Joe Anderson
ABOUT Joseph

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

Alan Clopine

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

Published On
December 8, 2020

There are taxable, tax-deferred, and tax-free accounts, and the proper balance of investments in each is called tax diversification. Are you tax diversified enough? Plus, how do capital gains and ordinary income work again? Should you contribute to your tax-deferred traditional 401(k) or IRA accounts, or to your tax-free Roth accounts? What can you do about excess contributions to your Roth IRA? And to mix it up, are municipal bonds a good idea for conservative investors?

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Show Notes

  • (00:52) Tax-Free, Tax-Deferred, and Taxable: Am I Tax Diversified Enough?
  • (07:46) Confirming How Capital Gains Are Stacked on Top of Ordinary Income
  • (11:44) TSP to Roth IRA Conversion: Long-Term Capital Gains vs. Ordinary Income?
  • (17:26) Withdrawal Rules for Roth 401k to Roth IRA Direct Rollover?
  • (23:51) How to Deal With Excess Roth IRA Contributions?
  • (30:36) In the 35% Tax Bracket: Contribute to Traditional 401(k) or Roth 401(k)?
  • (35:06) Why Contribute to the Traditional IRA Instead of Roth IRA?
  • (38:31) Are Municipal Bonds a Good Investment for Conservative Investors?

Free resources:


LISTEN | YMYW PODCAST #295: Capital Gains “Sit On Top” of Income? What About When Doing Roth Conversions?

LISTEN | YMYW PODCAST #292: Dividends and Long Term Capital Gains – Part 3

LISTEN | YMYW PODCAST #287: Tax Planning and Roth Conversions: Itemized Deductions, Dividends, and Long Term Capital Gains

LISTEN | YMYW PODCAST #272: $10K Ordinary Income, $40K Qualified Capital Gains. In What Tax Bracket is the $10K?

LISTEN | YMYW PODCAST #266: Capital Gains Tax vs. Ordinary Income Tax

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There are taxable accounts, tax deferred accounts, and tax-free accounts, and finding a proper balance of your investments in each type of account is called tax diversification. Today on Your Money, Your Wealth®, Joe and Big Al will help you figure out if you’re tax diversified enough, and they’ll confirm once again how capital gains and ordinary income work. Plus, should you contribute to your tax-deferred traditional 401(k) or IRA, or your tax-free Roth IRA or Roth 401(k)? What are the withdrawal rules for a direct rollover from a Roth 401k to Roth IRA? What can you do about excess contributions to your Roth account? And just to mix things up, are municipal bonds a good idea for conservative investors? I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

Tax-Free, Tax-Deferred, and Taxable: Am I Tax Diversified Enough?

Joe: Let’s go to Susan. She writes in. “Hey Joe, Al, and Andi. I’m writing from the suburbs or maybe exurbs outside of Atlanta, Georgia-” HotLanta. So Susan, she drives a 2005 Acura MDX. That’s kind of sexy “- and I have an 8-year-old lab hound mix named Rex. I have two questions. One is maybe more for Joe and maybe one is for Al. Number one, I’ve been converting traditional IRA funds to my Roth IRA over the last several years all while staying in my 12% head of household tax bracket. Currently, I have about 45% of my rollover traditional IRA; 25% in my Roth IRA; and 30% in non-qualified brokerage accounts. I recall one of your episodes talking about spreading investments among taxable, tax-deferred, and tax-free for flexibility. Should I continue to convert the traditional IRA until I’m closer to 30%, 35% in each type? Or is another percentage desired? I have about 19 years until my required minimum distributions.” Let’s see. We don’t have a ton of time let me- let’s take a break Al, and then let’s kind of dive into that. Let’s slice that open a little bit more.

Al: Yeah, there’s some different ways we can go with that for sure.

Joe: Right. And then we can talk about- this is a really good question too. She’s got a question on capital gains that are stacked on top of ordinary income.

Al: That’s the exact term I used, stacked on top.

Joe: Yep. And so this is interesting stuff because a lot of times people get confused especially if you’re doing Roth conversions and trying to zero out your capital gains.

Al: Yes. Because you can get some surprising effects with that.

Joe: Absolutely. And she’s asking Al, I heard about tax diversification. She’s got a certain percentage in- 45% in like pre-tax or IRA dollars; 25% of her liquid assets are in Roth dollars; 30% in non-qualified brokerage accounts. So she’s asking, is there a better percentage? Am I diversified? And  I would say just- we don’t know how much she has, but just from a percentage standpoint, those look pretty good.

