Transcript Episode 134: The Roth IRA

Listen to this Podcast

In this Episode:

• Roth IRAs
• What will the future be like from a tax standpoint?
• Inheriting a Roth IRA
• The Contributing 5-year rule
• The Converting 5-year rule
• With the 5-year rule, there’s no tax on the gain.
• At age 72, no required minimum distribution.
  and you don’t have to take the money out.
• Leave it to the next generation, and they’ll get it tax free.
• Distributions: contributions first, conversions second, gains third.

Narrator

This is Retire South Shore Radio, a weekly program designed to educate you on all your retirement options and introduce you to Mark Rowlette, founder of South Shore Retirement Services for the latest on free seminars. To obtain a report or to set up a consultation, please visit RetireSouthShore.com – Retirement Services and real-world retirement solutions. Looking at the whole picture to design a complete strategy, including retirement planning, Medicare decisions, and legal documents. Now, here’s Mark Rowlette, and your host, Jordan Rich.

Host Jordan Rich

Hello, and welcome once again to another edition of Retire South Shore Radio. I am Jordan, great to be with you and great to be with our good friend Mark Rowlette, who assembles his team, the All Hands Analysis team at South Shore Retirement Services, helping people every single day with a great track record of success. And these days Mark, you need to be reassuring because as you meet people, and just met a bunch of them in seminars these last two weeks, people are concerned and rightfully so.

Mark Rowlette

From my perspective, you remember when you were little and summer was over and you were back to school? Well, similar things happen when you’re in my line of work. In summertime, people maybe are taking a little bit of a hiatus. But come September, we’re right back into it. And last week, I think we did at least one webinar and three seminars. And it was just an overwhelming majority of people that I met with over the course of the last few days, that were obviously concerned about everything that’s going on. We saw what happened in the Market last week. It was pretty nerve racking for a lot of folks, the Market having a huge drop in one particular day. And they’re also concerned about what the future is going to be like from a tax standpoint, whether it’s a potential tax increase, or what I would think is an inevitable tax increase.

A lot of people are kind of wisely looking at trying to optimize what they have now, meaning that optimize low tax rates that are out there right now and what to do, and not that this is the greatest thing since sliced bread. But in the right situation, the proper use of a Roth IRA, which I want to talk about a bit today, can have a really big impact on what you’re going to put in your pocket ultimately.

Host Jordan Rich

We’re going to talk about the Roth in various aspects. All I can say is kudos to the government for putting it into place when they did many, many years ago (1997), because it has been an outstanding vehicle. But it does have many, many uses. And there are many questions that our listeners have about converting and about required minimum distributions, things like that. So we’re going to do a primer. Don’t worry, folks, it’s nothing, that will “make your hair hurt.” Mark is very clear and concise. But give us your sense of where we are with Roth, and let’s do the overview.

Mark Rowlette

I want to talk about the basics, and then maybe go into a little bit more slightly complicated ways of utilizing the current tax codes that we have. And you know, and we say this the beginning middle end of every show, I can’t give tax advice. We just build tax strategies for folks. And we can quarterback with their CPAs. Or we can have our CPAs help them actually do the filings if they want.

But I want to talk about, you know, ways of utilizing these accounts where you’re still able to avoid any penalties, that you potentially could withdraw the money right away if you want to, and what to do, like if you inherit a Roth IRA, the rules around that, because that’s a little bit foggy as well.

And I thought, if we start with the basics, right, understand the difference between a traditional IRA and a Roth IRA and what the two of them are.

Traditional IRA
Very simply, a traditional IRA is an account that you can put money into to a certain limit, and you get a tax deduction for the money going in. The money then grows tax deferred, so any growth in it is not taxed on an annual basis. It’s taxed when you pull the money out. And there’s certain government rules around traditional IRAs, where you have to be 59^1/2 to take money out of it with one exception of using certain tax code. And you have to start taking money out of it at 72.

