Joe Anderson, CFP® and Big Al Clopine, CPA answer your questions on Social Security disability, the file and suspend strategy, IRA contributions and Roth conversions, estimated tax, estate tax, gift tax, Social Security tax, the qualified business income deduction, selling appreciated stock, and whatever else they can jam in.

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Show Notes

(00:39) How is a Social Security Disability Lump Sum Taxed? Is It Affected by a CALPERS Pension?
(08:14) Can I File and Suspend Social Security?
(15:08) Do I Use Form W4-P for Additional Tax Payments Without Penalty?
(19:55) Is There a Penalty for Selling Appreciated Stock at the End of the Year and Not Paying Quarterly Taxes?
(21:39) When Do I Pay Next Year’s Estimated Taxes? Does the QBI Deduction Apply to Me?
(29:02) Can I Contribute to an IRA or Should I Convert to Roth?
(34:45) What Are the Estate Tax, Gift Tax, and Gift Exemption Rules? (video)

Transcription

Today on Your Money, Your Wealth®, we’ve got no time for a guest because Joe Anderson, CFP® and Big Al Clopine, CPA, are answering a whole slew of your emails, voice messages and money questions. They’re talking Social Security disability, filing and suspending, IRA contributions and Roth conversions, estimated tax, estate tax, gift tax, Social Security tax, the qualified business income deduction, selling appreciated stock, and whatever else we can jam in there! Some of the questions the fellas even answer correctly! If you’ve got a money question or a comment, go to YourMoneyYourWealth.com, scroll down to Ask Joe and Al On Air, and send in your email or voice message, just like Kenneth did:

:39 – How is a Social Security Disability Lump Sum Taxed? Is It Affected by a CALPERS Pension?

Joe: We got one, Al!

Al: We did.

Kenneth: “Good Morning Al and Joe. Question: I recently received a 2½ year backpay check from Social Security disability. The question is, will I have to pay taxes on this next year? And how would it be taxed? Would it be taxed on the yearly average pay, or if it has to be taxed, how will it be taxed and do I have to pay taxes on a back paycheck from Social Security disability. And does receiving a pension, a CALPERS pension, affect my taxes for both state and federal on my Social Security disability back paycheck? Thank you.”

Joe: All right, Kenneth. So if I understand this, so he received a two and a half year payback check.

Andi: How is that possible?

Joe: He filed for Social Security disability. And so it went through the bureaucracy of…

Andi: The what? (laughs)

Joe: Whatever, I knew that was gonna come out bad, I knew it! Dammit! (laughs) You know what I’m saying.

Al: Yes. Bureaucracy.

Joe: Yes, thank you beer-ocracy.

Andi: Beer-ocracy! (laughs) That’s his new podcast!

Joe: There ya go.

Al: Still thinking about your birthday.

Joe: Yes I am. It is my birthday and I’m working very diligently, OK?

Andi: Happy birthday Joe.

Joe: So it’s probably going through the B.S. of Social Security for a couple years.

Andi: That’s a much better word for it.

Joe: And they’ve gotta see if he’s actually disabled and they’re like, “oh yeah, Kenneth, you are disabled.” He’s like, “Yeah, no doubt. I’ve been hanging out in my bed for two and a half years! I’m starving here!”

Al: Right. And that is a true statement because sometimes – I haven’t heard it two and a half years long, but it can’t take a while to go through. And so what happens is this: they sort of back date the benefits to when you were disabled and you can get a lump sum. So I’ll answer kind of the first or the main question here, which is how is it taxed? And the answer is, Social Security and Social Security disability, it’s taxed based upon your provisional income. And so if you have virtually no other income, it’s generally not taxed. If you have other income, there are different levels to where it would be taxed, single versus married. But let me get to the main heart of the question, which is if you receive a lump sum, it’s the year that you receive it is the year you’re taxed in, unfortunately. They don’t average it out over several years and do an income averaging or anything like that. It’s the year received is the year it’s fully taxable, even though maybe it should have been received over the last two and a half years and maybe your taxes would have been lower. But that’s the way they do it.

Joe: So Kenneth has a CALPERS pension. So he goes, “hey, does receiving a pension, a CALPERS pension, affect my taxes?” The answer is yes. So you have income, so you have to add up your provisional income like Big Al just said, and that is your adjusted gross income. So you would add up dividends, interest, your CALPERS pension. If Ken’s married, his spouse’s income, and then they would take half of the Social Security benefits. But what I don’t know Al, on provisional income in a situation like this, they would not count that back pay – they would count that as the whole amount of the adjusted gross. They would not take half of that. Would that be an accurate assumption?