Al: I would say she’s in great shape. I think that the better way to think about this Susan is, are you in a low enough tax bracket where Roth conversions still make sense? And if they do, keep going. Keep going all the way up to RMD age, which is 19 years from now, required minimum distribution age, or even longer. You can do conversions after you hit 72. You don’t have to stop, if you’re in a low enough bracket.

Joe: Here’s what I would do if you really want to put some pencil to paper here. Is that she’s got 20 years to 72, so she’s in her-

Al: She’s 53.

Joe: – early 50s. I don’t know if she’s working or not. But how you want to look at this is when you start needing to take money from the account is really gonna determine- your diversification is really going to come into play there. Because it’s how much money that you want to generate from the portfolio is key. If you want to grab, let’s say $50,000 a year from the overall portfolio, your mix is probably just fine. But if you want higher income, but pay lower brackets or pay lower tax, you probably need less in the 401(k) and more in your brokerage account and Roth. Because it’s like you want to take money from your 401(k) or IRA or pre-tax accounts to get you let’s say to the top of the 12% tax bracket. If you’re single, that’s $40,000. So you pull from there or if you have Social Security, depending on what your Social Security is, maybe that’s- I’m just going to throw a number out- $20,000. So then you pull another $20,000 from your 401(k) plan. So that’s $40,000. So that keeps you right at the top of that 12%. Well, let’s get more complex. Now another- then you got your standard deduction, let’s call it $10,000.

Al: I was going to bring that up. Last time I did a simple example, you stopped and said ‘Alan, do you understand how taxes work?’ I was gonna do the same thing, but you beat me to it.

Joe: Because it’s complicated. There’s a lot of moving parts here. So you’ve got to look at, what’s your income need? Is it $100,000? And then take your $100,000, minus the standard deduction, and then pull money from your 401(k) to keep you at the 12% tax bracket. If you want more income, then pull from your Roth IRA or pull from your non-qualified account. But how much more income do you want outside of that 12% tax bracket is going to depend on your tax diversification strategy from now until age 72? Is my point.

Al: So that’s a lot of words. I don’t know if anyone can take that and use it. But here’s what I would say. I would say 19 years out, just keep converting as long as you’re in a low enough bracket. But if you’re closer to retirement- for those of you that are- say you’re going to retire next year, a couple years from now, whatever, then you can do that math to say, how much do I want to spend? What’s my fixed income? Now I kind of have a better sense of that and I want to make sure I have enough ordinary income to fill up the 12% bracket. In other words, why would I do a Roth conversion in the 24% bracket if I’m already going to have my RMDs in the 12% because my balance is so low? So that’s the math that you do. But you kinda- to me Joe, you have to be closer to your retirement because 19 years away, anything can change.

Joe: But 19 is her RMD age, so she’s 53, so she could retire at 55. She could retire at 60.

Al: She could. You’re right about that.

Joe: Well maybe she’s currently retired. I don’t know. Susan, she’s cruising around in her Acura, got an 8-year old lab named Rex, she probably retired, she’s listening to us. Most people are super successful.

Al: Yeah you’re right. They’ve listened to us maybe 2,3 episodes and then they’re good to go.

Joe:  Because they can’t take it. So the simple answer is, just convert to the top of the 12%, if you’re in the 12%. If you’re going to convert to the top of the 22%, make sure that your RMDs are not going to be less than the 22% tax bracket. Tax rates are going to go up in 2026. So you’ve got to take a look at that. It’s going to give you more flexibility if you get more money into the Roth. It’s not going to hurt your Medicare premiums because Roth doesn’t count for IRMAA as increase in benefits. It also could create tax-free income for your Social Security because Roth distributions do not count in provisional income. So you could potentially have a very high income later in life and virtually pay zero tax. So she’s in the 12% tax bracket. Keep converting to the 12%. Does that make sense to convert to a higher bracket? Well it’s going to depend on how much money that Susan has in a retirement account.

Confirming How Capital Gains Are Stacked on Top of Ordinary Income

Joe: Hey Al let’s talk about stacked up. So we had a previous episode you mentioned capital gains are stacked on top and don’t change the tax bracket. “Can you confirm that my understanding is correct? For the first time in several years, I sold some stock in my non-qualified account. The stock was from a former employer so I could buy a discount for my 401(k) match was also in company stock. I want to reduce my exposure to the single holding. This sale was a gain but should have zero tax consequences because she’s in the 12% tax bracket. I use my annual expected self-employment income, my expected dividends, and this gain amount, to estimate adjusted gross income. Then converted funds to my Roth based on the amount available within my tax bracket, using the calculated AGI. Does the stacked on top that Al mentioned mean that I can convert additional funds from my Roth equal to the gain amount while still staying in that 12% bracket?”