Roth IRA
A Roth IRA is different. In a Roth IRA, when you put money into the plan, you don’t get a tax deduction. It’s after-tax money you’re putting into the plan. It grows tax deferred, and then when you take the money out, the money that you put in and the gain (assuming that you hit this magical five-year rule) is tax free. You’ll never pay tax on that money when you make distributions if you follow those rules, which I’m going to talk about today.

Host Jordan Rich

Yeah, we’ll get into more detail when that occurs. But the people you deal with on a regular basis, clients and people who have inquiries, so many of us have these vehicles. It’s a very popular savings device, isn’t it?

Mark Rowlette

Yeah, I think it’s probably one of the best wrappers around any sort of investment. It doesn’t matter what you put the money into, whether it’s the CD and annuity and mutual fund, the stock, it doesn’t matter. It’s the wrapper around it.

It’s the tax qualification being Roth, where that growth inside of that account, once you stick within the guidelines of the rules, is tax free to you when you distribute it, which is really nice for a lot of people. Because if you think about it, taxes are very low.

Right now, I think we’re all in agreement on that the highest marginal tax bracket is 37%, which is probably as low as it’s been in about 15 years. So taking the tax deduction now might not make sense. Using a Roth IRA, getting the taxes done, putting that money into that account. Then when you do need to take the money out, it doesn’t really matter what the taxes are doing at that stage. If taxes are twice as much as they are now, you’re not paying any tax on the distribution.

However, there are some significant limitations to Roth IRAs, in that you could only put a certain amount of money in, you know, around $6,000. And if you’re over a certain age, you can do a catch up with that $7,000 total you can put into it. They are talking about increasing that, but they’ve not done it yet. Also, once you start earning over a certain amount of money, then you’re not allowed to contribute to a Roth IRA.

And then once you retire, (a lot of our clients are retired and they don’t have any earned income), you cannot contribute to a Roth IRA. So those are the limitations.

However, there are ways and tax codes that former President George W put in place, that allow you to re-characterize some of your existing IRA money, which we do a lot with our clients, and re-characterize it to a Roth IRA. And there aren’t limitations on that currently.

Host Jordan Rich

You’re listening to Retire South Shore Radio. I want to remind you, it’s easy to arrange. It’s a quick way to get information. And it offers help to questions you’ve been having, and particularly questions about where we are right now. It’s the 15-Minute No Obligation Strategy Call.  Easy to set up, go to RetireSouthShore.com. And you do yourself a favor by taking advantage of this opportunity. So let’s get into more of the depth and detail here.

You talked about withdrawals of money, 59-and-a-half and some of the limitations and so forth. But most people in retirement age, we’re going to say post 59, maybe post 65. We see the 70s looming, and that’s an important age bracket for this kind of withdrawal information. Give us a bit more.

Mark Rowlette

Most of our clients are over 59 ½. We do have a number of clients that are not 59 ½. So once you hit 59 ½, you can make distributions from a Roth IRA, and there are no penalties associated with it. If you hit that 5-year rule, there’s no tax on the gain.

When you get to that 72 age, the required minimum distribution age, though there is no required minimum distribution from a Roth IRA, you don’t have to take the money out.

So a lot of our clients, want to leave money to their children or their grandchildren, but they’re not 100% sure if they’re going to need the money themselves. So it’s a nice wait-and-see approach of leaving a legacy right? You may need the money. And if you need it, it’s sitting there in your name, and you can distribute it tax free. If you don’t need the money, you can leave it to the next generation. And they’ll also get it tax free.

I’ll elaborate on that in a minute as to how they could structure their Roth IRA as an inherited Roth IRA.

The 5-Year Rule

But I want to talk about the 5-year rule just to clarify this. There are a couple of 5-year rules that apply to Roth IRAs.

There’s a contributing 5-year rule, and a converting 5-year rule.
I’ll get into more detail on what conversions are in a second.

The contributing 5-year rule is it’s five years from the point in time that you started contributing to a Roth IRA. If you’re making contributions into it. Conversions, when you are re-characterizing some of your traditional IRA to a Roth IRA, is five years from each time that you make a conversion.

So essentially, how Roths work, when you take distributions from them, is contributions first, conversions second, gains third.