Al: They would not take half of that…

Joe: Because let’s say Kenneth’s Social Security benefit is $20,000 annually. What’s included in provisional income would be half of that. So $10,000 plus his CALPERS pension, plus interest, dividends, and things like that. And if it’s more than, if he’s married, $44,000, then 85% of the Social Security benefit is subject to income tax, 15% of it is tax-free. But that Social Security disability pension that is paid out to him, so would it go to the provisional income, and let’s say 85%, so 85% of that lump sum is going to be subject to tax?

Al: I believe so. And the reason is because we’re all cash basis taxpayers. So when we receive lump sums, it doesn’t really matter what period it was for – it was the year received. And so what that means is that your provisional income will be higher, because it’s half of a much bigger number. And so then more of it would essentially be taxed, potentially, depending upon how big the numbers are.

Joe: Right. So it could be tax-free. It could be a hundred percent tax-free, or 50% of it’s going to be taxed, or 85% is going to be taxed.

Al: Yes. There are different levels and it’s not what we call “cliff” changes, which basically means it doesn’t all the sudden become zero and then 50%. Once you get over into the 50% category, only that part is taxed at 50%. So it’s kind of a gradual thing. So the point is that it could be taxed at nothing, or it could be taxed as high as 85% of that income being taxed. Whatever your tax rate is, let’s just say it’s 12% or whatever the tax rate is – 12% of that income could be taxed, up to 85% of that income.

Joe: So… I know that’s just clear as mud, huh?

Andi: Yeah pretty much. And I’m thinking pension? WEP and GPO? Does that get involved at all?

Joe: Not with this situation.

Andi: Okay good.

Al: The principal question is does he sort of get it spaced out over a few years and the answer is no. The year that he receives the payment is the year it gets added to his tax return, and therefore he’s got to pay tax based upon that. And the fact that he’s getting a bigger lump sum and he has other income probably means that more of it would be taxed than had he received it over the two and a half years. That’s unfortunate, but that’s the reality.

Joe: Yeah. The more I think about this the more…

Andi: We should call Mary Beth Franklin? (laughs)

Joe: He probably should call someone else to figure this out. (laughs) But yeah, I think – I’m 90% confident in that answer.

Al: I’m 99.

Joe: 99!

Andi: Oh wow, okay. I’ll go with that.

Joe: All right, well Kenneth, if you get a giant tax bill, you know who to call. Big Al. He’s standing behind his word. I got 50/50 on that, bud. (laughs)

Andi: I thought you were 90%, now you’re 50/50?

Al: When he mentions my name it goes way down. (laughs)

Joe: All right, so thanks for that. So everyone that’s listening, see that’s a pretty cool thing to do, you just hit the button and then you talk. And then next thing you know, then you’re on the air. I’m sure Kenneth is super excited. He just got a little airplay.

Andi: So yeah, go to YourMoneyYourWealth.com, you gotta scroll all the way to where it says “Ask Joe and Al On Air”.

Joe: Yeah, you gotta get carpal tunnel almost on your wrist from scrolling.

Andi: And if you’re on your phone there, just hit the voice message button and you can just talk into your phone and we’ll get it and we’ll play it.

Al: Yeah. And if you’re on your computer, make sure you have a microphone on your computer, otherwise, we won’t hear it very well. Just FYI. (laughs)

Joe: How many people do you think have done that? (laughs)

Al: A few. (laughs)

Joe: “Yeah. Left you a few voicemails.” “Well how’d you leave me a voicemail?” “You know, through the computer.” “Do you have a microphone?” “Oh! That’s why you haven’t called me back!”

8:14 – Can I File and Suspend Social Security?

Joe: We got, let’s see, Steve from YouTube land. I don’t know where the hell that is.

Al: I don’t know either. It’s a new city.

Joe: I’d like to go. Ever been to YouTube land?

Al: No.

Andi: Oh come on, we all spent hours on YouTube land. Anytime you go there and search for something? You’re in YouTube land.

Joe: I’ve never really spent any time on YouTube.

Andi: That’s because you get the Hulu and the Netflix and Amazon and all that.

Joe: Not necessarily. You watch movies and stuff on YouTube?

Andi: You can, yeah.

Al: I’ve actually watched some TV shows on YouTube, but for the most part it’s snippets.

Joe: I could see you watching, like, learn to speak Spanish or something like that on YouTube. (laughs)

Al: Yeah.

