I think you got enough money here to do it. The hardest part is the down payment, so you got to figure that piece out.

Joe: Yes. All right. Congrats. Thanks for the question. And good job, Andi, with the alias.

Andi: Hey, I hope Abigail liked it.

Al: We got educated.

Joe: Did that take you, like, a couple of hours of research there?

Al: She’s too awesome-

Andi: It took me like 30 seconds. Like I said, I just searched for famous women of Portland-

Al: I was gonna say- Andi’s going to submit overtime for that work.

Joe: Andi wants another $1600 a month for that work.

Al: I think so.

Rental Property Long Term Capital Gains Tax Explained (Juan)

Joe: Juan writes in. Is this my buddy Juan?

Andi: No, this is a completely different Juan.

Joe: Okay. “We bought this rental property approximately 20 years ago. We are concerned as to how much capital gains we would have to pay if we sell it now.”

Al: So let’s talk about how that’s calculated. Well, first of all, before we even do that, when you sell a rental property and if you want to buy another rental property for the same or greater value, you can do a 1031 exchange and not pay any tax. It just defers the tax into the next property, right? So as long as- once you sell, you have 45 days after close of escrow to identify 3 potential targets to purchase and then you have another 4 and a half months after you’ve identified to buy one of those 3. And it’s a little more complicated than that. There’s other ways to satisfy it, but that’s the most common one. If you’re wanting to buy a whole bunch of properties, there’s different ways to do this. But at any rate, you can avoid any current taxation. Whatever gain you would have had just rolls into the next property and you’ll pay the gain on the old property plus the gain on the new property at the time that you sell that. And if you never sell, if you pass away with it, it gets stepped up to the next generation and no one pays the tax. So think about that first of all. But secondly, if you want to sell, you need the money for other purposes. And that’s just fine. Here’s how you calculate the gain. You take a look at the- well, first of all, your tax basis. So in other words, your cost basis, what did you pay for it? Paid a couple of hundred thousand dollars. Okay, cool. And then you put $50,000 of improvements in it over time, so that gets added. So now it’s $250,000 is your cost basis. But you got to subtract out how much you depreciated. Depreciation means you can write off a piece of the property each and every year to reduce your taxes. So let’s say you depreciated $100,000, as an example. So now in that example, your basis was $250,000, subtract $100,000, now it’s $150,000. So that’s one part of the equation. The second part of the equation is, what you sold it for minus your closing cost. So let’s just say you sold it for $1,000,000 net of closing costs. You sold it for $1,100,000, $100,000 closing costs. Just to make simple math. So $100,000 or $1,000,000- I mean- $1,000,000 net sales proceeds -$150,000 basis, you have $850,000 gain- that’s long term capital gain. Some of that could be taxed at 0%, some taxed at 15%, some taxed at 20%, some would be subject to the net investment income tax of 3.8%. Some would be subject to a 25% tax because it’s depreciation recapture, which is on the $100,000 depreciation. So you have lots of different taxes. You just have to calculate what that would be. And that’s actually the first thing you should do when you want to sell a rental is, is it worth my while to do a 1031 exchange? And it may not be. Maybe the tax is low enough that who cares? Just cash out and go from there.

Joe: Is there any tax forms that people get when they sell a rental?

Al: Yeah, they get a 1099S. So that’s just 1099 sale. That’s all they get really.

Joe: Who- ?

Al: That would be the escrow company that sends that.

Joe: Escrow company, got it.

Al: But the IRS has no idea what your tax basis is, so you’re on the honor system for that.

Joe: Because when you sell a stock, the custodian is going to send you the 1099. But if I have a rental and then it’s like, okay, well, how much did the depreciation – there’s a lot of complex moving parts there.

Al: Nobody knows. However, if you’ve been depreciating it over time and you’ve included the depreciation schedules on your tax return, the IRS would know that, if they really want to take the time to figure it out.

