Paul Merriman

Paul Merriman is a nationally recognized authority on mutual funds, index investing and asset allocation. He founded a Seattle-based investment advisory firm in 1983, but is now retired and devoted to educating investors, through weekly articles on Marketwatch.com. In 2013 Merriman created The Merriman Financial Education Foundation, dedicated to providing comprehensive financial education to investors, [...]


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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
May 15, 2018
Nationally recognized mutual fund, index investing and asset allocation authority Paul Merriman

Nationally recognized mutual fund, index investing and asset allocation authority Paul Merriman gives us the truth on market timing versus buy and hold – and he explains why he still does both. Plus, answers to your questions on collecting Social Security and a pension, non-deductible, Roth and SEP IRA rollovers, Backdoor Roth conversions, and are there financial perks to getting married before the end of the year?

Show Notes

  • (01:30) Are There Financial Benefits to Getting Married Before the End of the Year?
  • (06:24) Paul Merriman: Market Timing Vs Buy and Hold
  • (15:46) Paul Merriman: When It Comes to Money, Most of Us Are Nuts
  • (27:24) Non-Deductible IRA, Roth IRA, SEP IRA, Backdoor Roth Conversions and the Pro-Rata Rule
  • (38:10) Can I Collect Both Social Security and My Teacher’s Pension?


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The “Sell in May” has not worked, I think, for four out of the last five years. So I don’t think people will stick with a system that underperforms for that long. And when you’re a timer, you are wrong so often – that’s the nature of that strategy. And most investors just don’t like being wrong that often. – Paul Merriman, PaulMerriman.com

That’s nationally recognized mutual fund, index investing and asset allocation authority Paul Merriman of the Merriman Financial Education Foundation. Today on Your Money, Your Wealth®, Paul gives us the truth on market timing vs. buy and hold – and he explains why he still does both. Plus, answers to your questions on collecting Social Security and a pension, rolling and converting IRA money, and podcast listener Clint gets the answer to his question on whether there are financial perks to waiting until after the first of the year to get married. Now, here are Joe Anderson, CFP® and Big Al Clopine, CPA.

1:30 – Are There Financial Benefits to Getting Married Before the End of the Year?

JA: We got Paul Merriman coming on a little bit later, stick around for that interview because we taped it earlier, and since I listened to it, I’m telling you, it was pretty good.

AC: (laughs) You’ve already heard it?

JA: I’ve already heard it. So I already know what’s coming up.

AC: Wow. So should I listen to it?

JA: You were with me.

AC: Oh that’s right. I already heard it. (laughs)

JA: It was pretty good. Question. This is from Clint. “Hey Joe, Big Al, my question is about marriage. I have found the woman of my dreams…

AC: This is a question for you.

JA: … and I plan on asking her to marry me very soon. Pending an answer of yes, are there any financial benefits to getting married before the end of 2018? We plan on eloping to save some money and not burden our family and friends. Thank you for the awesome podcast. Clint.”

AC: So it could be December elopement or a January elopement, depending upon our answer.

JA: Yes. He found his dreamboat here, and so he’s really in love, because it’s, “hey, I could push this thing off until January of next year if need be.”

AC: The last time I gave advice on when to get married, I got trouble with the girl’s family. I remember that. They were supposed to get married in November on a cruise. And I said, “you might want to push it out next year.” Anyway, I’m still, what the heck – that was a couple of years ago. (laughs) So I would say this, Clint – a couple of things. The answer is, “It depends,” which is the answer for most things, but here’s what you got to consider: If your fiancée let’s say, is not working or doesn’t make a lot of income, then all things being equal, you probably would be better off being married, because the married rates – although they are the same as the single rates – it takes a lot longer to get up into the higher rates. In other words, you can make a lot more income and still be in lower rates. For example, the taxable income for a single person is about $37,000, $38,000, and you’re still in the 12% bracket. But when you’re married, the 12% bracket goes up to $77,000 of income. So in other words, if your fiancée is not making a lot of money or maybe you’re not making a lot of money and your fiancée is, then yeah, that would probably be, at least from a tax standpoint, a good idea.