Andi: And that’s exactly what it’s there for – if you want to know something, Google it, figure it out on YouTube.

Joe: If you wanna learn how to fix a carburetor.

Andi: Or if you want to know about Social Security.

Al: I did just do a how-to thing. I can’t even remember what it was but I learned how to do it.

Andi: (laughs) It apparently stuck with you.

Al: Yeah really. That’s why I need YouTube. (laughs) I don’t even know what I YouTubed!

Joe: Well Steve was on YouTube checking out some stuff and he goes, “after watching your info on YouTube” he had a question he didn’t see explained on the video. Well, Steve, we do that on purpose. So you come into our office and we sell you a bunch of stuff.

Al: Not true. (laughs)

Joe: All right. But since you emailed us we’ll give this to you for free. Because we usually charge five cents per question. (laughs) All right. “I’m soon to be 69 years old, employed 24 hours per week with full benefits.” He was a full-time employee up until February 2019. “Is there a spousal benefit my wife can claim if I file for Social Security, then put a hold on Social Security till age 70? She’s 66 years old. She can get 50% of my FRA – full retirement age – benefit. Then once I reclaim my full 70-year benefit from Social Security, she will not get the benefit and her own Social Security will build till she is 70 and starts collecting her own retirement benefit? Hope this is not too confusing. Thank you, Steve.”

Andi: Social Security is confusing.

Joe: All right. Let’s break this thing down Big Al. First question he’s asking us: he is 69 years old and is curious about a spousal benefit. So the spousal benefit – let’s just explain that.

Al: Yes. So the current law is that when your spouse is taking his or her benefit, and if you are retirement age, you can claim a spousal benefit. If you’re full retirement age that benefit is 50% of your spouse’s full retirement age benefit.

Joe: So what happened is that Social Security was established, what, in the 30s. And most women didn’t work in the 30s. No offense to any female out there.

Andi: No, that’s history. That’s how it happened.

Joe: And so they were like, “OK well we need to figure something out.” So for years, the men could not get a spousal benefit. So how it worked is that let’s say the woman stayed at home and took care of the kids. I’m not being sexist but that’s what happened. And so they gave that spouse a benefit and that benefit is equal to half of the other spouse’s benefit. So let’s say my benefit was $2,000, my spouse that never worked a day in her life, she took care of the k- I mean never worked for money a day of her life, she worked her ass off at the house…

Andi: Well done.

Joe: …killing herself and being the best damn employee that the household could ever hire. Once she reached full retirement age, her benefit would be a thousand dollars – half mine. Right? OK? So what our friend Steve is asking us, he’s saying, “Hey, can she get the spousal benefit?” The answer’s yes. But what he’s asking us is that he would like to turn his on so she can claim it, then turn his off. That was called file for benefit and suspend. That is no longer, Steve. You cannot file for benefits and suspend. You would file your benefits at age 69. Your wife at 66 would claim a restricted application to take the spousal benefit – if the spousal benefit was higher than her own. Because now there’s something that’s called “deemed.” You can’t say, “I’m filing a restricted application. I just want to take the spousal benefit, claim half of it, let mine continue to grow and then turn mine on at age 70.” These are old rules that went away in April of 2015? Something like that?

Al: 2016.

Joe: 2016. Pretty close there. So what would happen is that once she’s claiming for benefits, they’re going to give her her benefit or the spousal benefit – the higher of the two. She cannot let her … but 66, was she born before 1954?

Andi: If she’s about to turn – oh no, she’s 66 years old. So I think she was born in ’53.

Joe: All right. So she’s still allowed to do a restricted application. So what that means is Steve, yes. So she could file a restricted application with Social Security benefit, claim the spousal only, let hers continue to grow until age 70, then turn hers on at age 70. She could continue to claim the spousal benefit all the way to her age 70. So when you turn 70, hers just doesn’t turn off. She would still have that benefit, that spousal benefit, until she turns 70, then it would flip to her own benefit.

Al: Well said and complicated. And so a couple of things changed in April of 2016. You could no longer file and suspend and then have the spousal benefit be collected, and then the other thing was that deeming rule – that would take a whole ‘nother segment or two that makes this much more complicated.

Since the answers to those last two questions were almost as confusing as Social Security itself, I’ve posted some Social Security resources in the podcast show notes at Your MoneyYourWealth.com, including our most recent interview with the Goddess of Social Security, Mary Beth Franklin – honestly, she explains spousal Social Security benefits really well. Plus, check out the Social Security Secrets episode of the Your Money, Your Wealth TV show, and download our free Social Security Handbook. It’s all in the podcast show notes at YourMoneyYourWealth.com If you still have a Social Security question that needs a complicated but correct answer, scroll down YourMoneyYourWealth.com and click Ask Joe and Al On Air.