Al: So let’s kind of break this down a little bit. So when you’re in the 12% bracket and so Susan, I don’t know if you’re married or single, but let’s just say-

Joe: Head of household. Head of household.

Al: – head of household. OK. Oh boy. Now I gotta look up what the- what that table is. The top of the top of the 12% bracket for head of household is $54,000,  $54,000 of income. All right. Let’s say taxable income. So Joe, you already kind of went through this. Your income minus $12,000 standard deduction, roughly. So let’s say she does that calculation, she’s at $40,000. So what did I say, $54,000? Yeah. $54,000. So there’s $14,000 of room. So now you can sell stocks with $14,000 of gain and pay no tax. If you sell stocks with $15,000 of gain, the first $14,000 is tax-free. But the extra $1000 is taxed at a 15% tax rate. That’s the way this works. So you can’t sell everything, it’s just to make sure that you stay below that $54,000. That’s how capital gains work. Now, when you do a Roth on top of that $14,000 because you think you get $14,000 of room, so the Roth pushes your taxable income to $54,000 already. So now if you do a capital gain on top of that, you will pay 15% tax on the capital gains so you don’t get to do both. And here’s what happens- we’ve seen happen- is people try to do both. They try to do a Roth conversion to the top of the 12% bracket and they try to do a capital gain to the top of the 12% bracket. You can’t double do it. You only get one 12% bracket. And when you do that, it becomes a very expensive Roth conversion. Because if you think about it this way, your Roth conversion is taxed at 12% because you’re in that bracket. Your capital gains, which would have been tax-free, got pushed up into the next bracket and now they’re taxed at 15%. So now it’s a single dollar of Roth, you’re paying 27% tax. Because of the 12% plus the 15%. And I’ve seen that happen. And in the old days, you used to be able to re-characterize in the following year before you filed your tax return to fix it. Now you can’t. You’re not allowed to re-characterize. So just be very careful in combining Roth conversions and capital gains when you’re in the 12% bracket.

Joe: Because the capital gains sits on top. It stacks on top. So if you did the conversion to the top of the 12%, which is $54,000, so now you used up that 12% bracket and then you sell- the capital gains is on top of the $54,000. So you’re going to be taxed at 15% because it sits on top of the conversion.

Al: Yep.

Joe: Hopefully that clears things up, Susan. Appreciate your questions. Very good questions, appreciate it.

TSP to Roth IRA Conversion: Long-Term Capital Gains vs. Ordinary Income?

Joe: We got Tim writes in. Tim the stalker, Andi? Is that who this is?

Andi: Yes. Yes, it is.

Joe: Got it. OK.

Andi: I’m so glad Tim’s the stalker instead of me now.

Joe: Yes. He’s out of control. This guy follows me everywhere. He’s in line at the grocery store. He’s like ”hey, I’ve got a Roth question for you.’

Al: All right.

Joe: I’m like who are you? Get away- oh Tim.  Tim, you crazy man. Tim writes in. He goes “Hi. I’m a long time listener and I have appreciated the excellent response to the questions I’ve had.” You’ve had a lot, Tim. He’s worse than Bruce. I mean these guys are just milking us, Al.

Al: They are. It just never stops.

Joe: “When listening to your recent comments on 401(k) conversions to a Roth IRA, I thought of a tax question. I transferred a portion of my government TSP to Roth IRA at a brokerage house, just enough to keep me at the top of the 24% income tax bracket. The TSP or thrift savings plan does not transfer its fund, but cashes them out and sends the cash amount to my brokerage house. Even though the TSP cash was going to a Roth IRA at the brokerage house, the transfer became regular income added to my tax year causing a significant tax burden. Since the fund and the TSP were long-term held for many years, should that income be considered long-term capital gains and taxed at the long-term capital gains rate versus ordinary income at the 24% tax bracket? Or because the TSP cashed out the amount and sent cash, does that just become regular income even though it went to my Roth IRA? I have since transferred the remaining amount of my TSP 401(k) to a new traditional IRA at the brokerage house and purchased ETF stocks and mutual funds within that traditional IRA. The brokerage house can convert the stocks ETF mutual funds to my Roth directly. If after a year, I convert the traditional IRA assets to a Roth IRA, will that be considered long-term capital gain and taxed at the lower long-term capital gains rate? Thank you.” So Tim has asked multiple questions over the years, Al. A longtime listener.

