In a recent article I outlined some virtues of rolling over a traditional IRA or 401 (k) into a Roth IRA. As baby boomers transition into retirement their concern moves from accumulating wealth to keeping it.
Today we are going to learn from a professional who deals with these issues regularly – a certified expert. Good friend Jeff White, President and CEO of IFG/Russell Advisors, Inc., part of the American Financial Group offered some great suggestions. I grabbed the opportunity to corral a busy man for an interview.
DENNIS: I know how busy you are so let’s get right to the subject. Jeff, in the past we discussed the need for people to save for retirement. Today the focus is on how they can keep as much of their nest egg as possible by using good tax strategies. What do boomers and retirees need to consider?
JEFF: First of all, thank you for giving me an opportunity to speak about something very close to my heart.
This question may be key to your financial health in the future! At the moment, until Congress changes the rules, there is an open window of opportunity to shift gears from a “Pre-Tax Asset” to a “Post-Tax Asset.” Not an easy question and at the risk of sounding like an economist, the answer depends on multiple factors.
Many of us follow the theme of “defer taxes as long as possible.” The amount of tax you would pay to convert a traditional IRA to a Roth IRA could be earning extra money for you until you are forced at age 70 ½ to begin your “Required Minimum Distributions” (RMD’s). Then, based on life expectancy tables, a portion of your Pre-Tax account must be withdrawn and taxed.
DENNIS: What are the primary factors?
JEFF: They include:
A. How much you have in pre-tax accounts
a. Unless you have a significant amount and plan to build that to something over $500,000 by age 70, I would not convert
b. Add other sources of retirement income such as any investment accounts, stock options, deferred comp accounts, etc.
B. Your tax bracket today vs your potential tax bracket after retirement
a. The following graph shows the volatility of the top tax rates since 1955.
b. No one knows what tax rates will be in the future. The only thing we do know is congress is likely to discuss raising taxes as government debts continue to grow.
C. Do you have cash sitting in an account earning little or no interest?
a. I would never take the conversion tax out of the IRA account unless you have no other choice.
b. If you are earning a rate less than the CPI, conversion tax may prove to be a wise use of idle cash.
D. Will the market value of your account be higher or lower at time of liquidation? (Don’t forget the value of dividends, interest and cap gains between now and then).
a. No one knows where markets will be at any point in the future. But if you include dividends, interest and cap gains, your account has a great chance of being higher.
b. The farther you are from retirement; the more likely future values will be higher.
DENNIS: It sounds to me like the individual has to make bets on the future.
We rolled ours to a Roth because we felt tax rates would rise substantially in the future. The time horizon and amount you have built up in pre-tax accounts is also a factor. At one time you mentioned volatility could be your friend. Can you explain what you mean?
JEFF: History shows that market declines are followed by recoveries. That applies to markets in general and even more so, specific asset classes.
The recent market decline and the continuing decline in oil prices is a good example.
We review specific positions within a client’s Pre-tax account for opportunities to convert those positions to their Roth account. While we never know where the bottom is, one might look at their commodity and emerging market funds and move some shares to Roth.
In 2008 when the stock index funds were low, we had clients roll them into a Roth and they have come back nicely inside their now tax-free Roth.
Market declines are terrific windows of opportunity to convert to a Roth. You need not move an entire account, just some positions that have fallen to a level that makes a Roth conversion less taxing.
DENNIS: That is a great technique; not only do you minimize taxes, you roll assets which have great appreciation potential inside a tax-free account. Any other techniques you want to share today?
JEFF: Sure. While they are never perfect but we like to use “limit transfer orders” in which the client agrees that, should their shares in a stock or ETF fall to a specified level, we transfer that position to their Roth account. We can do that with shares in a mutual fund too but we do that close to the end of the trading day. Of course, the client may wish to sell the shares and move to a different investment position.
It is more proactive than just waiting for a periodic review of their account.
DENNIS: What if people are still working or have an “encore career”?
JEFF: That generally does not present a problem. There are a lot of retirees enjoying “encore careers” who love a Roth. There are limits, but they can still contribute to a Roth, but do not get a tax deduction. That is offset by the fact you put money directly into the Roth and never have to pay taxes on the income it earns. Many retirees with encore careers are still contributing to their Roth and seeing it grow.
DENNIS: What happens when a person dies with a sizable amount in their Roth?
JEFF: This is one of the beauties of a Roth. It becomes an incredible financial bequest for your children! Perhaps the most financially effective asset you can leave your children is a Roth Account!
They must take a minimum distribution but it is based on their life expectancy, which is most likely quite long, hence the annual required distribution will be modest – and it is income tax-free! What remains in the Roth after their minimum distribution continues to grow. It can provide them solid tax-free income for a good long time.
DENNIS: What if Congress changes the rules and Roth accounts are no longer available?
JEFF: To me, this is big reason to begin the conversion now while the Roth Window is open. You mentioned the unknown of Congress increasing taxes. By opening a Roth now and rolling over at least part of your pre-tax assets you are hedging your risk.
And you might also ask, could Congress tax Roth accounts someday?
I would suggest that the French had the answer to an over bearing aristocracy …it is called the guillotine! Americans have been tolerant for years as Congress spends their money. But as King George learned many years ago, we have our limits!
DENNIS: I recall former House Speaker Pelosi was in favor of requiring qualified plans to hold some government bonds, as they are less risky than the stock market. While no one knows what happens in the future, what could possibly happen? How would Roth holders have to adjust?
JEFF: That is a good example of one of the many unknowns that could happen in the future. Please understand this is my opinion and not a prediction.
While I jokingly referred to King George and the guillotine, the last thing Congress wants is the citizens’ to storm the palace. My opinion is they would probably grandfather existing Roth accounts. I believe this is the doctrine of equitable estoppel. In street terms, that means they would get what they want over time without the uprising.
Bottom line is the government can do what they want – they are the government! That is one of many reasons why people should at least get a Roth opened now while it is still available. The window of opportunity may never close, but better safe than sorry!
Dennis: Jeff, thanks so much for taking the time today. On behalf of our readers, thank you very much.
Jeff: Thank you Dennis, my pleasure.
I want to add one comment from my personal experience. The mechanics of rolling over a traditional IRA or 401 (k) is not difficult; a good stockbroker can probably walk you through the process. I strongly recommend that anyone thinking about doing so consult with your CPA or investment advisor. As you can see by talking with Jeff, a licensed, qualified professional helping build an effective strategy can help save a lot of tax dollars.
You worked hard for your money, and sacrificed to save it. Keep as much as you can and enjoy the rest of the ride.
On the Lighter Side
Jo and I went to Las Vegas for Super Bowl weekend. We visited the Pawn Shop that has been made popular in the TV series “Pawn Stars”.
We were totally impressed. While it was crowded, things were orderly. They have some really amazing items in there for sale; things you would not normally find. If you are a sports or music memorabilia fan I would encourage you to visit.
Congratulations to the Denver Broncos who won Super Bowl 50. I’m glad I did not bet because I would have lost. There is an old sports saying, “Defense wins championships” and it proved to be true this time.
We had a great time and would come again. Next time I would make reservations for a place to watch the game. We went into three hotels on the strip and everything was reserved, and had been for months. We really had to scramble to find a place to watch the game.
Good friend Dennis A. sent me an appropriate Phyllis Diller quote:
“The reason women don’t play football is because 11 of them would never wear the same outfit in public.” – Phyllis Diller
Until next time…