15:08 – Do I Use Form W4-P for Additional Tax Payments Without Penalty?

Joe: Judi. She’s a little San Diegan. “The latest podcast talked about estimated payments to cover alternative year donations. I’m retired with a pension. Not yet taking Social Security or using RMD.” RMD stands for required minimum distribution. I don’t know how you “use” an RMD. Maybe you spend an RMD? But if you’re not using it, do you think she’s already taking it and not spending it? Or she’s not 70 and a half?

Al: Don’t know.

Joe: Okay. “I do move some funds…”

Al: I assume she’s not 70 and a half. We’ll make that assumption.

Joe: Okay. But she’s not using RMD. All right. “I do move some funds to Roth, taxes taken, and make charitable donations. Can you explain form W…” KRP in Cincinnati. (laughs)

Al: (laughs) Remember that show?

Joe: Yes I do.

Andi: I don’t remember that form though.

Al: That was a great show.

Joe: Form W-4P.

Al: That was Loni Anderson?

Joe: It was Loni Anderson. Yeah, we’re related.

Al: Yeah. That’s what I thought. (laughs) Cousin? Distant?

Joe: Distant. Yeah. “I was under the impression that I could use this form at the end of the year if I needed to make additional tax payments without penalty. Second question: are there steep penalties too? If so can you tell me about California? Thanks, I learn a lot from you all.” So what she’s stating here is that with estimated taxes – and we talked about this last week, I believe – is that there’s a timing sequence with estimated taxes and you can kind of talk about it a little bit cleaner than me. (laughs)

Al: This is interesting. It’s like me trying to talk about – what?

Joe: Let’s just carry on. (laughs)

Al: Okay. I’ve got the W-4P right in front of me.

Joe: (laughs) Man, you are ready.

Al: Look at this. I was prepared.

Andi: This is show prep, Joe.

Joe: Yes I got it.

Al: So “withholding certificate for pension and annuity payments.” So it’s a W-4 is if you’re an employee, W-4P is if you’re withholding on your pension. So basically all this is doing is it’s telling the payor of your pension how much to withhold from your pension.

Joe: So that’s like an I-9 or – what are those called?

Al: Well it’s a W-9, that’s if you are an independent contractor I think.

Joe: But you know when you first get your job.

Al: Yeah. That’s W-4.

Joe: W-4. That’s what I’m saying. (laughs)

Al: I already said that! (laughs)

Joe: I know, whatever. (laughs)

Andi: It is called a W-4P. (laughs)

Joe: (laughs) I thought it was something completely different.

Al: I said W-4 is for employees.

Joe: (laughs) I wasn’t listening.

Al: (laughs) I am aware of that.

Andi: (laughs) Judi, I’m sorry.

Al: So Judi, I’m going to try to answer your question now. The question was you were under the impression that you could use this form at the end of the year if you need to make any additional tax payments. That’s not correct because this form is so you can withhold from your pension payment. Now if you’ve got a gigantic pension payment of $8,000 a month and you want to withhold it all, then you would change this form for the month of December. But if you needed to make a payment larger than your pension payment, you could not do that.

Joe: She could change it throughout the year. But it’s like instead of taking $300 out you’re going to take $400 out. And if you owe $10,000 at the end of the year, I mean, it would be pretty hard to make that catch-up.

Al: Yeah that’s exactly right. So some people – I mean I’m not saying this is right or wrong, good or bad, I’m just saying what some people do – and that is, they have low withholding at the beginning of the year, so they have more use of the funds, and then they have higher withholding at the end of the year so that they basically catch up to the right spot. And then by year end, you’ve got the right amount of withholding. The IRS and state of California has no idea when that was withheld and that actually is valid. Now, if you get to December like I said, let’s use a real example – you owe $5,000 but your pension payment is only $3,000. Well, you could change your W-4P if the pension company allows you enough time to do it, and have $3,000 withheld fully. But you’re still short $2,000 – you’re going to have to make an estimated payment for that, and you will be penalized because you made it in December, not April, June, September, and then January.

Joe: So there are penalties if you under-withheld. Is there state penalties, California?

Al: It’s the same rule. Same exact rule.

Joe: And that penalty is a pretty small percentage.

Al: It’s small. It’s about three percent annual interest. So it’s not like it’s the end of the world.