Al: Yes.

Joe: Is he really comprehending anything that we’re talking about?

Al: Well he’s- and he asked several questions here, but they’re all the same question.

Joe: So here’s- this is what scares me. He goes ‘I’m gonna convert to the top of the 24% tax bracket.’ So he’s already thinking I’m gonna be paying 24% that’s why I’m converting to the top of the 24%.

Al: Yeah I agree. So we got through the second or third sentence I thought OK. So far, so good. And then it all went south after that.

Joe: Right. And then he’s like well wait a minute, then they cashed out my TSP. So when you go from a 401(k) or TSP or type of employer-sponsored plan, as you do a rollover to get the money out, of course, they have to cash it out. They’re not going to transfer shares. If I have an IRA, let’s say at Fidelity and I have a Roth IRA at Fidelity. I can transfer shares in kind. But he converted to the top of the 24% tax bracket. Then he’s like wait a minute, shouldn’t that be long term capital gains? Well, no. That’s the whole reason why you do the conversion is that you’re getting rid of the- you have to pay the ordinary income tax for it to forever grow tax-free. The whole basis of a lot of our shows- because of all these questions that come in, is about Roth. And we want to get rid of the tax-deferred ordinary income tax treatment of those accounts by having tax diversification by putting money into the Roth. So if you’re already saying I’m going to go- convert to the top of the 24%- then he’s shocked that he got hit with a huge tax bill. Well, I don’t understand, where else we go with that.

Al: Well let me say it another way. So we like to draw little circles of 3 different kinds of taxation. We like to call it the Tax Triangle. But one is tax-deferred; one is taxable, and one is tax-free. Tax-deferred, that’s an IRA; that’s a 401(k); it’s a 403(b); it’s a 457. Always, always, always, always, always, always, when you take money out of any of those accounts, it’s ordinary income. Ordinary income. Never, never, never capital gain. Whether it gets cashed out or you trade; you do a conversion of shares in kind, it doesn’t matter. It’s all ordinary income. That is right, Joe. That’s why we encourage people to get money out of those accounts so they can either have tax-free or capital gain in the future.

Joe: The only way it would be capital gain rate is if it was net unrealized appreciation. You could take company stock out of the 401(k) plan and move it into a brokerage account, sell that stock and pay capital gains rate, but it was in a TSP, it’s mutual funds. So he took the money out. It’s going to be taxed at ordinary income rates. The top of the 24%, you’re gonna pay 24% on those dollars, plus the state of California. I think is where you live. So yeah. But then all those dollars will grow tax-free. So hopefully, that helps Tim. Appreciate the email.

Wow. It’s not often you hear Joe or Big Al say “always” and “never” so emphatically. Hopefully that will help this ordinary income vs capital gains thing stick in all of our heads! By the way, a number of people have asked, and the discussion of capital gains sitting on top of or stacked on top of ordinary income has been discussed several times in previous episodes of YMYW. So I’ve linked to a pile of ‘em in the podcast show notes at YourMoneyYourWealth.com. Click the link in the description of today’s episode in your podcast app to hear a refresher, to send in your money questions and comments, and to spread the word and share all this cool stuff with your friends either via email or on social media.

Withdrawal Rules for Roth 401k to Roth IRA Direct Rollover?

Joe: We got one from Brian. Queens, New York City. “Hello, Joe, Al, Andi. This is Brian from Queens, NYC.” He’s a schoolteacher. “Thanks for answering my very lengthy question in podcast 275. I’ve continued listening to the podcast every week and enjoy season 6 of the television show. Great seeing Big Al out there in Hawaii. Jealous. Smiley face.”

Al: It was pretty cool. I must say.

Joe: That was great. “I took the advice you recommended from my first write-”

Andi: “- write in-”