JA: And that 22% goes to about $160,000 of income, married, $80,000 single. Exactly. So let’s say, Clint, you’re making $40,000 and she’s making $120,000, then you kind of do the math there and it’s like, well if she would file single and you file single, you pay less tax, she would pay a lot more. But if you filed married, both of you would pay less tax.

AC: Yeah. So that’s a consideration there. There are other things to think about, but that’s maybe the first thing. The second thing though is, now let’s say you’re both making a good income, for example, and what tends to happen there is you tend to push yourself up in higher brackets. And unfortunately, not everything is cut in half. In other words, a lot of the marriage brackets are cut in half for single but not all of them. And the same thing for certain phase-outs. So in general, if you’re both making a good income, you do a little bit better filing single, but I can’t guarantee that. You have to do some tax projections to figure this out, for sure.

JA: He’s found the woman of his dreams, Al.

AC: Well he’s asking me.

JA: Now you’re telling him – he’s like, “we both make a killing. So you’re telling me if we get married, I’m going to have to pay more tax.” He’s just looking at, “hey, if I just pushed this thing off a couple of months.” You’re saying, “no, forever!” Don’t do it, Clint! Be like me, man. I’m single. Such a good time. Lonely at night, cry yourself to sleep. (laughs)

AC: I’ve been married 30 years and paying more than my fair share of taxes for a long time.

JA: I’ve been single for 43 years and I’m the happiest guy in the room right now. (laughs)

AC: (laughs) I beg to differ on that one.

JA: Hopefully that helps, Clint. We really appreciate you taking the time to e-mail us.

Your Money, Your Wealth® listeners, if you’ve got a money question, you can email us like Clint did at info@purefinancial.com, or you can call (888) 994-6257 and Joe and Big Al can answer your question live during Your Money, Your Wealth®. Whether it’s about taxes, investing, preparing your portfolio for market volatility, or timing your wedding for the maximum financial benefit, there’s a pretty good chance these fellas can give you the insight that will help you make better money moves. Email info@purefinancial.com or call (888) 994-6257. That’s info@purefinancial.com or call (888) 994-6257. Now, let’s address one of the most common questions in investing: should you try to time the market, or should you buy and hold?

6:24 – Paul Merriman: Market Timing Vs. Buy and Hold

JA: Hey welcome back to the show, the show is called Your Money, Your Wealth®. Joe Anderson here, Certified Financial Planning Professional, with Big Al Clopine, he’s a CPA. Thanks for tuning in. Big Al, it’s that time again, Bub.

AC: It is, I can’t wait. We actually have one of our absolute favorite guests on.

JA: The legend. Paul Merriman.

AC: I know, right?

JA: I just got goosebumps saying that.

AC: (laughs) I got goosebumps hearing it!

PM: And I can’t talk because I’m laughing so hard.

JA: (laughs) Thanks for taking the time, Paul. It’s been a while since you’ve been on, so it’s always a pleasure having you on. You always very interesting things we could talk about. You do so much for the industry. You do so much for the public. I personally just want to thank you. Some of the articles and the books that you’ve written, your podcast, you just bring a wealth of information and knowledge to a very well needed audience. I think that’s professionals and the public. So thank you very much for what you do, Paul.

PM: Thank you. I really appreciate that. I’ve got to tell you, I absolutely love what you guys are doing. I just think you are right cutting edge, doing the best thing that a firm can do for their clients.

AC: Well I appreciate that. And now we’re getting goosebumps. (laughs)

PM: (laughs) My wife has left the room so we can talk.

AC: Now you can be honest, right? (laughs)

PM: Yeah.

AC: There’s always a lot of discussion in the market about what’s the best way to invest? Should people just buy and hold and forget about it, or should we market time, should we be in and out? And I know you’ve had a lot of history in the market, coaching others and with your own investments. And what would you say, based on that? A lot of people right now, the market is so high, people are wondering, “should I  get out?”

JA: Well I think Paul, too, “Sell in May, go away.” You know we’re in the first week of May. What do you think about that?