Joe: So if you owe $1,000, 3% of $1,000 is a couple of bucks.

Al: Yeah right.

19:55 – Is There a Penalty for Selling Appreciated Stock at the End of the Year and Not Paying Quarterly Taxes?

Joe: James from San Diego goes, “Hi Joe and Al…” Come on James. Love the show? Nothing like that? He’s just right into the question. All right. “If you sell appreciated stock in a taxable account at the end of the calendar year and did not make quarterly estimated tax payments in April, June, and September of that year, is there a penalty for underpayment? Jeez, another penalties question.

Al: That’s right. No one wants to pay penalties.

Joe: No way. “Can you pay the tax that is due to the government on the same day that you sell the stock to avoid any penalty? It seems that you might not know early in the calendar year what the future holds later in the year for tax purposes unless you’re a psychic.” James! Love your little…

Al: It’s a great question.

Joe: Like that.

Andi: So we slam you for not liking the show but we think your question is great.

Joe: Yeah and I like you as a little comic humor at the end.

Al: Yeah. So the question is relating to – so you sell some appreciated stock right at year end. So how could you make quarterly estimated payments when you didn’t even know that was going to happen?

Joe: Or that you were even going to sell the stock.

Al: Yeah right. So I got good news for you James, there’s form 2210: “underpayment of estimated taxes by individuals, estates and trusts.” You go to page 4, last page…

Joe: (laughs) Are you writing this down, James?

Al: Yeah, please. Schedule AI for annualized income, part 1. (laughs) Anyway so the gist of this is the last page of this form, you get to put in your income each quarter. And obviously, if you sell that stock in the last quarter, then it just simply goes in that last quarter only. So you don’t have to pay the tax the same day but you do have to pay it by January 15th – that’s when the fourth quarter estimated payment is due.

21:39 – When Do I Pay Next Year’s Estimated Taxes? Does the QBI Deduction Apply to Me?

Joe: Olg?

Andi/Al: Oleg.

Joe: Oleg? That’s kind of – Oleg?

Andi: Oleg, he’s Russian.

Joe: Oleg from San Diego. Not Russia. It says San Diego here. (laughs) “Question 1. When am I expected to pay projected taxes for next year? Quarterly? By the end of year? Any penalty if I pay them next year when taxes are due on April 15th?” God, this is so popular, we talked about that once and all we do is keep getting questions on this.

Al: Yeah. They want clarification.

Joe: (laughs) “I don’t want to pay that $4 penalty.” So question one, Alan can you please answer that.

Al: Certainly. So there are two ways to avoid penalties, and either you pay in up to 90% of this year’s tax…

Joe: So if you owe $10,000…

Al: As long as you pay in $9,000, quarterly, or you could do it withholding-wise. Withholding, the IRS doesn’t know when it’s withheld. So as long as you have $9,000 withheld you’re golden. If you don’t have any withholding and you pay it quarterly, so what’s that, like $2,250 I guess, quarterly, you have to pay that each quarter otherwise you get penalized. And so that’s what he’s referring to.

Joe: Isn’t there a certain percentage? Isn’t it kind of some weird…?

Al: Well that’s the first way to avoid the penalty. Maybe this will answer your question. The second way to avoid the penalty is to pay in 100% of last year’s tax – regardless of what this year’s tax is. So the last year’s tax was $5,000. This year’s $10,000. So as long as you pay in five thousand then you’re not penalized.

Joe: Got it. And is it a certain percentage on the quarterly estimates? Like I pay 20% then 40% then 30%?

Al: For the IRS it’s 25%. It’s one quarter each quarter. State of California is the oddball. They make you pay 30% the first quarter, 40% the second quarter. They let you skip the third quarter and they make you pay 30% the fourth quarter. So try to figure that one out.

Joe: Okay. There you go. There had to have been something going on there.

Al: So one little caveat is if your income for the prior year was over $150,000 adjusted gross income, you have to pay 110% of last year’s tax. So I’ll just throw that in there.

Joe: So they want you to overpay a little bit.

Al: Yeah in that example they want you to pay $5,500 instead of $5,000.

