Jason and Emilia discuss ROTH conversions and if and when to use them when planning for your retirement.

Below is the full transcript:


Announcer: Welcome back America to Sound Retirement Radio, where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for, and transition through retirement. Now here is your host, Jason Parker.

Jason: America, welcome back to another round of Sound Retirement Radio. It is my good fortune to have Emilia Bernal back in the studio with me. Emilia, welcome back.

Emilia: Hello, hello. Good morning.

Jason: Good morning. Emilia, we like to start the day right by renewing our mind. I’ve got a verse here for us to do that with. This is 1 Timothy 4:8. For physical training is of some value, but godliness has value for all things, holding promise for both the present life and the life to come. That’s awesome. Yeah. Yeah, especially … Just awesome.

Emilia: Yes, and I hear you have a joke for me. I’m already laughing-

Jason: I do.

Emilia: … and I don’t even know what’s happening.

Jason: Are you ready? Oh man. I’m excited. I got to set the stage. I shared this one on the webinar last night actually, but I was getting ready to do the webinar. I was walking out of the house, and I said, “Libby, do you have a good joke for me?” Libby’s my … You know.

Emilia: Yes.

Jason: Our listeners may not know. She’s my 10-year-old daughter. She got this little crooked smile and this really kind of naughty sparkle in her eye, and almost like she tilted her head, kind of wondering if she really wanted to tell me this joke or not. So here it is.

Emilia: Okay.

Jason: Why didn’t the toilet paper-

Emilia: I’m already like, ooh, okay.

Jason: Why didn’t the toilet paper cross the road?

Emilia: I have no idea. I can’t even think of one.

Jason: Because it got stuck in a crack.

Emilia: Oh my.

Jason: Oh man I actually like that one.

Emilia: That was cute. That was cute I can imagine she was…

Jason: I told her when I said, “Libby I shared that with the web” and she goes, “No, you didn’t dad, you didn’t share that with people!” And I said, ” Oh yeah, you’re the one that told it too, it came from you.” And she was embarrassed.

Emilia: That’s a cute one though. I can see why she was like, not sure, but that’s cute, it’s funny.

Jason: This is episode 161, Is a Roth Conversion Right for You?

Now before we get into this episode, something exciting I want to share with our listeners with, so up until now we’ve only allowed the last 10 podcasts to be available for download, otherwise you had to visit the site, and then it was a little bit clunky unless you knew what you were searching for.

So I just made a change, now the top 100 podcasts are available, and I did that for two reasons. One because we had a listener ask us, “Hey how do I get access to the old material?” But also there’s some really great shows in there that I think would really benefit people’s lives, and so if you’re just getting ready to retire, I want you to go back, or if you’ve recently retired, go back and listen to episode number 63. The title is Are you Fully Alive? And it’s a really wonderful interview, I don’t know that a lot of people have heard that one, but it really speaks to that transition, making that transition into retirement and then just also kind of finding your bearings once you’re there so I went back and listened to it and I was like, “Man, that was a great show.” We had a couple audio issues in there but really great interview.

Okay so episode number 161 Is a Roth Conversion Right for You?

Emilia: Yes, so let’s go ahead and begin. Why are people considering Roth conversions?

Jason: So, a couple of reasons, but I think what has really thrown some fuel on the fire because rots are pretty special, these new low tax brackets that just went into effect this year have really made the Roth conversion something that more people are considering, so that’s one of the big reasons, but then also you figure our national debt is quickly approaching $21 trillion, we continue to spend more than we bring in in tax revenue and then you have this opportunity where we have these all-time low tax rates, lower than we’ve seen in a long time, plus this really high standard deduction and people are saying, “Jeez, I’ve got all this money trapped in these tax hostile accounts.” That’s what an IRA or 401K is, when you contribute to those accounts you get a small tax break at the time of the contribution and then you get tax defer growth. So you get this little bonus upfront that you get the tax break and then all of your money gross tax deferred so you’ve got this little tiny bit of money you put in, but then when it comes time to pull it out you’ve got this huge sum of money in that account and now it’s all taxable. That’s what I call short-term gain, long-term pain.