PM: Well I never used a market timing system – and I should be up front here. Half of my retirement account is market timing, and half is buy and hold. I happen to believe in both, but I don’t think one out of a hundred individuals will ever get it right without professional help. For what it’s worth, most of the professional market timers cheat on their systems. So there’s a lot of neat things about timing. But the fact is, there’s a lot of bad stuff about timing. But Sell in May and go away? If the idea of having market timing is to protect against a catastrophic event – let’s just say that’s the primary purpose. That’s why it’s in my portfolio. But if that is the primary purpose, you go back into the market in October, and it is absolutely possible that that six month period that you’re in the market, the market could go down 50%. And for what it’s worth, the sell in May has not worked, I think, for four out of the last five years. So I don’t think people will stick with the system that underperforms for that long. And yet, with buy and hold – and this is what I like about buy and hold – the buy and holder knows their day is coming and they just need to be patient. They don’t have to worry about being in or out. They’re more tax efficient, it’s lower cost. And when you’re a timer, you are wrong so often. Even the best timers make mistakes. That’s the nature of that strategy. And the public – most investors just don’t like being wrong that often.

JA: Paul, tell me a little bit about your strategy when it comes to timing. What are you looking for? Are you overweight, underweight equities? Tell us a little bit about what your overall outlook or thought is of the overall market?

PM: Well it starts with the portfolio that you hold. And with buy and hold – I’m very similar, I think, to what you guys do – and that is, in my own portfolio, I’ve got big and small, and value and growth, and U.S. and international, and REITs and emerging markets. All great asset classes. And I never know when they’re going to catch on fire, or when they’re going to be in the doghouse. That’s the nature of a diversified portfolio. I do the same thing with timing. My portfolio is a combination of all those same kind of assets, certainly not with DFA funds, because they wouldn’t allow that to be done with their funds. So I’ve got huge diversification, and then, I may have as many as 100 different ETFs or no-load mutual funds, each one being tracked with a trend-following, moving-average kind of a system, that is completely mechanical, completely unemotional. And because they’re not great all the time, they drive people nuts.

AC: So a couple of years ago Paul, you wrote an article and talked about mechanical market timing, but you also said, “the bad news is it doesn’t work for most investors.” And why is that? Well I guess first of all, what is it. And then second, why doesn’t it work?

PM: Well the reason that it doesn’t work, almost any market timing system, by the way, is because they come in with the wrong expectations. They think that market timing is going to make more money than buy and hold. It is not designed to make more money than buy and hold, I’ll tell you how you can do it in a second. But the basic timing and approach means that if you are getting in and out of the market, and you’re going to cash part of the time, and you’re in equities part of the time, you’re going to reduce the risk. Most people think timing increases the risk, it doesn’t, it reduces the amount of time you’re in the market. But when a market is going up, you are not going to be able to catch that wave and stay on that wave, because timing is going to kick you out of the market sometimes. And then you got to get back in at a price higher than your last got out. Yeah, people really like that. (laughs) And then you have two or three trades in a row on a particular asset class and they’re losing trades. It’s a lot of pain that most people can’t take because there is no actual evidence that all this work with timing will work out. It doesn’t have the same long-term trend that buy and hold does. So you might have 10 different market timing systems, and it may be that four of them do OK, and six of them don’t. Now with buying hold, I don’t care whether maybe some people have U.S. only and some international only, and all big, or all small, or whatever it is – probably almost every one of those buy and hold systems, if you want to call it that, is going to work in the long term. But the timer, it’s all about a pattern. And we don’t know what kind of pattern we’re going to have. Will they be short ups and downs? Long ups and downs? Will they be faking you out and kicking you out and then you’ve gotta get back in? You just don’t know. So you’ve got to believe if you’re going to use trend-following market timing, that what you’re defending against is what happened to me in 1987, a month before the market crash. I was in cash. I did not call that bear market, that big 22% one-day decline. I didn’t call it. The system had simply kicked me out. And when I was out, I made money while others were losing. But Dick Fabian, he had money under management that didn’t get out until the next week after that one-day crash. By the way, I’m not picking on him. If he did what his system said to do, what you’d find out is his system was slower than my system. So some systems are very slow. Some are more responsive to market turns. There is a lot to know. And the fact is, when it’s not working, people give up hope. And the other thing that drives me nuts is people say in market timing doesn’t work. But when I look carefully, they’re all using what I call ICSIA – the “I Can’t Stand It Anymore” timing system – and I don’t think that works! And that’s the way that most people time.