Joe: All right. “Question 2: is the first 20% profit not taxable by the new tax rules for a medical practice?” Oh, the QBI

Al: Yeah. 199A. QBI, qualified business income deduction. So what he’s referring to is a sole proprietorship, S corporation, LLC, small businesses, flow-through businesses to your return, you don’t have to pay taxes on 20% of the profits. Of course, there are all kinds of limitations so it could be phased out but that’s the basic rule. And he’s asking do you get that right up front? And the answer is no, it’s pro-rata which means that let’s say your QBI deduction is $10,000 so you get $2,500 for first quarter, $2,500 second quarter and so on. It’s actually based upon your profitability. So whatever your profits were in the first quarter, you don’t have to pay taxes on 20% of that and so forth. So that’s how they do it. I think that what he’s asking, he’s trying to skip the first quarter estimated payment because it’s all tax-free up front. And the answer is no, he can’t do it that way.

Joe: Interesting way to answer that question because I thought it was some completely different.

Al: What do you think? What question do you have? Or how would you answer it? (laughs)

Joe: Well I think we answered it but I thought the second question was completely different than the whole estimated payments.

Al: Oh well if you have a different interpretation then I’ll answer that one.

Joe: Okay. So our buddy Olg – Oleg. God, I am so bad at this. How do I keep employed?

Andi: How are you on the radio, Joe?

Joe: I have no idea.

Al: Because you have lots of personality and you’re enthusiastic. (laughs)

Joe: (laughs) No clue. He goes, “is the first 20% profit not taxable by the new tax law” for his medical practice, so Oleg is Doctor Oleg. And he’s healing people and he’s got a business and he’s the man. And then so he’s saying, “all right this QBI tax deduction, how the hell does this thing work? I got profit. So my first 20% of the profits that I make, is that tax-free?”

Andi: That’s how I took it. Does the QBI apply to him?

Al: That’s how you took it?

Joe: Yeah. How does QBI work to this guy that has a medical practice, Dr. Oleg.

Al: Yeah all profits, first, second, third, fourth, sixth, however you want to break it up, 20% of that is tax-free as long as you don’t get disqualified for a number of other limitations and reasons. But the reason why I thought he asked it on how I answered it was his first question was on estimated payments. So I’m figuring he’s thinking the first 20% is tax-free so I don’t need to include that in my first quarter estimate and that’s false.

Andi: I think because of the fact that he mentioned that it is a medical practice, he is asking you if that is a service business that is under the QBI rules. That’s why I took it that way.

Al: It is a service business. Well, if you want to go down that path then it gets way more complicated. Service businesses, if he’s married and he and his wife make less than $320,000 approximately of taxable income, it doesn’t matter whether it’s a service business or not. He gets the full 20%.

Joe: If it’s over that then it’s a totally different ballgame.

Al: Then there are phase-outs like crazy so. So forget about it. And if he’s single it’s half of that. So it’s about $160,000 of taxable income. And so what I tell people, if you’re married, less than $320,000 of taxable income, it doesn’t matter for your service business or not – you get the 20% as long as your business income is greater than your taxable income. Those are the limitations there.

Joe: Yeah because any of these other businesses and then you have another spouse that works and then the taxable income is high – so it’s complicated. So maybe, Dr. Oleg, maybe.

Check the podcast show notes at YourMoneyYourWealth.com for more on the qualified business income deduction. The fellas have a couple more of your money questions to attempt to answer momentarily. You know, if you haven’t done so already, the two best ways to show your love for Your Money, Your Wealth® are to share the podcast with everyone you know. That helps us spread this financial lunacy – I mean literacy – and to make sure you’re subscribed to the podcast. Episodes will download automatically to your device and you can listen whenever you want. In the coming weeks on YMYW, Oliver Renick from TD Ameritrade Network talks about the effect the media has on the markets and economist Dr. Chris Thornberg gives us his thoughts on the Southern California real estate market and the state of the economy in general. Subscribe and share at YourMoneyYourWealth.com.

29:02 – Can I Contribute to an IRA or Should I Convert to Roth?

Joe: All right. We got Rob from Santa Clarita. You like how I rolled the tongue on that one?

Al: Really. You’ve been in Southern California a while.

Joe: I have. “I have a pension plan at work. I have an IRA with Schwab that was rolled over from a previous employer’s 401(k). I make too much to open a traditional tax-deferred IRA and too much to contribute to a Roth. The way that I understand is that I could still contribute $7,000 to an IRA (I’m 56) and still get the benefits of not paying the taxes on the gains and dividends and allow those non-taxed gains to grow exponentially. Is this correct? But would it be wiser to convert a portion of my IRA to a Roth or do both? I currently only have one IRA so there is no complication with the pro-rata rule if I convert a portion to a Roth. Of course, from your lessons, I would not convert so much that it would throw me into a higher tax bracket.” OK Rob, let’s talk about a couple of things. Lessons. Lesson one, you’ve got to go back and re-read and re-watch (laughs) because you failed a couple of them. You did say yeah, you don’t want to convert too much to throw you to a higher tax bracket. That is – check, A+ there. But – so he makes too much money. So is he single or is he married?