Joe: Oh, “- write in-“, thank you. “- and switched future contributions from pre-tax 457 to Roth 457. You guys thought with my maxing out 403(b) and 457 pre-tax totaling $40,000 that it was possible I’d be in the 12% tax bracket. However, that is incorrect as I failed to mention my wife is also employed and actually the breadwinner putting us in the 24% tax bracket for 2020. My wife is 40 years old and looking to stop working in about 5 years. From her previous employer, she had a 401(k), Roth 401(k), which she did a trust A to trust B direct rollover to a traditional IRA, Roth IRA. Now starting in 2020 she is using the Roth conversion ladder strategy, converting a portion of the balance each year, paying the taxes from general savings so she can have tax and penalty-free access to the Roth funds after 5 years when the conversion requirements are met. We will attempt to fill the 24% tax bracket using the strategy. At her current employer she continues contributing to 401(k), some pre-tax, some Roth 401(k). When she separates from service from the employer once again she’ll do a direct rollover- 401(k) goes into the IRA and then the Roth 401(k) goes into a Roth IRA. My question is the following, as we know, contributions to a Roth IRA can be withdrawn at any time, conversion to traditional IRA funds to a Roth IRA can be withdrawn after 5 years. But what are the rules regarding direct rollover to Roth 401(k) funds to Roth IRA? Do those funds have a 5-year clock? Can they be assessed immediately? Or must you wait till 59 and a half on those funds to receive tax-free, penalty-free withdrawals? Thanks again for all that terrific information.” Gotta shorten that question way up. Look here’s a hint. What’s the 5-year clock for Roth 401(k)? Love, Brian.

Al: Well it’s a good question though. It’s like what happens to the character of your Roth contributions in a 401(k) plan if you roll it to a Roth IRA? That’s what the question is.

Joe: Correct.

Al: And his statements are right. And in other words, when you do a Roth contribution at any age you can withdraw the money at any time. You don’t have to wait 5 years, you don’t have to wait till 59 and a half. You just have to wait for the earnings until you’re 59 and a half. Now, when you do a Roth conversion under 59 and a half, that’s where there’s a 5-year clock for every single conversion. Because the IRS doesn’t want you avoiding that 10% penalty by simply doing a Roth conversion. And then turn turnaround spend the money tax-free. So that’s why that rule is there.

Joe: I guess the 5-year clock on conversion is that you have a 5-year clock for each conversion if you’re under 59 and a half, until you reach 59 and a half.

Al: That is true. Then once you’re 59 and a half, that doesn’t apply anymore.

Joe: With each conversion because then they’re not avoiding the 10% penalty because they’re over 59 and half, so they have access to the principle of the money. But the earnings still need the season for 5 years or 59 and a half, whichever is longer.

Al: But if you have money in a Roth 401(k), some of that’s contributions, some of that’s earnings. So whatever it is in the Roth 401(k) rolls into the IRA. Same same. So let’s say of $100,000 in a Roth 401(k) and $60,000 is contributions; $40,000 is earnings; so $60,000 is treated like a contribution.  So you could withdraw that at any time and then $40,000 is earnings. So you’ve got to wait for 59 and a half on that.

Joe: So I guess the question for me is, what is he really trying to get at here is what I’m trying to figure out.

Al: I think he’s trying to figure out how his wife can spend money at age 45.

Joe: Don’t take it from the Roth. Right Brian. Don’t do that. There are other ways to create income. Because you want to make sure that the Roth money continues to parlay for you and your family tax-free. That’s a whole reason for that. You’ve got to give it time. So if you’re thinking if we’re doing these conversions and this and that, she wants to retire in 5 years, are you looking to spend the money? Is that what you’re trying to do? Because if you roll the 401(k) into the Roth IRA, then you’re fine because you’ve already have these Roth dollars for over 5 years. But are you trying to get money from the overall accounts- you’re just taking principle and then let the earnings grow tax-free? I would be careful. Don’t even do it in the Roth. Don’t even invest. Go into a brokerage account if you want to have a bridge there. Because you’re going to screw this thing up. You’re going to probably- how you’re filing and you’re this is pre- or this is after-tax dollars that came from this 401(k)- and trying to track all that stuff. If you’re trying to look at a way to spend money prior to 59 and a half, start building a brokerage account. Start building non-qualified dollars. I would not take the money from the Roth, it just defeats the purpose of- especially at his age- of saying my wife wants to retire at 45. Then all of a sudden, you blow out all that Roth money which could parlay for another 20 years and you’re going to have 3 or 4 times as much tax-free. You’ve got to look at long term here.

Al:  It’s just depends- if that’s their only choice though. And she really, really, really, really wants to retire at 45. Then it can work. How about that?

Joe: All right.

How to Deal With Excess Roth IRA Contributions?

Joe: We got Ce from Jersey. C- E? Or C?

Andi: That’s correct.

Joe: C- E?

Andi: I don’t know. It was Ce, with capital ‘C’, lower case ‘e’. So I’m gonna go with Ce.

Joe: Not C- E?

Andi: Or maybe it’s Ce (‘Say’). Not sure.

Joe: Ce (‘Say’).

Al: Could be.

Joe: Huh. OK. Help me out there. “Hello there-”

Al: I would say Ce. Let’s go with Ce.