For a transcript of this podcast and to catch up on episodes you may have missed, visit YourMoneyYourWealth.com. While you’re there, you can access white papers, articles, webinars and hundreds of video clips on tax planning, investing, retirement planning, Social Security, estate planning, small business strategies and more in our Learning Center. Plus, we’ve got clips and full episodes of the Your Money, Your Wealth TV show, in case you’re just dying to see what Joe and Big Al look like. Get up to speed on just about every money topic that affects you, and subscribe to the podcast – it’s all at YourMoneyYourWealth.com.

15:46 – Paul Merriman: When It Comes To Money, Most of Us Are Nuts

JA: Joe Anderson here, Certified Financial Planner with Alan Clopine, he’s a CPA. Thanks a lot for tuning in. We’re talking to the great Paul Merriman. He’s nationally recognized authority on mutual funds, index funds, asset allocation. Check out PaulMerriman.com. You know Paul, I think that the key component of this is that you’re buying into a certain system, and you’re buying into the risk. And I think that has to do with any type of portfolio construction. Let’s say if you have a well-diversified portfolio that’s tilted towards small and value, such as our portfolios here, and some of your portfolios. And if value is having a 3, 4, 5 year stint where it’s not necessarily outperforming growth as the long-term history will tell you it should, people will give up on that particular strategy at the absolute worst time. And I think it’s true with timing. If if I have a market system that I’m following on, you’re right people will cheat it. The emotion will come into play. The system will tell you one thing, but then your intuition or your gut feeling might tell you another thing. So you’ll cheat the system. And I think that’s why most market timers don’t necessarily perform is just because it’s human nature to get the hell out of the way when a train is coming at you. And so you might not believe the system in certain areas of the overall market. So you have to be 100% totally bought into the system, and check your emotions, I guess, at the door.

PM: Totally, totally. And the reality is that most people on their own won’t do it. And you’re right. Intuition wants to say, “hey wait a minute, what does this mechanical system know about what’s going on in Korea or what or what’s going on in the Middle East or what’s going on in the economy? What does it know?” And so you start overriding your system with your “common sense,” which is nonsense, by the way. And I don’t use any of that in my buy and hold either. I think you’ve just gotta let all that noise out of your life if you’re going to be a buy and holder, or if you’re going to be a mechanical timer.

JA: Well I mean the whole behavior of finance has now such a play. I like your article that you wrote for MarketWatch, “This is What Investors Should Really be Afraid of.” You get into Zweig’s book and there are so many interesting tidbits when you look at how the behavioral aspect of investing is. For no reason at all, there was this company, what, “Computer Literacy” rose 33% in just one day because they changed their name to FatBrain.com. (laughs) Stories like this are hilarious. There’s no academic reason for it. It’s just we’re not equipped emotionally, I think, to deal with money. Because we’re twice as fearful to lose a dollar than we are to gain a dollar. But there’s still that greed factor involved too.

PM: Let’s take it one more step. The poor people who are buying actively managed funds. What they don’t realize – they know that they’re in a little bit crazy and have found themselves as an investor to do things that were emotion-based rather than intellectually-based. Well guess what? So do professional managers allow their emotions to become part of the decision making process. So what you have is probably a position in a very fine asset class, but that asset class is being fooled with by the amateur, and by the professional. And so you have two forces that are both, on their own, damning historically, but you’re trying to take two wrongs and make a right? I don’t think so.

JA: (laughs) Well said.

AC: I think that’s a good point. And so Paul, what you’re talking about, buy and hold is a great strategy, and timing can be, but it’s hard to implement. So what should the average investor do, in your opinion?