Emilia: Ooh.

Jason: Yeah, we want to flip that upside down. We want to say, “how do we have some short-term pain, but long-term gain?” And that’s why the Roth is becoming so popular because it does just that, it says, “I’m willing to endure some short-term pain, when I understand the long-term gain.” Another visual that I think is really powerful here, Emilia, is the idea of planting an apple orchard. So you’ve got this seed and the government comes to you and they say, “Emilia, you can either pay taxes on the seed, or you can wait until the apple tree grows and produces all of the crop and then you can choose to pay tax on your harvest.” So you can either pay tax one time on the seed or you can pay tax on the harvest. What people are realizing is they get this… What they’re doing with their IRA is they’re waiting to pay tax on the harvest, so they get the tax break upfront, the apple tree grows, now it’s got all these apples, but now they’re having to pay tax on every single apple that grows off this apple orchard. Were as the Roth IRA is the opposite of that. You don’t get the tax break up front, but then when you go to harvest all of your apples it’s all tax free to you. So most people like the sound of tax free.

The other thing is to understand the tax law, we’ve got a limited window, it’s a ten year before the sunsets unless congress takes some action to continue those tax cuts, and if you look at our national debt being $21 trillion you think, well is this really sustainable? So, I think there’s an opportunity for people to be thinking about.

Emilia: Great, so before I go on to some more questions, I wanted to let our listeners know that Roth conversion are going to be part of your upcoming webinar, it’s going to be discussed in your webinar, and that webinar is going to take place on Thursday March 22nd at 5:30 pacific standard time, so if you’d like to register for that webinar go to soundretirmentplanning.com and you can register by clicking the link there.

Alright, so my next question then, moving on with Roth conversion or Roth IRAs. What are the advantages of a Roth IRA?

Jason: Yeah and I want to address conversions too because specifically a lot of people can’t contribute to a Roth IRA because their income is too high. We’re not talking about contributions to Roth IRAs here, we’re talking about conversions. Many people don’t realize that back in 2010 the law changed that said everyone’s eligible to do conversions. It used to be if you had more than $100 thousand of income that you weren’t allowed to do a conversion, but today everyone is allowed to do conversions. So we’re not talking about contributions, we’re talking about conversions, money that’s already in traditional IRAs, or 401Ks, or 403Bs, these qualified accounts getting that money over to a Roth IRA, so a conversion is different than a contribution so I just wanted to make sure our listeners understood that.

But here are some of the things that some people may think about them, may not. Number one, you’ve got, of course, the tax free growth, so all of the money is going to grow tax free within those IRAs, and then as long as you follow the rules and they are qualified distributions, such as the money has to be there for five years and based on the age and when you’re pulling the money out, you have to follow the IRS rules, but as long as you do the money is going to be tax free growth and then tax free income for you when you need it. One of the things that many people don’t realize on traditional IRAs, when you turn 70 and a half you have to take required minimum distributions. With a Roth IRA there is no required minimum distribution, so you’re not required to pull your money out, it can just sit there and continue to grow tax free, which is really powerful.

One of the other things people don’t consider, Emilia, is the taxation, how that money being tax free effects other areas of your retirement cash flow plan. For example, social security, there’s something called the provisional income rules that determine how much of your social security income is taxable to you and they basically take all of your income sources, including municipal bond income, and 50% of your social security to determine the taxation, but Roth IRA income is not included in that formula, so you could have $100 thousand of Roth IRA income and your social security income and literally pay no money in tax, no money at all in tax on that social security income either. Typically, if we were pulling $100 thousand out of a traditional IRA then 85% of your social security gets taxed, so you get this double whammy in taxation by pulling money out a traditional account, so that’s another piece people don’t think about.