Joe: Ce. Ok “Hello there. Dynamic trio, Joe, Al and Andi. I’m a big fan of your podcast and YouTube channel. You made IRA, Roth IRA- we made IRA, Roth contributions in early January 2020,  $7000 wife, $7000 husband. Also a IRA to Roth conversion of $35,000 was made in June of 2020. This year we made significant gain in the stock market that will push our income above the threshold limit MAGI $206,000; we’re married, filing jointly. My question is this, what is the best way to correct the excess $7000 contribution?” So they put in $7000 each for Roth IRAs. They also did a conversion of $35,000, Alan. But then he’s saying, you know what? We made significant short term gain in stock market that will push our income above the threshold income where the Roth contributions are no longer available. So $206,000 is the amount for a joint couple. So then he’s saying, how do I get out of this thing?

Al: Right. How do I do it?

Joe: How do I re-characterize? Is the correct term. So a few questions that I would have is that- first of all, the $35,000 that Ce made is not applicable in the MAGI calculation for your Roth contributions.

Al: I think that’s the first key point to make. I agree with you, Joe. So when you do a Roth conversion, it’s not included as income for the modified adjusted gross income number of $206,000 to see if you can do a Roth contribution. So you can keep that part out. But let’s just say the stock gains without the $35,000 pushed him way past the $206,000.

Joe: So what, do they use day trading the account? I mean are they realized gains? Is the gain inside the Roth? Some people get kind of confused. It’s like let’s say he did a- because he did the conversion in June. He converted $35,000 in June and all of a sudden he’s looking at his balance today and it’s $50,000 because the market has been on fire. The market has COVID or something. Right. It’s running from COVID.

Al: Yeah. It’s recovered.

Joe: It makes zero sense. It’s recovering, very nicely. It’s laying in bed. It’s drinking some-

Al: It’s got immunity.

Joe: It does. Yes.

Al: Anyway. If the gains are in a Roth, don’t worry about it, doesn’t matter.

Joe: But some people think I converted $35,000, it’s now worth $50,000, do I pay tax on $50,000? It’s the amount of dollar that you converted. It’s not what the end of your balance is.

Al: True. That’s a good point. But let’s just say it’s in a brokerage account, outside of retirement account, that all these stock gains were. So you have a couple choices. One is you can withdraw the IRA and the earnings before the due date of the return, April 15th or if you extend the return on October 15th, and then you will not be charged a penalty. You will have to pay income tax on the earnings, number one. And number two is if you’re under 59 and a half, you’ve got to pay a 10% penalty on the earnings part. Just the earnings. The second thing, which might even be cleaner, is if you haven’t- if you talk to your brokerage house, you can just re-characterize the Roth conversion- Roth contributions-

Joe: Contributions.

Al: Sorry- Roth contribution to an IRA contribution.

Joe: And the IRA contribution then would have basis of the $7000. So you put $7000 into the Roth. The $7000 let’s say hypothetically grew to $8000. Then he finds out I have too much income because we killed it in my day trading. He’s all over the place. And so it’s like shoot, we’ve got to re-characterize it, so he could just take the money back. Take the $7000 back. The $1000 would be taxed at ordinary income rates and then there could be a 10% penalty assessed on that $1000, depending on how old Ce is. Or you just re-characterize it into an IRA contribution. You have $206,000 of income so you cannot take the deduction. So you’re going to have basis in that overall IRA. And then guess what you do? You convert it into a Roth and you would just pay tax on the $1000 of gain that the IRA made. And once again Al, each question has a backdoor Roth solution.

Al: Somehow it always comes back to that, doesn’t it? I wasn’t going to even bring that up. You did.

Joe: Well that’s the right play.

Al: I know. I agree.

Joe: So you just re-characterize the $7000 into an IRA and then you take the IRA and then you convert it. As long as you don’t have any other IRAs. Because then you got the pro-rata and the aggregation rules.

Al: That’s a huge point there and we could spend another 10 minutes on that.

Joe: So hopefully we pronounced your name right. Ce from Jersey. Ce from New Jersey. So all right, we appreciate your question.

Due to popular demand from the Your Money, Your Wealth® audience, we will be publishing our Ultimate Guide to Roth IRAs very soon. It’ll explain in depth what a Roth IRA is and the benefits of it, how a Roth IRA differs from a traditional IRA and from a Roth 401(k), the rules for Roth contributions, conversions, withdrawals, and more. When you have a question about Roth conversions in the future, you can simply consult the Ultimate Guide to Roth IRAs! Click the link in the description of today’s episode in your podcast app to go to the show notes and subscribe to the YMYW newsletter to ensure that you’ll be able to access this comprehensive resource about Joe and Big Al’s favorite topic as soon as it’s available.  Then help us spread the financial fun and knowledge by forwarding the newsletter to your friends.