Joe: Got it. All right, cool. Thanks, Juan. It sounded like a simple question, but a pretty complex answer. That’s how Big Al does it.

Al: I make the simple complex.

Joe: It should be the other way around.

Al: It should be.

We do have a guide that can simplify this stuff for you: learn more about 1031 exchanges and other real estate investing strategies when you download 10 Free Tips for Real Estate Investors from the podcast show notes at YourMoneyYourWealth.com. Just click the link in the description of today’s episode in your favorite podcast app to get there. And while you’re in the show notes, get your own YMYW Retirement Spitball Analysis: click Ask Joe and Al On Air and send an email or priority voice message. Tell the fellas when you (and your spouse, if you have one) want to retire, how much you’ll need to spend in retirement, how much you make now, what you have saved, and any other relevant details. And don’t forget to give us the irrelevant details too, like your name and where you’re from, where or how you listen to YMYW, your drink of choice, your pet, your car – you can make stuff up, it doesn’t matter. Tell a good story, because the show wouldn’t be a show without you! And don’t forget, we also take your suggestions, requests and comments there too.

Joe: We get any one stars this week?

Andi: Not this week. No.

Joe: Dammit.

Andi: He loves the one stars, folks. Those are apparently his favorite ones.

Joe: They don’t like how we’re so flippant-

Al: -the flippant. I was trying-

Joe: Because I guarantee that guy talks in third person. He’s a third person talker, and he was, like, talking in third person, and I was blowing him up, and he’s like, we’re going give him a one star-

Al: I was explaining this to a family member this weekend, and I couldn’t remember the word.

Joe: Flippant.

Al: Yeah.

Joe: Flippant.

Al: Yep. Okay. Thank you.

Joe: Yeah, we’ll keep the stars coming. I don’t care what type.

Al: Be honest. If you like us, 5 is great.

Joe: -They’re fine.

Andi: Remember that when the amount of downloads start going down. It’s not my fault, it’s yours.

Al: Well, truly, if you don’t like us, let us know. And let us know why. We’ll try to improve it.

Joe: Look at Al. We just did the company town hall. He’s all excited about input.

Al: That’s what we just said to our employees.

Retirement Spitball: Are We Saving Too Aggressively for Retirement? (John, Boone, NC)

Joe: “Hey, Joe and Big Al. Question, am I saving too aggressively for retirement?” All right. This is John from Boone, North Carolina. All right, “Can we scale back?” Let’s see if we can scale back here. So he thinks he’s saving too much here, Big Al.

Al: Yeah. You know what? I’ll tell you what, John from Boone, North Carolina. I like it when we get the question up front so we sort of know where we’re going.

Joe: Yes. “Can we scale back, stop Roth IRA funding, and contribute just enough to receive full employer match while having enough to support our projected retirement expenses?” So, little question. Thanks for the question. Now here’s the context. He’s very organized.

Al: I like it.

Joe: He must be an engineer.

Al: I think so. Or an account.

Joe: Or maybe he wants to change the whole format of our show and say maybe people just throw the question up there and Andi puts it in bold. But it’s not the question from the people. So then I don’t like to read it.

Al: He could be an attorney.

Joe: Could be. Yes. This looks like a legal document. “Here’s the context.
My wife and I are 35 years old with two children, 6 and 4. As our household income is on pace to be approximately $185,000, 2022, I anticipate this will rise to the low $200,000 range in the coming years. Our expenses are roughly $75,000 per year. I would like to be able to increase our annual expenses to $90,000 to $100,000 per by the time we are 40, 5 years from now. I want to improve our quality of life while the kids are at home and we are young and healthy. This would occur mainly via housing upgrades and/or more family experiences/vacations. As July 2022, we have the following across the account types.” So John wants to live it up. He’s 35. He’s like, man, I got two kids.

Al: Why not? Making some good money.

Joe: Yeah, making money. I want to spend.

Al: It’s like, I’m tired of being a pauper.