For a lot of our clients, when they’re doing the conversions at first blush, they’re like, “Well, what if I need the money immediately?” Well, if you’re over 59½, you can take that money immediately. And it quite honestly, if you needed the money immediately, you wouldn’t be doing Roth conversions, you’d be taking the distribution to spend it, right?

So it works fine for most of the people that we talk to. And I don’t mean that this is the be-all-and-end-all or every single person should do this. You should seek advice. You should sit down and figure out what the best strategy is for you. This is just one concept that works quite well if it fits in your overall retirement.

Host Jordan Rich
… Which leads to the very oft-used phrase, “balanced portfolio”, planning ahead and building your future. Anytime you want to think about diversifying and having things in different places, perhaps as a safety measure?

Mark Rowlette
That brings up a really good point. Because when people think of a balanced portfolio, most of the time, people are thinking of “oh, well, I have a nice balance of stocks and bonds”.

We look at balanced portfolios from the perspective of not only how your monies position from an investment standpoint, but also the tax qualifications of your money.

So if you have some traditional IRA, some Roth IRA, some brokerage account, some money in the bank, some money and savings, and CDs, and so forth.

But with their different tax qualifications, you can chip away at each of those accounts on an annual basis to try and minimize your lifetime tax bill. This gives you more control over how much taxes you’re going to have to pay in retirement.

Most people that we work with, while they’re working their W-2, don’t really have control over what their tax bracket is going to be. So if you prepare ahead of time, you have much more control over what you’re going to pay, when you’re going to pay, and ultimately how much money you’re going to leave in your pocket.

Host Jordan Rich
I can’t believe we’ve gone this long in the program without the “B” word mentioned, the buckets. You know, you’re thinking it.

Mark Rowlette
I was doing a presentation last week, and I must have said “buckets” a million times. I figured if you were in college, it’d be great drinking game every time Mark says that.

I just think that’s the way people should be thinking about positioning their money.

And in too many people, as they get closer to retirement, their brokers are saying, let’s just get more and more and more conservative with all of the money. And if that’s comfortable for you, we’ll have at it, but we look at it from the perspective of, you grow your money for 20, 30, 40 years, make contributions, put away what you can, and then you retire.

And let’s say you retire on a Friday, and on a Monday, you don’t need 100% of your money that day. If you didn’t save enough money, and if you need it all that first year, unfortunately, you didn’t save enough.

But for most folks, they’ve saved money, they have Social Security, they may have a pension plan, and they need some money from their pool, from their life savings, from their nest egg.

But we try to “bucket things out” and position the money that you need today to be extremely conservative, if not cash, if not savings accounts. And then as you go out further and realistically look at it. “Well, some of the money I don’t need till next year, five years, 10 years, 15 years,” so on and so forth.

With the money that you don’t need for a longer period of time, make that money work harder. It doesn’t mean tie it up. It doesn’t mean it’s not available to you. But if you have all your eggs in one basket, and that basket has a hole in it, and money goes down because the market drops, well, you probably still need the income, but now you’re drawing the income you need from an account that’s losing value.

That, to me, is the kiss of death – taking $3,000 a month from an account when maybe that $3,000 distribution was worth $3,300 a week ago. Well, you just lost that $300 You realize that loss and you’ll never get that money back. The pressure that you put on your money if you’re distributing income needs on a monthly basis from an account that’s losing value can have a detrimental impact to you actually having enough money. And sure, that’s what everyone wants, whether your number is $2,000 or $22,000. Nobody wants to have to worry about running out of money. Everyone wants to know they’re going to be okay. So, by using buckets and segmenting money out, if an account loses value (because you still will be in the Market with that account) you just don’t take a distribution from that bucket.

Host Jordan Rich
Roth IRA information continues after this break along with other important issues to help you gain confidence in retirement. We’ll be right back.