In the 35% Tax Bracket: Contribute to Traditional 401(k) or Roth 401(k)?

Joe: We got Jason from Nashville. He goes “I know you guys, especially Joe, love the Roth account. My wife and I are in the 35% tax bracket. I have the option to put money in a Roth 401(k). Would do you put my 401(k) contributions into a Roth 401(k)? Or would you recommend with our tax bracket to stick it in the traditional 401(k)? Or some combination? Also I’ve got a backdoor Roth question for you. Just kidding.” Figured that out. Thank you Jason. First of all, we don’t give advice here on the show. Suggestions.

Al: True. We’re just- we chat. I don’t even know if they’re suggestions.

Joe: Yes.

Al: It’s kind of having an open chat.

Joe: Open chat. OK. 35% tax bracket, Alan. He’s got the option to put the money into the Roth 401(k). What say you? What- you and Jason are sitting down in Nashville, listening to a little country music, having a couple of pops.

Al: Yeah, let me get one.

Joe: He says ‘Hey Big Al. What do you think? I’m in the 35% tax bracket, should I go Roth or pre-tax?’

Al: Are we listening to Willie Nelson or-

Joe: It doesn’t matter. Some good old honky tonk music.

Al: OK. Blake Shelton?

Joe: Sure.

Al: I would put most of it into regular traditional 401(k) because they’re in a high tax bracket. But I would at least put some in the Roth 401(k) just to start a 5-year clock. That’s what I would do. How about you, Joe? I know what you’re gonna say.

Joe: You know the answer.

Al: I know your answer. I gave you my answer. That’s what I would do.

Joe: I would put it into the Roth 401(k) to be honest with you. I don’t care what tax bracket people are in, just because they’re not going to save the tax bracket. They’re not going to save the deduction. If they’re in the 35% tax bracket, and if they’re only saving $19,000 a year, I’m not- I don’t know how old Jason is.

Al: There’s a lot we don’t know.

Joe: There’s a ton we don’t know. He lives in Nashville. I love Nashville and I wish Jason would invite me to Nashville and I could hang out with him and his wife and we could talk.

Al: And then you could get into it to find out what the answer should be.

Joe: So what is the bottom of the 35% tax bracket, Alan?

Al: Oh gosh. Let’s see. Is he- yeah he’s married. Okay. Bottom of the 35% tax bracket is $400,000-

Joe: $450,000.

Al: Yeah $414,000.

Joe: OK. He’s making over $400,000 a year. So by saving a couple of bucks by putting $19,000 into the pre-tax 401(k) versus the Roth? I don’t think he’s got the option to put a lot of money into Roth because he makes $400,000. Let’s say he saves a reasonable amount of money. If he saves 10% of his income, that’s $40,000. If he saves 20% it’s $80,000. So maybe he’s saving 20% of his income. I just think with people in high brackets the more money that they can get into the Roth IRAs, I think the better they’re going to be. Because the tax deduction is not nearly as big as it was in previous years. If people were making $400,000 in the 80s, they would get a 70% tax deduction, not 35%. So I don’t know. I just don’t think the tax deduction- because he’s going to have to pay it back anyway. People in that bracket, if they’re young, they have savings, we see how big these 401(k)s and IRAs get. And where do you think tax rates are going to go from someone that’s in the 35% bracket today? If they’ve got a ton of savings, they’ll probably be in that same bracket or higher. So I would hedge as much as I can into a vehicle that I know that I’ll never ever pay taxes on it again. Because the $19,000- so he saves $5000, $6000 in tax by going pre-tax; but I guarantee you he’s going to spend 10 times that in the future. I don’t know about 10 times. I don’t know about 10 times.

Al: Yes. So the quick math works this way, if you’re going to-

Joe: We’re out of time.

Al: If you think you’re going to be a lower bracket in retirement and you save the tax money, you’re going to do better doing the traditional and using my approach. End of story.

Joe: Do what you want to do, Jason. But I would go Roth.

Why Contribute to the Traditional IRA Instead of Roth IRA?

Joe: Got Brian writing in, just personally I guess. “Hi Joe. Love the show.”

Andi: I like how it’s in quotes. It says “Joe” in quotes like he doesn’t really mean you.

Joe: Yeah, what the hell is that all about?

Al: It’s a dig.

Andi: Hi “Joe.”