Joe: “Roth IRA $84,000, pre-tax accounts $200,000, after-tax $12,000, pension plan $36,000, home equity $125,000, cash $25,000.”

Al: Did you have that much money when you were 35?

Joe: Absolutely. Way more than that.

Al: I did not.

Joe: I was, like, killing it. That was only a few years ago, Big Al.

Al: Not exactly.

Joe: At 35, yeah, he’s doing well. He’s doing pretty good job. “We max out my Roth 401(k), $20,000, 16% of my pay and get $5000 pre-tax match, 50% employer match up to 8%, match 4%.” I don’t care about your plan. Just tell me what you’re saving. “My wife contributes 10% of her pay into her Roth 403(b) and then gets a 3% match.” He is an engineer or something. He’s just telling me the rules of his plan. “Additionally, we max out two Roth IRAs, cumulative, that is $40,000 in Roth contributions and $7200-

Al: Here we go, $46,000. Now we got it.

Joe: Thank you. Now, that’s the number. After this whole long diatribe. “I like to continue to work into the 58 to 60 range-” Sure it’s not 59, John? Maybe 58 and a half?

Al: Better be 59 and a half.

Joe: “- and want to retire with enough assets to support $75,000 in annual expenses. Drink of choice- High Noon.” Here you go.

Al: You like that?

Joe: I do like High Noons.

Al: Never heard of that.

Joe: Vodka Seltzers. Super crushable on those hot summer days. Drink those on the old golf course. Al.

Al: You do?

Joe: Oh yeah.

Al: Okay. Got it.

Joe: Nice little beverage of choice. Especially when you play a little early-

Al: You’re not feeling like beer.

Joe: You crack open a Coors Light at, like 8am, you’re gonna get some weird looks.

Al: That is true. I agree with that.

Joe: You get a little High Noon in you-?

Al: No one cares.

Joe: No one cares. Would you judge me, Andi?

Andi: I was just noticing I was remembering the fact that so many people have called you snarky and all of that and how snarky you were being to John.

Joe: I wasn’t being snarky. Was I being snarky? Sorry, John.

Al: Anyway-

Joe: I’ll crush some High Noons with John.

Al: So you have $46,000-

Andi: Hey, if it helps your golf game, go for it.

Joe: If he was my friend and if he wrote- I treat people like I treat everyone. This is so cumbersome. I’m like, you can make it easier.
It started out great. It started out A+, and then it just slowly deteriorated from there.

Andi: So you review our show and Joe will review your questions.

Joe: That’s right.

Al: That’s true. $46,000 of savings, making $185,000, probably netting what do you think?

Joe: He needs $2,500,000.

Al: I know, but I’m just going to go do the back of the envelope the other way. So netting $150,000. So saving roughly a third of your income. Yeah. That’s a lot more than you need to save. I mean, we want you to save at least 20% of your income, and you’re 33% or more. So I think there’s some room here, and I think that’s what your calculation is going to tell us.

Joe: All right, so he wants to spend $75,000 in annual expenses. So he needs $2,500,000. It’s less than that because you put Social Security in there, it’s probably $1,700,000.

Al: Which will happen between 35 and 58 to 60.

Joe: Yes.

Al: I mean, easily.

Joe: The guy’s killing it.

Al: Right. That’s what I’m saying. You hardly have to run the math. Yeah. You’re in good shape, John.

Joe: He’s got $400,000 without the home equity.

Al: Right. That’s right.

Joe: And he’s saving $50,000 a year. So we’ll call it $400,000. And then he wants to- so what is he, 35, 45, 55-

Al: Let’s call it 25 years.

Joe: 25 years.

Al: 7%?

Joe: Yeah. And then add $50,000 future value, and that’s $5,500,000. So you’re like several million dollars over.

Al: $5,500,000. Now, your expenses will be more by then. I mean, even if it’s double. You got plenty.