PM: I think it’s dirt simple. I think you have somebody help you if you can do it yourself, or you have somebody check you if you’ve done it yourself to make sure you do know the rate of return you need, and you need to know your risk tolerance and all those kinds of things, that help yourself or somebody else understand who you are. And then you put together a portfolio that addresses, within your personal limitations, built to create that return and to address that risk tolerance, and you keep your hands off. And if you have the ability to rebalance your portfolio on your own – and interestingly, as easy as that is, so few people do it – and you let somebody do that for you if you can’t do it yourself. But I think that that being a successful investor has absolutely never been simpler than today. We have low-cost index funds. We have massively diversified funds that all the evidence leads us to believe that you’ll make more with more diversification, rather than less with more diversification. And today, an investor can create this massively diversified portfolio with a thousand dollars. You could do with a thousand dollars today, what it would have taken, when I went into the business in the mid-60s, it would’ve taken a million dollars to recreate what you can do for a thousand today. And the problems – and you guys just mentioned it – it’s the person you look at in the mirror when you get up in the morning. And you haven’t read Jason Zweig’s, “Your Money and Your Brain,” make that the first next book you read, because it is filled with all the evidence that any of us should know that when it comes to money, most of us are nuts.

AC: Yeah. And I think sometimes when people hear this, “OK, I’m diversified,” and they buy four different S&P 500 funds and think, “OK I’ve got it.”

PM: I want to just leave one little piece of time the people would just look at it because we’re all worried that we’re going to get into something and about the time we need it to do something good for us, it does something bad to us. And I just want people to know, who are sitting on just the S&P 500, that for the 10 years from 2000 to 2009, it basically lost 1% a year. Now, what does that do to somebody who was using the S&P 500 only during that period of time to start their retirement? On the other hand, a portfolio big and small and value and growth and U.S. and international et cetera, that compounded at about 7 to 9%, depending on how you constructed that portfolio. That’s with more diversification, not less.

JA: Paul tell us., we got a few minutes left here – well first of all, are you in Seattle or are you in Mexico?

PM: I’m on Bainbridge Island actually, that’s where we live.

JA: But don’t you spend the winters in Mexico?

PM: Not this year – next January, February, March. I’ll be down there with my Virgin margarita. (laughs) Yeah, I’ll be there. On a diet losing weight, of course.

AC: Yeah of course. I was just in Cabo San Lucas celebrating our 30th wedding anniversary and cervezas is what we had. Or at least that’s what I had. (laughs)

PM: Yeah, nice.  (laughs)

JA: A couple of resources – I saw that you’re doing some work with M1 Finance, which I’m a fan of. Just to piggyback a little bit about what you said is that now a smaller investor could get a globally diversified portfolio with just a few dollars.

PM: A hundred dollars. And you know what we’ve done there, to try to help young investors: we’ve created target date portfolios. They’re not target date funds, but they’re a portfolio made up of other funds, just like Vanguard’s target date fund is a fund made up of other funds. But it’s built with the kind of stuff you’d like. Lots of small-cap and value in the early years. We even had one of our target date funds that’s 2085, for the child whose being born today. Don’t wait. Get them started right now. And as you know, that’s a commission-free environment, and for 100 bucks and commission-free, it’s a great way to get started.

JA: Tell our listeners a couple of more resources where they can go to to get a little bit more education and information from the great Paul Merriman.

PM: Well, on our Web site we have over I think about 300 articles. Another 300 podcasts. And we have portfolios at Vanguard, Fidelity, T. Rowe Price, Schwab, free portfolios for people to track. We have 401(k) plans. I think we’re up to about 140 401(k) plans that I’ve analyzed and put up my recommendations. And you might have some listeners who take a look at the companies that we’ve done that for, and if they work for a big company and their company is not up there, they just email Paul@PaulMerriman.com and say, “Look Paul, I don’t want you taking off any time this weekend until you get done with this 401(k) plan!” And then I’m going to have my wife call them. (laughs)

JA: So folks, check our Paul online at PaulMerriman.com. There’s a ton of great resources on that if you are just a novice starting to figure out exactly where to find an advisor if you wanted to hire one. “How Not to Get Screwed in this Industry” is one of your books, Paul. Or just figuring out, “hey, I’ve got a 401(k) plan, how should I allocate this,” or “I want to construct my own portfolio,” or if you want to go to M1 Finance. There’s a ton of really good information. Check it out, PaulMerriman.com. Paul, it’s always a great pleasure to have you on. I know you’re a busy guy. You’re probably working harder in retirement than you ever had when you were working.