Joe: Hi “Brian.” What a- He’s a dedicated listener to the podcast. Well you know what? Some of these listeners that are dedicated, I don’t really care for. I’m just going to throw that out there right now.

Andi: He said he just recently became, so don’t chase him away.

Joe: Well, hi “Joe”?

Andi: Maybe he thinks that’s emphasis. Hi Joe.

Joe: Got it. Got it.

Al: Yeah yeah. Let’s figure out how to stroke your ego because apparently that has to happen every question.

Andi: Exactly.

Al: He could have done all caps, but in Joe it means you’re like royalty or something exalted. How about that?

Joe: Got it.

Andi: And Al and I don’t even get credit at all.

Joe: That’s fine.

Al: That all right. I don’t need my ego stroked at all. I’m secure.

Andi: Yep.

Joe: Oh boy. OK, just some thoughts in my mind. I’m not going to go there. “I’m debating between contributing to a traditional IRA or a Roth. Because of the prior shows on Roth conversions and backdoor Roth IRA contributions, I’m leaning toward making the Roth contribution by the end of the year. I’m curious is there a scenario or a certain set of circumstances where you wouldn’t recommend contributing to the Roth and instead tell your “client”, in quotes, to contribute-” he’s a quote guy. So yeah, he’s got quotes all over this question. So is there-? Yes, Brian. If you just listen to another episode. Because I guarantee you, we answered this question. Look at your tax bracket. I think people should go Roth because it doesn’t matter they don’t save the tax deduction. So if you put $10,000 into a 401(k) plan and you’re in the 25% tax bracket, you save $2500. So do you save that $2500 into a non-qualified account? Likely that people spend it. If I go straight Roth IRA and put $10,000 in there. I do not save the $2500, but that $10,000 grows to $20,000, $30,000, $50,000, $100,000. I pull it out, I don’t pay any tax whatsoever. If I get the tax deduction today of $2500 and that $10,000 grows to $20,000, $30,000, $50,000, $100,000, whatever it is, when I pull the money out, that’s when the taxes are owed. So if I pull $100,000 out at 25%, what do I owe in tax? $25,000. So I save $2500 on the front end to pay $25,000 later. In that example that will probably never happen. It’s hypothetical, but you get the point.

Al: So what if you save $2500 and that allows you to buy a more expensive home because that’s an extra $200 a month and your home goes up by exponentially because you live in Southern California? You do a lot better with that saving the tax money?

Joe: Well then hire a financial advisor to run those numbers, don’t ask us on a stupid podcast.

Al: Got it. You should have said ‘stupid podcast’ with air quotes. Are we even a podcast? I guess.

Are Municipal Bonds a Good Investment for Conservative Investors?

Joe: Okay. Another question here. “For a conservative investor, what are your thoughts on municipal bonds? Bank interest is basically zero. I have a few CDs that are maturing and looking to get better returns. Would you recommend moving money into muni bonds? Or California muni bonds as a source of fixed income vs. the savings money market account? Can’t handle a lot of risk so investing the money in stocks or mutual fund isn’t an option. Thanks again.” We don’t give advice Brian, but yet it depends on what your tax bracket is. Yields are really low. So it’s, what are your goals? What are you trying to accomplish? You don’t want to go in stocks I get it. Would you go into it tax-free California municipal bond funds? Sure, why not? FYI, I own tax-free California municipal bond funds. I’m not getting a lot of interest on them, but they’re safe and the income and interest I do receive is tax-free.

Al: I think sometimes people that have been burned in the stock market, maybe they’ve invested in a stock and it went down and they think the stock market doesn’t work for them. I would suggest to you and there have been all kinds of research- Harry Markowitz did a study, came up with a theory called the Efficient Frontier.

Joe: Wow, are you name-dropping?

Al: Yeah. And Harry and I, we go way back, because I saw him at a seminar once. Here’s the point, forget the comment. Here’s the point-

Joe: My old buddy Harry and I were- Nobel Lariat (Laureate.)

Al: The point is this, owning 10% to 20% in stocks is actually less risky than owning zero, just because they tend to balance out each other. So that’s my point, Joe.

Joe: Got it. OK. Thank you for that Nobel Prize work, the Efficient Frontier.

Al: I wonder, who’s the most famous person I actually know? Maybe Joe Anderson.

Joe: It could be. Could be. Well, let me tell you about this time I met Harry Markowitz.

Al: I don’t think I said that. Let’s rewind the tape.


More on Brian’s air quotes in the Derails, and Joe tells his story of living in Atlanta – again – so stick around to the end if you’re into that sort of thing.

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