Joe: So, John, just map this out. Just take a look at your- I guarantee he’s a wizard because of how he kind of calculates things. Just look at your living expenses and what you want to spend today. Just calculate that out with inflation, use 3% to 4% inflation. And then that’s the future needs that you have. Then look at your Social Security. What is that going to be? Then you subtract your fixed income by your Social Security. But there’s a bridge there. Because you want to retire 58 or 60, you’re still going to have to wait probably another 10 years until the Social Security comes in. So your distribution rate is going to be a little bit higher at first, and then it’s going to drop down. Just create a spreadsheet and build this thing out. Or you can go on to several different websites and there’s, like, retirement calculators to kind of give you the back of the envelope. But yeah, you’re saving plenty. If you want to tone down and party a little bit and go on family vacations and do all that, I don’t blame you.

Al: Yeah, go for it.

Joe: Because I think you’ll have more than enough given what you’re saving right now. But maybe you continue to save what you’re saving but put more into a brokerage account. Because then that’s going to give you more liquidity there.

Al: Right. Yeah. Agreed.

Joe: All right. Sorry for being snarky.

5 Year Clock: Can I Open a Roth IRA with a Backdoor Roth Conversion? (Bobbi, NYC)

Joe: I got Bobbi from New York City writes in. “Hey guys. My drink of choice is Coke with a splash of Dr Pepper.” That sounds absolutely disgusting.

Al: Yes, I would agree with you.

Joe: “I drive my wife crazy.” Well, that’s witty. I like that. As in big city, drive shopping cart, no car. I’m 66. Can you tell by my AOL account?”

Al: I used to have an AOL account.

Joe: Yeah, I know. Or Hotmail account?

Al: Yeah, that’s another one.

Joe: “Working and making good change. I have IRAs, 401(k)s, Roth 401(k)s, but no Roth IRA. I plan to work full time a few more years and do not plan to start RMDs until 70+.” Well, you have to take the RMD-

Al: At 72.

Joe: But he doesn’t plan on taking them until he has to.

Al: Yeah, I guess that’s what that means.

Joe: That’s a distribution versus a requirement. “In regards to starting the 5-year rule for future withdrawals from a Roth IRA ultimately may consolidate all Roth 401(k)s to Roth IRAs. Since I cannot contribute and establish my first Roth IRA, income limits, can I just do a small nominal IRA to Roth back door conversion to get account open? Stay safe.” So Bobbi is drinking a little bit more than Coke and a little splash of Dr. Pepper when he wrote this here.

Al: In defense of this, the 5-year rule is pretty complicated. And it’s hard. You read it and it sounds like it says two different things-

Joe: Because it is.

Al: Because it is. Right. And so that’s why it gets confusing.

Joe: So let’s talk about the 5-year clock. 5-year clock, there’s two 5-year clocks. One on contributions, one on conversions. And this is what people need to think about if you take money prematurely from a retirement account- in most retirement accounts, it’s 59 and a half. Everyone is pretty much, not everyone, but a lot of people that probably listen to the show is familiar with the 10% early withdrawal penalty. The 5-year clock has to do with a 10% penalty to some degree. Okay. So if you kind of think of it like that. So on a contribution, you need to hold the account open for 5 years or until 59 and a half, whichever is longer, to get the tax-free treatment on earnings only.

Al: Yeah, earnings. That’s the key. Right?

Joe: So you have a $5000 contribution. It grows to $10,000. You are 60 years old when you made that first contribution. You have access to the contribution, but you have to wait until age 65, 5 years or 59 and a half, whichever is longer, to get the access to the other $5000. Makes sense?

Al: Yep.

Joe: Okay. Now, the conversion is what was kind of this loophole, they had to create another 5-year clock for people doing Roth IRA conversions. So if I did a Roth IRA conversion- so I’ve already paid the tax on the conversion. You have to wait 5 years on every conversion that you make or until you turn 59 and a half. So it’s kind of like a back rule if you have access to any of the cash.