PM: By far, and it’s great to work with you. Thanks for the opportunity.

So how do you know if you should buy and hold, or if you’re capable of successfully timing the market? Making informed investing decisions actually requires a bit more than listening to Your Money, Your Wealth®. If you’re in Southern California or you’re planning to visit soon, you can learn from our team in person at our two-day retirement courses, or at our free monthly Lunch ‘n’ Learn events. All of our classes are designed to give you the tools and confidence you need to help you plan the retirement you’ve always dreamed of, in spite of market volatility. For dates, times and locations for our Lunch ‘n’ Learn events and retirement classes in San Diego, Orange County or Los Angeles, just visit The Learning Center at YourMoneyYourWealth.com or call (888) 994-6257. That’s (888) 994-6257.

27:24 – Non-Deductible IRA, Roth IRA, SEP IRA, Backdoor Roth Conversions and the Pro-Rata Rule

JA: We’re way behind on a lot of different e-mails, so let’s just get to work. This is from Mac. His question starts, “when doing a backdoor Roth conversion for my personal IRA, will my 401(k) IRA, or after-tax dollars, or my spouse SEP IRA, come under the pro-rata rule?” So let me translate that. I think he’s a little confused. He’s like, “when I’m doing a Backdoor Roth conversion for my personal IRA” – so he’s got an IRA he wants to do a back door, he did an IRA contribution and he wants to convert it. “Will my 401(k) after-tax dollars, or my spouse’s SSEP-IRAcome under the pro-rata rule? Also, after the backdoor conversion, if I make a traditional IRA contribution this year, will I have to convert that as well, since it’s the same calendar year? Or if I wait, after X amount of days to make the contribution it will be excluded from the pro-rata rule?” So what’s say you? So he’s just basically asking some in-depth questions on how the whole backdoor Roth works.

AC: Yeah, let’s start with how it works.

JA: I think one of the things – we did a white paper on backdoor Roth IRAs, so if you want more information on that, you can just go to purefinancial.com. It will tell you all the pros and cons and everything that you need to do within that. But we’ll just break it down.

AC: Yeah we’ll just kind of go in summary now. So here’s the idea, is that once your income is too high. Married couple, it’s $199,000 for 2018. Single is $135,000 ish, somewhere in there? When you’re over those amounts, you can no longer do a Roth contribution. That’s $5500 per person, an extra one thousand dollars if you’re 50 and older, so $6500 if you’re 50 and older, but if your income is too high, you cannot do a direct Roth contribution. However, you can always do an IRA contribution, as long as you’re under 70 and a half years of age and you have earned income. And so what a lot of people do is, they go ahead and do that IRA contribution, and their income may be too high to actually take a deduction. So it’s what we call a non-deductible IRA contribution. And then you turn around and convert that IRA into a Roth, and because you never got a tax deduction, then you don’t have to pay tax on the conversion. So it’s a kind of a sneaky way to do a Roth contribution if your income is too high to kind of get around the rules. But Joe, there are some limitations which he’s kind of alluding to.

JA: Yeah, there’s a pro-rata and aggregation rule. Pro-rata and aggregation rule, all that means is that they aggregate all your different IRAs together. So if you do not have any other IRAs, and you put in $6500 if you’re over 50 into a Traditional IRA, the only limitations to putting money into an IRA is that you have to be under 70 and a half, and you have to have earned income. Those two things. So if you’re under 70 and a half and you have earned income, you can put $5500 in or $6500 if you’re over 50. Now, if I make over the income limitations, as Big Al just alluded to, then I cannot take a deduction – it’s called an after-tax contribution. So if I do not have any other IRAs, I can convert that, because 100% of my contribution is after tax. However, if I put in the $5500 and I have $105,000 into a retirement account, well roughly five percent of my IRA – so I have two different IRAs, one’s $100,000 the other one’s $5000. $5000 is  after tax, $100,000 is pre-tax, $105,000 total in IRAs. So to keep the math simple it’s just like OK well roughly 5% of my total IRAs is after tax, 95% is pre-tax. So if I did a conversion, well then 5% of the conversion, no matter what dollars I converted, would be after tax, 95% would be pre-tax. So the aggregation rules mean everything is going to be included. The pro-rata rule is to look at how much is pre-tax versus after tax, and they do that percentage when you do the conversion.