Another thing, that in today’s environment, that they’re not thinking about is the health insurance right now any subsidies through the affordable care act are based on your income, your modified adjust to gross income. So if you have income from a Roth IRA, again that doesn’t count against you, so there are some people that are supplementing their income sources using the Roth IRA to keep their income low so that they get some assistance with their health insurance premium before age 65 because health insurance often times is one of people’s biggest expenses as they’re making this transition into retirement.

The other big piece that people don’t think about here is the money transferring to the next generation. So what happens is, when you die, if you have a Roth IRA your children can inherit that Roth IRA and at the time of inheritance they don’t have to take it as lumps sum, they can leave the money in the Roth IRA, now they do have to start taking minimum distributions at that point based on the formula that the IRS has for required minimum distributions but it’s just a little bit of money so that account can continue to grow tax free, not just for your life time, but also potentially for your heirs. I mean there’s just so much to the Roth IRA and some of the advantages and people can be kind of short sighted, but again we want short-term pain, long-term gain, not short-term gain, long-term pain.

Emilia: That sounds like a lot of great advantages for our listeners and anyone that considering a Roth conversion. My next question, Jason. If a Roth IRA is so great, should everyone convert to a Roth IRA?

Jason: No.

Emilia: No. That was a no.

Jason: Yeah, so it really gets back to being able to answer the question. What’s the purpose of your money, what are you trying to accomplish with it? But my experience has been, the reason that most people save for retirement is because they want to be able to maintain their lifestyle, they want to be able to have cash flow, they want to be able to travel and spend time with the grandkids and that’s all about consuming the resources that you’ve saved, I mean that’s in many cases why people save them, so that they could supplement their social security income.

Well the hard part with the Roth IRA conversion is when you take money out of the traditional account and you convert it over to the Roth that causes taxes to be due and so in a perfect world you would be able to pay those taxes from an outside source, some other qualified account and not have to pay the taxes from the conversion money. So what could happen, is if you do conversion and then it messes up your financial life because now you end up running out of money early in retirement because of that tax hit, well that was a bad move for people. So tax planning is an important component because most people we serve say, “Jason we don’t mind paying taxes, we just don’t to pay more than our fair share in taxes.” So we definitely want to consider the tax implications, but if the tax planning means that we blow up the retirement cash flow plan, well that was bad planning, so we’ve got to make sure that it’s sustainable and that’s what we’re going to be covering in the webinar. To help people understand the retirement cash flow plan first, and then some of the tax planning that people could be considering.

Emilia: Alright, so you said it’s not for everyone, but can everyone do a Roth conversion?

Jason: Yeah, again, getting back to this so, I’ll never forget a couple years ago I’m out with a gentlemen and we were talking about this and he said, “Jason, I’m not eligible to do a Roth conversion, I make too much money.” See he was still operating under the old rules, the myths and misconceptions. Emilia, this is kind of a fun exercise, but when I speak, like I was teaching a class at the local college recently, and I’ll ask people. What color is a yield sign? And people will raise their hand and I’ll go around the room, and guess what color they always tell me a yield sign is.

Emilia: The same color I thought it was too, yellow.

Jason: Yeah, myths and misconceptions of the old world. Well they were yellow and black up until about 1974 or 1975 that they changed and now they’re actually red and white, but in our minds we hold onto these old rules, these old facts that used to be the case and it’s just not the case anymore and people are making bad decisions because they don’t have all the information. Charlie Munger is Warren Buffet’s right hand man and when he became eligible to do a Roth conversion, when the law changed he said, “of course I’m going to do a Roth conversion” not for his lifetime, I think he was in his eighties at the time, but because that money all gets to go tax free to the next generation and they only have to take minimum distribution. So now again, just because Charlie Munger is doing it doesn’t mean everybody needs to rush out and do this. You really need to sit down with a financial professional that can help understand the retirement cash flow plan first, but then if there is an opportunity to do a Roth conversion, to consider that.