Al: We don’t know.

Joe: OK. Well, I was going to say if you’re married then the Roth IRA income limitation is around $200,000.

Al: Yeah, it’s like $193,000-$203,000 is the phase-out.

Joe: $193,000-$203,000. So if you make more than $203,000 of adjusted gross income – modified adjusted gross income, Rob cannot put money into it. So he’s doing a non-deductible IRA contribution is what he’s doing. $7,000. So he’s asking if he gets the benefits not to pay taxes on the gains and dividends and allow those non-taxed gains to grow exponentially. I mean, like, infinity! (laughs)

Al: Because you don’t have to pay taxes, they grow exponentially.

Joe: But if it’s in a traditional IRA, Rob, you will still have to pull the money out at age 70 and a half and then you will have to pay taxes on those exponential gains that you earned – at ordinary income rates.

Al: Yeah. Think about this: if you kept it in your non-retirement account and it grows, you’re not going to pay capital gains until you sell that asset. So you might have some dividends to pay along the way, but then when you do sell it, it’s long-term capital gain. What you’re thinking is you put it into your IRA, you defer the taxes, but all of that deferral, including most of the IRA that’s in there…

Joe: You put $7,000 in, over the next 20 years it grows to 50. Well, the $7,000 you put in comes out tax-free but the $43,000 that it grew to is all going to be taxed at ordinary income rates if it’s in the traditional IRA.

Al: And it’s pro-rata so that $7,000 – I don’t know how much you rolled into the IRA, but let’s just say it was a couple hundred thousand bucks. Now you put seven in, so now $7,000 divided by $207,000, that’s the amount that’s tax-free and the rest is fully taxable. So there are some better ways to do this. Number one is either just not do it and leave it in your trust account, non-retirement account –

Joe: Yeah, your brokerage account.

Al: – to get long term capital gains, or if you have a 401(k). It says you have a pension at work. If it’s a 401(k) you could potentially roll your IRA back into the 401(k). The 401(k) will not let you roll in the pre-tax part, the IRA part. And so you’ll be left with $7,000 in your IRA that you can convert and pay no tax whatsoever.

Joe: Yeah. But I think you’ve just confused everyone.

Al: Probably.

Joe: Because what he’s stating is that he put $7,000 in an IRA. So do you get the benefits and the gains and dividends non-taxed exponentially? Yes until you have to pull the money out. So is this correct? Yes. Until it’s not. But “would it be wise you to convert a portion of my IRA to a Roth or both?” Well, it depends – he says he’s only got one IRA. But if you only have one IRA, is that one IRA the only one with the $7,000s in? If that’s the case, if that’s the only IRA you have, you put $7,000 in that IRA, you have no other IRAs – convert it! Because then it’s now in a Roth. And then now that will grow exponentially tax-free.

Al: In the Roth. But he’s saying he’s got the IRA. It doesn’t matter if you have 2 IRAs…

Joe: He says, “I currently only have the one IRA.” Is the one IRA the one he just put $7,000 in and that’s the only balance of the $7,000? If that’s the case, convert it, no pro-rata rules. You’re all good. If that $7,000 went into an existing IRA that had pre-tax dollars into it, now he’s messed up.

Al: Yeah. But the second sentence I’ll reread: “I have an IRA with Schwab that was rolled over from a previous employer’s 401(k)…”

Joe: Rob you messed up!

Al: (laughs) That’s why I answered that question that you said confused everybody.

Joe: It confused the hell out of me because I didn’t read his full question. (laughs)

Al: So when you roll from your 401(k) to an IRA, now you got all this pre-tax money – you can’t do the back door Roth anymore.

Joe: Yeah, you’re done. You can’t do it because it’s all pro-rata.

Al: Unless you roll it back into the 401(k).

Joe: You roll it back into the 401(k).

Al: That’s what I was trying to say.

Joe: Yeah. He says here he’s like, “Hey, there’s no complications with the pro-rata rule.” Yes, there is, Rob. Yes, there is.

34:45 – What Are the Estate Tax, Gift Tax, and Gift Exemption Rules?

Joe: We got Marcus he’s calling from Alabama. “Good evening Joe and Big Al. This is Marcus from Alabama. ROLL TIDE!” Oh boy.

Al: Exclamation point and caps.

Joe: All caps. Marcus.