AC: Yeah, and it doesn’t matter – you can have ten different IRAs, they add all the IRAs together as if they were a single account. So that’s the problem. If you have other IRAs, this is difficult to do effectively. Now interestingly enough, they do not count your 401(k). Or your 403(b) or other types of employer pension plans. So you might have a million dollars in a 401(k) and no IRA money. You can go ahead and do this. You’re still OK to do it.

JA: And it wouldn’t matter if your spouse has IRAs. So let’s say your spouse has many different IRAs, you don’t have any IRAs. You can still do the backdoor. They’re not going to look at a couple. Sometimes people think it’s a joint account. Well yeah, well maybe if you pass, your spouse will inherit it, or if you get a divorce, they’ll take half of it. But it’s still a separate account. So the IRS will still look at it separately in this instance, if you’re saying, “hey, I want to take an after-tax contribution and convert it,” that’s fine. They’re not going to look at the spouse’s.

AC: Yeah, that’s correct. And a little more detail is, your IRAs count if you have a SEP IRA, it counts, if you have a simple IRA, it counts.

JA: If it has IRA in the name it counts. (laughs)

AC: Just think of it that way – if it’s your account and it has IRA in it, it counts for this aggregation.

JA: Right. But 401(k) – doesn’t pass the rule, there was no “IRA” in “401(k).”

AC: And we’ve seen this mistake Joe, is people have no IRAs, they go ahead and do this strategy that we just mentioned, then they retire from their job and they roll their 401(k) to an IRA in the same tax year – that blows the whole thing. Because they look at your total IRA balances at year end, not at the time where you do this backdoor Roth conversion.

JA: So going back to the second part of the question: I have an after-tax contribution. Let’s say I make that for last year, I’m holding it in my overall account. I want to convert it, but then I make another IRA contribution. They’re going to take a look at the balance at 12/31. So the balance of 12/31 is going to be like, I have $5500 after tax. If you made another IRA contribution, let’s say, but you wanted that to be pre-tax? Well, then you got $11,000 in a retirement account. Well, then only 50% of your backdoor conversion is going to be tax-free because you just doubled up. If you were going to convert both of them, it doesn’t really matter.

AC: Yeah that’s right. And another thing is, when you do this backdoor Roth contribution, we’ll call it – you do the IRA contribution first. You can do that conversion virtually any time you want. Now we recommend that you wait a little while so that it’s not done simultaneously. So there’s some seasoning. Different advisors might say different things on that, but you can certainly do the conversion in the same year, you can do it the following year, you could do it ten years later, it doesn’t really matter when the conversion is.

JA: But you have to file the 8606 form, which is an IRS form that then tells the IRS that you do have basis, or after-tax dollars that are sitting in the overall account, and then also, when you do conversions that form is also needed. So a few things there. Follow up question from a different listener, our good friend Bob. Bob was like, “Hey Joe, I have a question about rolling money from a non-deductible IRA into a Roth IRA. I was thinking of opening a non-deductible IRA because I don’t qualify for a traditional IRA due to income limitations. I already have a SEP IRA with about $50K in the account. If I open the non-deductible IRA and directly convert that money into a Roth IRA will there be issue (pro-rata) with the SEP IRA? The SEP and the non-deductible IRAs are with different companies. Thanks for your help.”

AC: Yes. The answer is yes. You have an issue there, because again we’ll go back to what we just talked about – if it has the name IRA in your account and it’s your account, not your spouse’s, then that’s going to count in the pro-rata rule. So the whole $50,000 SEP, which is probably pre-tax, will be included in this backdoor Roth. And if you put $5,000 into a non-deductible IRA, then it’s a simple calculation of $5,000 divided by $55,000, which is somewhere around 10%. So somewhere around 10% of your conversion would be tax-free, 90% would be taxable.