[Begin Pre-recorded message]

When it comes to making key decisions about your retirement education is so important. So you’re invited to Register now for an upcoming free seminar on taxes in retirement sponsored by the All Hands Analysis team at South Shore Retirement Services. A host of taxes and retirement seminars are upcoming September 20 at the Mirbeau Inn and Spa in Plymouth that starts at 6pm. Then on September 27, and 29th. Each of these will take place at Davio’s Italian Steakhouse in Braintree at the South Shore Plaza. And these two are again at 6pm. Very convenient and accessible locations. Plenty of free parking and refreshments are served. And you’ll have an opportunity to meet representatives from South Shore Retirement Services and learn more about such a key issue – taxes in retirement. Register now online at RetireSouthShore.com.

Narrator
You can’t get a second opinion from the person who gave you the first. That’s especially true when it comes to your retirement. You deserve sound advice from qualified professionals. And that’s what the All Hands Analysis team at South Shore Retirement Services is all about. Here’s Mark Rowlette, founder and president of South Shore Retirement Services.

Mark Rowlette

Nobody should have to worry about running out of money in retirement. Our approach is simple. Build a strategy that can give you consistent income while allowing your money to grow. While times are good, consistent returns are critically important during your retirement. But I would argue that tax management and tax strategy is equally as important. It’s not just about reducing your tax bill this year. It’s about minimizing and being smart with your total lifetime tax bill, and that takes preparation.

Host Jordan Rich

Schedule your FREE 15-Minute Strategy Call today. Visit RetireSouthShore.com
That’s RetireSouthShore.com. Investment advisory services made available through Wealth Management LLC, AEWM. AEWM and Seltzer Retirement Services are not affiliated companies.

[End pre-recorded message]

Host Jordan Rich

Hello, this is RetireSouthShore Radio. I’m Jordan rich with Mark Rowlette, the founder and president of South Shore Retirement Services, a beautiful office in Hingham, Massachusetts. But with clients from all over with the ease of communication these days, it’s really a snap and Mark’s helping a lot of people as is the All Hands Analysis team. And we’ve been talking about Roth IRAs and the benefits and some of the things to be aware of. Now, what about the Roth conversion process? That’s an important issue.

Mark Rowlette

As I mentioned before the break, there are a lot of limitations to contributing to a Roth IRA. You’re only allowed put a certain amount of money in. Once you start earning over a certain dollar figure, you cannot use Roth IRA anymore. And then when you stop working entirely, you’re not allowed to contribute.

But Roth conversions are different.

Where you already have existing IRA money, you can take a portion or all of that money, and converted re-characterize it to a Roth IRA.

And there are no limitations to that at all. You can be making a million dollars a month, you can not be working at all, you can be under 59 ½, (you got to watch out for that if you’re under 59½) and still convert from a traditional IRA to a Roth IRA.

Why would you want to do something like that?

Well, for example, you’re in the 22% federal tax bracket, but you have $20,000 in that tax bracket before you go into the next tax band … well, maybe you want to utilize that. Taxes are really low right now, and I think the general consensus is that taxes are going to go up in the future.

So take advantage of an account that inevitably is going to be taxed at probably the lowest tax rates that we’re going to see for the next decade or so, and re-characterize that money over into the Roth IRA.

The reason I mentioned you have to be careful if you’re under 59½ is that if you use the money you’re converting from a traditional IRA to a Roth IRA, and you take the taxes that you have to pay, (because you still have to pay the taxes on it from that IRA) that’s a premature distribution, right? If you’re under 59½.

So, to a lot of the clients, even when they’re over 59½, we say to them, “Listen, you’ve got money sitting in the bank, you’ve got cash savings, whatever it might be, let’s use that money to pay the taxes on the re-characterization. So we can push more money into the Roth IRA.”  So if you’re under 59½, you can do the same thing.

Another huge advantage of doing something like that, especially in light of what’s going on in the Market right now is, if the Market is down, and you’re re-characterizing some of your IRA money over to a Roth IRA, you don’t have to sell the holding. You just move it in kind.

Hypothetically, let’s say you are that person who’s going to convert $20,000 a year. Let’s say you build a strategy over the next five years, $20,000 a year of your IRA money… let’s just take it a step further… and hypothetically say your IRA is all invested in one stock just because it’s easier to explain. And whatever that stock is X, Y and Z company. You love the company, it’s a solid company, the people who are helping you with your money say it’s a solid company. But because of the Market, it drops. Let’s say, as an extreme example, it drops by 50%. So now your stock has gone down by 50%, which means your account has gone down by 50%.