Al: Yeah. And that was so that you wouldn’t kind of skirt the rules and avoid the penalty. And so said another way, a Roth contribution, which is $6000 a person, $6500 or $7000 for over 50. So you make that contribution, I don’t care what age you are, you could do it at 22. At 23, you can pull that contribution out. No penalty, no tax. That’s $6000. But if it’s grew to $6500 or $7000 or $8000, all that growth and income, that’s taxed at your normal tax rate plus penalty. So that’s where the penalty comes in. So that’s a contribution. A conversion is where you take money out of your IRA and you convert it. So when you convert it, every single time you convert, you’ve got to wait 5 years to pull that conversion out, but you have to wait for the earnings and growth, 59 and a half to avoid the penalty. But once you’re over 59 and a half, it’s totally different rules.

Joe: Then you just kind of revert back to the contribution rules. And so you look at it and say, okay, well, here I’ve had a Roth for 5 years, then just ignore us. It doesn’t matter because that first Roth, the first dollar that hits the first Roth satisfies the 5-year clock.

Al: And I think part of the confusion is, does a Roth 401(k) start the 5-year clock for a Roth IRA? And the answer is yes. For what we’re talking about.

Joe: Yes, for sure.

Al: Once you’re over 59 and a half, we’ll put it that way.

Joe: Or the Roth IRA- if you have a Roth IRA and you’re going to roll the Roth 401(k) into the Roth IRA, the 5-year clock still holds true on the Roth IRA. It’s going to follow the longer of the two in most cases.

Al: So in other words, you roll the Roth 401(k) into a Roth IRA, you get that 5 year holding period when you started in the Roth 401(k). It doesn’t start over again when you start a Roth IRA.

Joe: Right. So I would look to make sure that you have- I would start a Roth IRA. And that’s what he’s asking to do here, because you’re going to put the money into the Roth IRA to begin with anyway. But he’s waiting to take RMDs. How old is Bobbi? We don’t even know.

Andi/Al: 66.

Joe: Okay, 66.

Andi: He’s got an AOL account.

Joe: Here’s what you do. You set up a Roth IRA, and if you want to do the back door, you can. You can make a non-deductible IRA contribution, convert it. Now you have a Roth IRA and then roll everything into the Roth IRA. It makes no difference. Or you establish a Roth IRA and roll the 401(k) into the Roth IRA. But if he’s not going to touch the money for a while, this is all for naught anyway.

Al: True. I just think there’s confusion when you’re over 59 and a half, if you got a Roth 401(k) that already started your 5-year clock.

Joe: There’s only two ways to get a Roth IRA established. You can make a contribution, but you need earned income to make a contribution. If you have too much earned income, then you cannot make the direct Roth IRA contribution. However, you can do an IRA contribution and convert it to a Roth. If Bobbi doesn’t have any income, then he can just take one of his existing IRAs and convert it to a Roth, that would establish a Roth IRA. He’s making good change. I’m guessing that means he’s making a lot of money.

Al: Also, you can use your spouse’s earned income, so that’s another approach to do a contribution.

Joe: But what are the goals? What are you trying to accomplish? Are you just trying to understand the rules? Or are you trying to figure out a strategy on how to create the income or how to- these one-off questions, I guess, is what’s the meaning behind it? Do you need access to the cash right now? Does it make sense to put it into a Roth IRA? Does it make sense just to keep it into the 401(k)? He could still have access to the money. A 401(k), you’re over 55, separate from service. If you retire, you can do an in-service withdrawal. I mean, there’s all sorts of different things that you can potentially do versus thinking about, all right, do I do a backdoor Roth and then move the money into the Roth? Well, what’s the money for? I guess we don’t know, really, what he’s trying to accomplish.

Al: Yeah, well, I read this is that there was confusion that they had to start a Roth IRA to start the new clock because the 401(k) is going to be rolled into a Roth IRA.

Joe: Okay, sounds good.