Emilia: You mentioned a lot about the tax implications and the tax planning of how important it is with Roth conversions. So how do taxes work with Roth IRAs?

Jason: Its ordinary income tax, that’s the problem with traditional IRAs is when you pull money out of those accounts you get dinged with taxes. But here’s a little bonus for people, most people know that if you’re under age 59 and a half and you take distribution from an IRA there’s a 10% penalty for taking money out of the traditional account before age 59 and a half, but there is no penalty, there’s no 10% penalty for doing the Roth conversion. So you can move the money from the traditional account to the Roth IRA and be under age 59 and a half and not have a penalty associated with that but there’s still tax consequence.

So some of the little nuances that people need to be watching out for. First of all, it’s going to increase your ordinary income tax, now again all of the tax brackets just got slashed, we had 7 before, we still have 7 tax brackets but they’ve all been lowered so there could be an opportunity here for people to capture. One of the other things that people need to think about, if they’re over age 65 and they’ve started Medicare some people don’t realize there’s this thing called IRMA, income related Medicare adjustments, and so they end up paying more money for their Medicare premium if their income gets to a certain point. So you’ve got to be careful about converting too much because you could start losing deductions, you could start having to pay more for things like Medicare, Medicare part D, so you just want to be careful when you’re doing these conversions that you’re doing them strategically and you’re thinking not just about the tax consequences but also how doing the conversion bleeds through into other areas of your financial life. But again I think there’s an opportunity here, I would highly encourage people.

One of the things that a lot of people don’t know too, the tax law changed a core component of doing a Roth conversion. Let me say that again, the tax law that just went into effect in 2018 changed one of the main rules around Roth conversions. Here it is, it used to be in 2017, if you did a Roth conversion they allowed you to do something called a re characterization, you could change your mind and go back and by October of the following year before you filed your taxes you could actually say I want to do a redo, take the money back out of the Roth put it back in the traditional IRA and not pay taxes. Well they no longer allow for the re characterization, so you’re all in, if you decide to do the Roth conversion there’s no do overs so definitely make sure you run the numbers so that you know what that tax liability is and that you’ve got the cash to be able to pay it because you don’t want to find that out after the fact.

Emilia: That sounds very important.

Jason: No more do overs.

Emilia: No do overs.

Jason: Get it right the first time.

Emilia: Come talk to Jason before…

Jason: We call that measure twice, cut once.

Emilia: Alright, yes. Again if you want to learn more about this join us for our webinar on Thursday March 22nd at 5:30 pm pacific standard time and Jason will give you some more information on this and help you out with that.

So just moving on here, a couple more questions. What kind of investments can you hold in a Roth IRA?

Jason: It’s so great, all the tools people are used to using in their traditional accounts are still going to be available on their Roth. So stocks, bonds, mutual funds, ETFs, annuities, bank Cd’s, money market accounts, I mean there’s just so many financial vehicles you can use. I mean there are some limitations there, but for the most part the traditional tools that most people use are going to be available to them.

Emilia: Good, good to know. So Jason, do you have to convert all of your money at once when you do Roth conversion?

Jason: No, that’s another misconception. People think I’ve got a million dollars pin this IRA, I don’t want to have to convert and have to pay taxes on a million dollars all in one year because that would bump you up into the highest tax bracket. So, no you can piece meal it, you can just do a little bit at a time, in fact, very rarely, in some instances it does make sense to do it all at once, but in many cases if they can spread that tax liability out over maybe a four or five year time period and just convert enough maybe that it doesn’t push them up quite into the next tax bracket that’s what we see as popular with a lot of folks.

Emilia: Okay, great. So the next question I have for you, Jason, what are some of the other little nuances to consider with Roth conversions?