Al: But a big fan of the show.

Joe: Big fan. He’s a big fan of the show. “Keep up the excellent work and providing funny but practical financial information to millions upon millions.” Thank you, Marcus. I think it’s two of you. (laughs)

Al: Well even he says “this might be an overstatement.” (laughs)

Joe: Little bit. “I believe this was covered earlier this year but can’t recall the episode. So here’s my request. Can you explain estate tax, gift tax, and current allowable gift exemption rules? There is confusion and how and when the gift tax and gift exemption rule applies. Let’s say Marcus’s got $5 million net worth. “I’ll give away $500,000 to an individual non-spouse, which is clearly over the $15,000 limit. Do I have to pay a $485,000 gift tax or is this subtracted from the current lifetime exemption of $11 million? In general, if one doesn’t plan on having a net worth of $11 million, should there be concern as to the amount of money one gives away to an individual in a year or over their lifetime? Disclaimer the above scenario is purely for educational purposes only. I do not have 5 million in net worth – yet. Thanks.” Marcus – sounds like Marcus is in the business.

Al: Yeah, he’s planning on making some big money.

Joe: He’s a financial planner. He’s like, “dammit, I got a client calling me. How do I answer??” Because this is a very sophisticated question Marcus has got going on here.

Al: It’s also very specific.

Joe: Very specific. So Marcus is in the profession and he gets a call from his client in Alabama. (laughs) And he’s like, “sonofa- I have no idea.” He’s looking all over, he’s on our website, and he’s like, “Screw it I’m just gonna-“

Al: Just see what I get. I couldn’t find your episode.

Joe: Yeah, just gonna say hey, I need some help!”

Al: Yeah. It’s a good question. So I’ll answer it. So, Marcus, you are correct. It’s a little over $11 million exemption right now. So what that means is if you were to pass away, the next generation can get $11 million of your assets with no estate tax, no death tax. And if you’re married, husband and wife can each get $11 million – like $11.2 million roughly. So call it $22 million That can go to the next generation tax-free. So if you think you’re going to be over that $11 million, one of the things that you can do is you can start giving it away before you pass away. And so the IRS thought, “well, we’re gonna have to have these rules because otherwise, everyone could give everything away and then not have to pay any death tax on it or estate tax.” And so they said, “all right, we’ll let you give right now $15,000, no questions asked, to anyone that you want to. But if you give more than that, you’ve got to file a gift tax return because we don’t want you getting out of paying this estate tax.” So that’s why these two things are related. So if you give away $500,000, then you file a Form 709, which I actually have right here. And I’m not going to go through it because it is way too complicated to go through on the air, but I’ll give you the essence of it: a form 709 is what you file each and every year you give more than $15,000 to any one recipient. And so, in your example, you give $500,000 away to somebody. So you subtract out the 15 because you’re allowed to give that. So what’s left is $485,000 – that goes on the return. And in essence, it gets subtracted from the $11 million. It’s actually done in a different way, but what really happens is the $485,000, you compute the gift tax on that and subtract it from the unified credit, but no one understands that including accountants. So I’m just going to say – it’s the inverse of it. I’m just going to say that’s roughly it. Basically, you’re taking some of that $11 million exemption and you’re giving it early.

Joe: Yeah, if you’re taking like the CFP® or CPA exam it’s the inverse. So you actually need different numbers. But for this show… (laughs)

Al: Yeah and for our ability to explain. Anyway, so I think that’s probably the best way to explain it and think about it – you’re basically giving some of your $11 million away early, and so why would you want to do that? Well, you would want to do that for a couple reasons. One is if you felt like the $500,000 you were going to give away is going to grow in value, then when you give it away it grows in the person you gave it to’s assets, not yours. And the second reason you would do it is that this $11 million has only been just a couple of years. I mean, it was $5 million just a couple of years ago and it could go back to $5 million. It could go back to $1 million at some point. So you give it away now while it’s still an exemption. So those would be a couple reasons that you would do it – or if you felt like Marcus and/or his client was going to eventually make a lot of money. Then yeah, you could start doing that right now.

Joe: All right. Hopefully, that helps, Marcus. That’s it for us today. For Big Al Clopine, I’m Joe Anderson. Thanks a lot for listening. We’ll catch you next time on Your Money, Your Wealth®.

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Check the show notes for the video of that last response on estate taxes and gift taxes, and stick around to the very end of the episode for this week’s derails. Read the transcript, subscribe and share – all the links are in the podcast show notes at YourMoneyYourWealth.com.

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