5 Year Roth Withdrawal Rules Explained (Janie, St. Louis)

Joe: We got Janie writes back in from St. Louis. She goes, “Hey, Big Al, this is Janie again from St. Louis. You recently answered a question I recorded for you, thanks. But I’ve been listening to older podcast. In Podcast 342, I think you said, and Andi and Joe agreed, that if I have a Roth 401(k), let’s say for more than 5 years since the first contribution, and then open a new Roth IRA with a rollover Roth money from the 401(k), the 5-year clock does not start over in the Roth IRA.” And if we said that, that is wrong. Because if you did not have a Roth IRA- the Roth will always have a 5-year clock.

Al: Yeah, and I think I did say that. So first mistake in a decade.

Joe: I wasn’t listening to you.

Al: Anyway, here’s what I like. Janie, and she says, “Hey, Big Al! exclamation point. So I say, hey, Janie, how are you doing?

Joe: Oh, wow. That’s so bad.

Andi: Yeah.

Al: Anyway, Janie, that’s right. I think I may have goofed that one. So thanks for bringing that to our attention.

Joe: Okay, so “Thanks for clarifying. You guys rock. Joe questioned my character since I rarely drink, so I thought I would tell you that when I do, I really like a good IPA or Pinot Grigio.” Ooo, cheers.

Al: Right.

Joe: Janie, all right. Very good. Sorry about the confusion. So let’s just kind of-

Al: Yeah, let’s talk about it.

Joe: – recount that. So Roth IRAs. The Roth IRA and the Roth 401(k) are two totally different animals. Because a Roth 401(k) will have a required minimum distribution. A Roth IRA does not. And so when you look at the 5-year clock, the Roth IRA has its own 5-year clock. So if you have a 5-year clock within your 401(k) and you’ve never established a Roth IRA, well, then you’re starting all over. But you can have the contributions out first. So depending on how much money that you’ve contributed to the overall Roth 401(k), you could probably still get by.
And the likelihood of them finding out what’s basis and what’s earnings after you roll it into a new Roth IRA-

Al: And usually- see this is why it usually doesn’t matter. So you roll your Roth 401(k) into Roth IRA, and if you don’t have a Roth IRA, it starts the 5-year clock over again. You take withdrawals, but the withdrawals, dollar for dollar, use up all your contributions that you’ve ever made. And so, in most cases, there’s enough contributions to cover whatever withdrawals you would need in the first 5 years. So there’s no taxes. Now, that’s not necessarily true if you drain the whole account. That’s a problem. If that’s the case, if you want large withdrawals out of your Roth and you only have a Roth 401(k), and you never had a Roth IRA, establish a Roth IRA, but just keep it in the Roth 401(k) until either the 5 years or until you’ve taken that big sum out that you needed and then roll the rest later.

Joe: Yeah. Because here’s the tiered system. You tell me how they calculate it. Because it’s FIFO tax treatment. So what comes out first are contributions. And then if you’re over 59 and a half, it’s conversions. And then from there, contribution dollars that have earnings. So the earnings on the contributions, then the earnings on the conversions. So that’s the 4 ways that the money comes out. There’s no way that you could ever calculate that.

Al: Of course not. I mean, it would be almost impossible.

Joe: Almost.

Al: And the brokerage firms are not calculating that.

Joe: Exactly.

Al: How would we? How would anybody?

Joe: How would anyone?

Al: Well, let’s see. I had an average IRA balance of X and 401(k) for this and from conversions. But I think that the most important thing- like, let’s just say you’ve got a Roth IRA of $200,000. I’ll be willing to bet your contributions are at least $100,000.

Joe: For sure.

Al: And then we’ll be generous, gross $100,000. So you roll that into a Roth IRA. Even though you haven’t met the 5-year clock, you can pull out $100,000 over 5 years, no problem. You just can’t get the earnings until the 5 years over.

Joe: And then again, if you pull a little, I don’t know how they audit that.