It doesn’t mean that you want to necessarily sell it because you believe that it’s going to come back in the future, while you’re still only able to convert that $20,000 In your tax band. But now that $20,000 represents twice as many shares in that company. So you characterize it essentially at a 50% discount, and then write it back up in the Roth IRA completely.

Host Jordan Rich

I hope people are really paying attention to what you just said. I thought that was something that really opened my eyes – what you just talked about, and the strategies that are involved in shifting and converting. But knowing that this has long term consequences – in this case positive consequences, doesn’t look positive on the outside, but it does have possibilities on the inside.

Mark Rowlette

Yes, absolutely. I say this week in and week out on the show, and in webinars, seminars and meetings with people who are new to the office who haven’t become clients yet.

I say, listen, whoever you’re paying to help you with your money (and you’re paying someone right?) – whether you have a financial advisor, whether you have a broker, whether you went directly to the company, whether your money’s sitting just in the bank, somebody is getting paid for that money to be positioned there. Even if you have it in a checking account, if you think about it, you put it in the checking account you’re making next to no interest, you know, the bank is lending that money out. So they’re getting paid on it.

Whoever’s helping you with your money, they should be proactively reaching out to you, not you reaching out to them saying, “what do we do?” They should be reaching out to you saying, “This is what I think is the best strategy.” And that’s what we do with our clients.

So Roth conversions are part of the conversation and today’s show is just around that. But I think everyone should look at the big picture of what’s the best strategy for them. Because it might not be, “hey, let’s try and Roth convert all of this money.” And there’s some people out there who are saying, “well, let’s get it all into a Roth IRA.”

Well, that might not make sense, because maybe it makes sense to do half of your money over a long period of time. So when you do hit required distribution, you’re dropping yourself into a lower tax bracket anyway, because you don’t have as much traditional IRA money at that point.

So again, the Roth is not the be-all-and-end-all. But it’s a really good strategy in the right situation for clients. And when we do our All Hands Analysis, we see if it makes sense to do that.

Some people are hitting right up at the limit of their 12% tax bracket. And we don’t necessarily want a Roth-convert, because the next tax bracket is 22%.

But we also talk to people a lot about, if you’re married filing jointly, you’ve got a traditional IRA, maybe you’ve got a great pension, couple of really good Social Security’s, and you don’t really think you need any distributions from the Roth. So you’re just going to wait, well, unfortunately, over time, and having done this job for a long time, 25 years-plus, sadly, clients pass away and when somebody passes away in a couple, the survivor is:

A. left without their spouse, which is tragic

B. generally, the lower social security drops away and

C. Now they’re a single filer.

So they’re single filer, with different tax rates than a married couple filing jointly. They’re left in a situation that, if they’re over 72, they have to take money out of these accounts. Now they’re paying higher taxes potentially on that. Getting ahead of it leaves you or your spouse in a much more comfortable tax-efficient situation.

Host Jordan Rich

If you have particular questions that have been gnawing at you, and if anything we’re talking about today raises a question in your mind, and you’d like a quick answer, and perhaps more in depth answers – you can start the process with a 15-Minute No Obligation Strategy Call to South Shore Retirement Services. Set it up on the very easy-to-figure-out calendar grid at RetireSouthShore.com on the phone from home, a very quick opportunity, and a very important one, to get those questions answered. The 15 Minute No Obligation Strategy Call. Set it up, go to RetireSouthShore.com.
I guess, in summary, and we still have a ways to go here. In summary, the answer to the often-heard question, is “Am I going to be okay, in retirement, especially now, especially during these times.” Am I going to be okay?

Mark Rowlette

It’s a very vulnerable time for a lot of folks. And it’s psychologically very difficult for most people to not work anymore, right? They’ve done something for 30 years, 40-50 hours a week. All of a sudden, they have a party, a cake, somebody gives them a gold watch, maybe? I don’t know, Monday, they’re retired.