Jason: Well I think I hit on those already, things like the Medicare premiums, just being careful because as you go up through those different tax brackets there are different tax consequences. You know it would be nice if the tax code was simple, but I can’t remember how many phone books high somebody once told me, if you were to take our current tax code and stack it, I can’t remember the number but it’s ridiculous, so you just have to realize that as your income goes up you lose certain deductions and there are new taxes that come along for the ride and so you just want to be careful with those.

Emilia: Yeah, it sounds like you want to be very organized when you have somebody look at that because tax laws are really, there’s tax attorneys specifically for things like that.

Jason: Absolutely.

Emilia: Like there’s so much information you don’t know what to do with.

Jason: That’s why we can’t over emphasize, to meet with a professional before that.

Emilia: Alright Jason, so question here. Should people convert all of their IRA and 401K money to a Roth?

Jason: Probably not. They are very attractive and in some cases it can make sense to do that but in most cases what I think makes sense is to diversify your future tax liability, just like you would diversify your investments. So obviously the Roth has a lot of advantages, but there’s some pain that goes along with having to get that money to the Roth. So if we can have, my dad use to say don’t put all your eggs in one basket, so right now a lot of people’s eggs are all in that tax deferred basket, if we can help maybe have some of their eggs in a tax free basket it just gives them more options when they’re putting together that retirement cash flow plan.

Emilia: So with the planning process, when is the best time to convert?

Jason: Yes, so obviously if there’s a major change to the tax code that makes it beneficial that obviously a good time to consider doing a Roth conversion. Like I’ve seen tax rates drop and standard deductions double, I mean that’s pretty attractive. Another thing is, sometimes it makes a lot of sense so people will sometimes lose a job, so their income drops way down, so in those years, where its taking lemons and turning it into lemonade. Our income is down so this is an opportunity to do a conversion.

We’ve seen it where when people are retired if all of a sudden they start experiencing a lot of medical expenses in the past they would use those to help reduce through their standard deduction, they would help reduce their taxes and so because they had higher than normal expenses they would use that as an opportunity. Sometimes when people are retiring early, so let’s say they’re retiring at age 60, but they’re not going to start their social security until age 70, so they’ve got this 10 year window of time, or maybe even shorter than that, maybe 5 years, if we’re also considering the impact on Medicare, where they could start doing these strategic conversions to start paying some taxes, but try to stay in the lowest tax bracket possible when doing conversions. So it’s a very personalized question, but those are some of the opportunities that we find.

Emilia: Well great, do we have time for another question though?

Jason: Yeah.

Emilia: Okay, so Jason, when is the deadline to do a Roth conversion then?

Jason: Great question, so it’s not April 15th. Yeah the great thing about doing contributions is you have up until April 15th of the following year, but with Roth conversions it’s a December 31st deadline. So, if you’re going to do a conversion in 2018 you have to do it before December 31st of this year. You cannot bump it up until April the following year. So a little bit different time line there for doing the Roth conversion.

Emilia: Great, so again I want to remind our listeners that if you want to learn more about Roth conversions, and retirement planning join Jason for his webinar on Thursday March 22nd at 5:30 pm Pacific Standard Time and you can register by going to soundretirementplanning.com.

Jason: Awesome Emilia. And with that we’re just about out of time so I just want to thank you again for being a guest.

Emilia: Great, thank you.

Announcer: Information and opinions expressed here are believed to be accurate and complete, for general information only, and should not be construed as specific tax, legal, or financial advice for any individual and does not constitute a solicitation for any securities or insurance products. Please consult with your financial professional before taking action on anything discussed in this program. Parker financial, it’s representatives, or it’s affiliates have no liability for investment decisions or other actions taken or made by you based on the information provided in this program. All insurance related discussions are subject of the claims paying ability of the company. Investing involves risk. Jason Parker is the president of Parker Financial, an independent, fee-based, wealth management firm located at 9057 Washington Ave NW Silverdale, Washington. For additional information call 1-800-514-5046 or visit us online at soundretirementplanning.com.