Al: I don’t either.

Joe: But I guess the point is, yes, if you have a Roth 401(k) and you do not have a Roth IRA, I would encourage everyone to open up a Roth IRA. And if you can’t convert money or do the backdoor, and if you can’t afford to pay- and if there’s pro rata rules and aggregation issues that you’re worried about, well take a couple hundred bucks, convert it into a Roth. Start your 5-year clock. Everyone should have a Roth IRA with a couple of dollars in it. And then that satisfies all the other BS that goes along with these complicated rules that they put in place to just confuse the average retiree.

Al: I agree with that. And if you don’t qualify for a contribution, then just do a $2 Roth conversion. And start the 5-year clock.

Joe: Well, it might have to be $100, depending on what custodian you use, but right. It’s just something pretty nominal. And it doesn’t matter how much money that you have in it. Just put something in it. And then there you go. Now you’ve established it. You establish your 5-year clock, and you’re good to go. So then when you roll your 401(k) into it, you don’t have to worry about it. So thanks for the correction.
Remember that one time when we really blew up that TSP-?

Al: I do remember that.

Joe: Oh, my God, we got, like, 15 different emails on that one.

I’m not gonna link to that TSP mistake, but I have included a guide dedicated to those 5 year Roth clocks in today’s podcast show notes at YourMoneyYourWealth.com, with an in-depth breakdown on how and when you can pull money out of your Roth IRA, based on whether you’re under or over age 59 and a half, and you can download for free. To get it, click the link in the description of today’s episode in your podcast app to go to the show notes, then look for the 5 Year Rules for Roth IRA Withdrawals banner. Download the guide, read the transcript of today’s episode, ask Joe & Big Al your money questions either via email or priority voice message, and share the show and free resources.  For more in depth personalized help, click the Get an Assessment button to schedule a comprehensive look at your entire financial situation. Stress test your retirement portfolio, find out where you might be able to save more on taxes, and get a plan tailored to your specific risk tolerance, goals and circumstances. It’s all at YourMoneyYourWealth.com.

Joe: Go to YourMoneyYourWealth.com. Click on Ask Joe and Al On The Air. We’ll answer them right here. Need your questions. Keep the show alive. No questions, we’re retired.

Al: We’re off.

Joe: We’re off. That’s good. It was a good run, Al.

Al: It was.

Joe: It was a nice run.

Al: Yeah. How many years? 15? ish?

Joe: Yeah.

Retirement Spitball: Can We Avoid IRMAA and High Taxes from RMDs? (Wilbur, Nashville, TN)

Joe: Let’s go with Wilbur from Nashville, Tennessee. “Love your work.” Love you, Wilbur.

Al: First of all, great city. Second of all, great name.

Joe: I love it. “You folks really put out some good information. My wife and I are 65 this year. She is retired and I plan to retire in September. We will both be on Medicare after retirement. We will have no pension and other income from outside our investments until we both start Social Security at age 70.” So that’s 5 years. “We have been contributing to Roth accounts since they came into existence and have been doing Roth conversions up to just below the IRMAA limits two years ago. Our current Roth accounts are $826,000, 75% dividend producing equity funds, 25% cash and CDs. Our remaining IRA balances are $1,000,000 or $1,000,041.-“

Al: We got the cents too. $0.98.

Joe: “- with 60% dividend producing equities and 40% cash. We avoided bonds due to anticipating rising interest rates starting 3 years ago and then we purchased 3% 5-year CDs from our credit union. Our thought was to prepare for this market downturn with the cash and CD bucket being able to carry us for 5 to 10 years by supplemented by approximately $36,000 per year in dividends. We own our house in Memphis, Tennessee and have a beach rental in North Carolina.”

Al: That sounds good.

Joe: Very nice. “It carries itself financially with some leftover that has never exceeded the amount of depreciation. We own both houses and our cars with no loans and have no debt. My primary concern is- “ what? What concern can Wilbur have?