JA: So Bob, here’s what you do. Here’s the solution to your problem. You take your SEP IRA and you move that into a solo 401(k) plan. Assuming you still have the business and assuming you don’t have any employees. But if he’s got $50,000 in the SEP, I’m guessing that it’s a small business, a little side gig. But if you do not have any other 401(k) plans if you are a sole proprietor, or you’re a single operator of your business, and you still have the business, move the SEP into a solo 401(k) plan, the solo 401(k) plan then is excluded from the pro-rata rule, because it does not have IRA in it, so it’s 401(k). So that would help the cause there.

AC: But do realize, let’s just say it was a side business, and let’s say he also was employed with a 401(k), in future, you can’t double up on 401(k) contributions. It would be $18,500 total or $24,500 total if you’re 50 and older.

JA: Good point. So if I worked for a company, a large company, General Dynamics, has a 401(k) plan, I’m putting my money into that, but then I have a small consulting business and I have a few clients on the side. And it’s like, “let me set up another solo 401(k) plan?” You couldn’t double up on it. You could set up a SEP plan within that, and the maximum defined contribution limit for a strategy like that is around $54,000 in a given year. So you can put more money into defined contribution plans, but you just can’t have two 401(k) plans.

AC: Yes. And one more caveat with the SEP: $54,000 would be the upper limit. But it’s also limited to 20% of your income. So you’d have to have a couple of hundred thousand dollars of income, or 250, to make this work.

JA: I’m sure Bob does.

AC: I’m sure Bob does.

JA: Bob’s a player. He’s out there. He’s hustling. Let’s see. Yeah, we got time for one more, what the hell.

38:10 – OK. Well, this is from Elaine. She’s a TV show fan. “After watching your show, I thought you would be the perfect person to answer my question.” Well, thank you, Elaine.

AC: Is it to you or me?

JA: Info.

AC: Info, so either. (laughs)

JA: All right, you’re answering the question. “I am a substitute teacher with STRS and Social Security. Is there a way I can collect both?”

AC: I’ll let you answer that.

JA: See I knew it. (laughs)

AC: Because I saw that question, I would muddle through that – you’re better at that.

JA: She goes, “I would be willing to collect one after the other runs out.” Well, that would be nice Elaine, if it worked that way. But it doesn’t. And so you’re a substitute teacher in CalSTRS, the State Teachers Retirement System, and you’re also in Social Security. So I would also double check to see how many years of service that you have in Social Security, and how many years that you have in CalSTRS. If you’re a substitute teacher, how much are you putting in, how much money are you making, what is the income? So there are more questions that I would like to dig into a little bit more to give you a better response to this, but here’s how it works is that they’re going to take a look at, how many years of service that you have in Social Security, versus how many years that you have in CalSTRS. Because when you are contributing into CalSTRS, you’re not putting into the Social Security Administration anymore, you’re just putting everything into the state teacher’s retirement. And so there’s something that’s called the Windfall Elimination Provision, which I guess Social Security came up with so you don’t double dip, or have this big windfall. So if you have this pension, and you have Social Security, it’s going to be dependent upon how many years that you have in Social Security versus STRs, and to help you with that calculation, you can go to SSA.gov and type in Windfall Elimination Provision, and you can put in your numbers, and it will tell you what happens – but you will receive both. It’s not like they’re going to pay you Social Security, that runs out, then they’re going to pay you CalSTRS or vice versa. It’s going to be two payments from both of those organizations, and they will pay for the rest of your life. Your Social Security benefit will probably be reduced, just because you’re getting also a CalSTRS pension. But with the information you gave us that’s the best I can do. All right, that’s it for us. For Big Al Clopine, I’m Joe Anderson. The show is called Your Money, Your Wealth – thanks for listening.


So, to recap today’s show: wait, are you actually listening to the recap? I didn’t think so. Let’s get right to the thanks and disclosures. Special thanks to our guest, Paul Merriman. For more of his wit, wisdom, and insight on investing, visit PaulMerriman.com

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