That’s a very difficult mental shift for folks. So to add the stress of “am I going to have enough money am, I going to be okay”, can be overwhelming for a lot of people.

And yet, maybe over the last, you know, 10-12 years, with the exception of the last two years, because the Market has such had such an incredible run, people aren’t that worried about it, they’re like, “Oh, I’m just making money hand over fist.”

I have clients that were working with us and coming in to us that were making more money in their investment accounts than they were in their in their salaries. But times are different now. Things have changed in the world, and I think things will continue to change.

In my opinion, I don’t think we’ve seen the bottom of this. That’s nerve racking for folks who are essentially going into what they would call a fixed income. Fixed incomes are a little bit different than what they used to be where, for example, my dad worked for Stan (stereotypical of an Irish person) with the Irish Social Security and a pension plan. And that was it. There weren’t really a lot of choices. But now there are so many choices.

There are so many different financial instruments that you could potentially use. And I think, up until recently, the financial world has done a really bad job. This is my opinion, in educating people on how to spend their money. It’s starting to evolve now because I think they realize they have to move in that direction because there are so many people who are actually starting to use the money.

This is how we’ve always counseled people, in a non-sexy way. It’s not doubling and tripling your money. It’s “how are you going to be okay, how are you going to make sure that you have enough money,” and how we do things like that is stress testing people’s accounts, stress testing their portfolios, looking at all of the what-if scenarios.

What happens if you lose money for three years? How would that impact you? What happens if inflation is 7½% for the next nine years? I know it’s more than that now. But if that happens? What happens if somebody gets sick? What happens if somebody passes away? Do you have the ability to ride that storm through?

And utilizing, for a portion of it, Roth IRA, getting rid of the taxes and having a bunch of tax-free money, it doesn’t matter where it’s invested, it’s just tax free. That can also add to the bottom line, I think it’s obviously really important to make money with your money even in retirement, but it’s equally as important to navigate the tax code, because that’s making money as well. Missing opportunities and saying, “Gosh, I wish I’d done that.” That’s unnecessary if you have the right people helping you.

Host Jordan Rich

That is the ultimate expression, “shoulda, coulda, woulda.” You don’t want to be in that situation. And I think the point is, you don’t have to be. And we’ve said this time and time again, everyone has an estate, everyone has something that they can use in in their later years, they worked for it. Don’t sell yourself short. And don’t, whatever you do wait to the last minute. And that’s easy for a procrastinator, like me to say. But seriously, don’t wait, get it done today. And breathe easier tomorrow.

Mark Rowlette

I totally couldn’t agree with you more. I think there are a lot of people who listen to the show. We’ve had people call the office and they’re like, “I don’t know if I want to make any changes, because the way the Market is right now.”

But you don’t have to make any changes, you can still build a strategy. And I think I had mentioned a couple of minutes ago, where if the market is down and you’ve lost money on your account, it doesn’t mean that your account is bad. It just means the market is down.

Look for an opportunity. Look for something that you can do when the Market is not performing and not making money. Nobody cares about (I shouldn’t say nobody cares)  but people, when they’re making money, are not as concerned about things. But when they’re losing money, they’re always looking for what should I be doing, I don’t mean, find the next great thing that’s bottomed out, that’s going to make you a ton of money when you put it in there. But if you have IRA money, maybe it’s a smart time to start paying taxes on some of that money while the accounts are depressed. You don’t have to sell the holdings to re-characterize some of that money to Roth, you’re just paying taxes at essentially a discount. And that could be a really smart strategy for a lot of folks in the current environment that we’re in.

Host Jordan Rich

Well, thank you for the schooling on the Roth IRA and so much more as you send your girls off to school every day. They’re back, and we’re back and we need to learn a lot and we appreciate it. Mark, have a great weekend.

Mark Rowlette

You, too. Thank you, take care.

Narrator (conclusion)

You’ve been listening to Retire South Shore Radio a presentation of South Shore Retirement Services for the latest on free seminars. To obtain a report or to set up a consultation, please visit RetireSouthShore.com Stay tuned for more real-world retirement solutions RetireSouthShore.com.