Al: There’s no concern.

Joe: He seems like he’s living the life. He’s got $1,000,000 in Roth. He’s got $1,000,000 in his retirement accounts.

Al: It’s like this is like a case design on what to do.

Joe: He timed the market. He knew bonds were going to blow up. So he got CDs. He’s got a beautiful house in Memphis and then he goes to a little beach in North Carolina.

Al: Which makes money. So all good. What is the primary concern?

Joe: “-to try to at the very least avoid IRMAA-” That’s why he’s living the life. Because he’s afraid to spend another $0.50 on his health insurance.

Al: To have to pay more to Medicare.

Joe: “-and at the very best avoid slipping into adverse tax situations due to future RMDs. I am sure we are missing something and welcome your thoughts on what we should watch out for in potential gotchas out there?” All right. Very good. I’m glad you wrote in Wilbur because he realizes he’s like, you know what, I don’t want to pay another dime to Medicare. Because it’s based on a progressive schedule of your income. And if you do Roth conversions, it’s potentially going to put you in a higher tax bracket because you’re prepaying the tax to get a tax benefit later. But IRMAA is going to look at that, or Mama IRMAA, Medicare, is going to say, hey, your income is X, so that means your Medicare premium is Y.

Al: Right. So it’s around $182,000 is your modified adjusted gross income for a joint filer. If you keep your income below that, then you don’t have to pay that $170- actually, you do pay the $170 premium, but it doesn’t go up to $238. Wilbur, I will tell you this. It’s a $50 difference times 12 months. I wouldn’t worry too much about that. It’s actually a lot more important to figure out, should you do more Roth conversions or not? You got roughly 7 years before your RMDs. So to me, that’s the bigger question.

Joe: Right. And I think that’s what he’s figuring out. It’s like, okay, well, here I want to keep below that so I don’t increase my Medicare premium. But is he tripping over dollars to pick up pennies?

Al: That’s what I’m saying. $600 difference? I get it. No one wants to pay what they don’t have to pay. But I think you will save more getting more money into a Roth than you will trying to figure out Medicare.

Joe: Because it sounds to me that what- they spend $36,000 or maybe $50,000 a year. I’m not sure what the actual number is, but depending on what their spending need is, they’re going to have Social Security at age 70. For both of them. So that’s going to be a big number. And then they have RMDs at age 72.

Al: Which right now on $1,000,000 plus growth, it could be $1,500,000. It could be $60,000?

Joe: Yes, $40,000 to $60,000. On top of your Social Security. And then where’s that going to put you from a tax perspective? So that’s the calculation that you have to look out for. And then the added IRMAA- So here’s the easiest way. Is that the added IRMAA tax or the payment-

Al: Yeah. Premium you got to pay.

Joe: – premium. Just add that into the tax. And so you’re looking at like, an effective tax. So, hey, I have to pay this extra $600. So just calculate that as an added tax. And then look at what your effective rate is there versus what you feel that your effective rate is going to be when you take RMDs. And even with the added IRMAA tax on it or added IRMAA premium, if it’s still lower than where are you going to be at RMD, it’s going to make sense to do it, and that’s going to help you gauge on how much that you convert. Would you agree with that?

Al: Completely agree with that. So you just treat it like an extra tax. And that IRMAA, it’s a one-year thing. Right. And it’s a two-year look back. So it means in two years from now you might have to pay a little bit higher Medicare. But you just figure that- if you do an extra $50,000 and it’s a $600 tax, that’s like 3%. Right? So your tax rate plus 3% in that quick, easy example.

Joe: Perfect. Wilbur, thank you for the email and the very exact numbers that you gave us. That really helps out our calculations.

Al: Right to the penny. It’s great.

Joe: Alright, that’s it for us, the show is called Your Money, Your Wealth®.


Just how long have Joe and Big Al been on the air? That’s in the Derails at the end of the episode, so stick around. 

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