Tax rates are at their lowest in three decades, and the law is set to revert back to the old numbers in a few years. So, does that mean that it’s the perfect time to consider a Roth IRA conversion?
Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.
Click the link below to watch the show:
Click below to read the full transcript…
Announcer: Welcome to “Make It Last,” helping you keep your legal ducks in a row and your nest egg secure, with your host, Victor Medina, an estate planning and elder law attorney and Certified Financial Planner.
Victor J. Medina: Everybody, welcome back to Make It Last. This is episode 52. This is the full deck of cards of the [laughs] Make It Last show. This is the ace of spades of episodes. I’m your host Victor Medina. I’m so happy you can join us here this Saturday morning.
I’m excited about today’s show in large part because we’re going to be talking about a topic near and dear to my heart, it’s Roth IRA conversions and taxes. I know I try my very best to make this topic as entertaining as I can for you. Sometimes you all hear the word “taxes” and then you start to tune out.
No, we’re going to actually talk about taxes in a way that will be enticing because of all of the great benefits of Roth IRAs. Now, if you’re brand new to this, I’m going to help dispel some of the myths that are associated with how you create a Roth IRA and whether or not you can convert money out there.
Then, obviously, talk to you about why today’s climate might actually be the perfect climate to be thinking about making a Roth conversion. It has a lot to do with the newest tax laws that are in place. We’re going to get to that a little bit later in the show.
As you all know, the focus of this show is really on people who are entering retirement and facing those issues. We blend in all of the expertise that I can bring to bear on things like legal and financial planning, as well as tax‑related matters.
Every time we see something that is new and exciting for a senior or a retiree, we almost feel it’s our obligation to start to talk about that a little bit. We have a new piece of news on this. I don’t know whether or not you’ve come across it, but there’s some new news on Medicare cards in terms of what is being provided to seniors.
If you already have a Medicare card, one from the past, you’ll remember that one of the things that’s on there to help identify that it’s your card is your Social Security number. That can be a dangerous thing, especially if it gets into the wrong hands.
If there’s so much identity fraud that centers around getting access to somebody’s Social Security number. More and more, of course, this is happening for people who are seniors. The financial abuse for elders is one of those growing areas.
People taking advantage of a lot of the diminished capacity that can come from getting older. Jeez, the moment that you get a social security number, it’s almost as though left the door wide open with a big neon sign saying, “Come in and rob me.”
The federal government has seen this as a problem, understood that elder specifically are people who are a little bit more at risk and are doing their part to try to help protect that.
One of the ways that they’re doing it is by mailing out a new Medicare card. They’re going to start mailing a new card that comes with an 11‑digit identification number instead of the social security number. Now these cards are going to be sent automatically to the nearly 59 participants in Medicare over the next year.
Senior should make sure that their addresses are up to date with the SSA, the social security administration. You want to make sure that even though you might have set up social security to automatically deposit your money into your account and then you moved, but you didn’t really need to tell social security about that because your bank account didn’t move.
You move but the bank account’s still being deposited all that money. This is a good opportunity that if you’ve moved since declaring a social security, or since telling them where you were at, that in fact, it’s time to update your address for that.
The way this happened by the way, is that Congress required the Centers for Medicare and Medicaid services to remove social security numbers by April of 2019. And so, the new identifier is an 11‑digit number. It’s really a mix of numbers and letters.
The SSA is saying, once you receive your new paper card, you should go ahead and destroy the old plastic one, and give the new card to medical providers. They will update their records with a new identification number.
There’s a little bit of a caveat here. If you are one of the 21‑and‑a‑half million seniors who are enrolled in Medicare advantage, you should go ahead and continue to use your card because your card does not include your social security number. It includes an identifier by the insurance carriers.
Again, you don’t have to destroy them if it doesn’t have your social security number. You might still be getting a new card depending on the way that it happens. Largely speaking, the people in Medicare advantage are not carrying a card with their social security number. And so, we’re not as concerned about it.
The whole idea here is really trying to minimize fraud. This comes with a darker side and it’s great that they’re doing this. I want to advise you to be on the lookout for scams. Medicare wants people to know that they don’t have to do anything to receive their cards as long as the address is correct and there’s no activation process or fee.
If you’re starting to receive phone calls or if you’re caring for an elder who is saying, “Well, I heard about this new Medicare card,” that strikes some chord in you, “Oh, I know about that. I remember that.”
“They want me to give them information in order to process it or activate it.” Definitely, your ears should go up. Watch out for that because anybody who’s calling you for personal or financial information, absolutely just got to hang up the phone on that. Medicare is not going to be asking you for this information.
It’s not going to ask you to do anything to receive these cards. It’s basically just going to be something that will automatically happen. The thing about it is, and this is one of the reasons why we do this show, not a lot of seniors know about the cards. They’re about 75 percent of the seniors surveyed on a AARP survey knew nothing about their new redesign.
Then when asked, about 60 percent of them thought that they could face a fee for updating it. We are ripe in this environment for somebody to take advantage of an elder who does not aware of this.
No matter where you are in your spectrum, if you’re hearing this, one of the things that you can do to help other people, share this information down the road, send them a copy of this show, either on Spotify or iTunes. Send them to the website where we’ll have a transcript of this show. Transcript usually comes in about a week after we broadcast.
This would be great information to share so that those vulnerable seniors, those people in your lives, won’t be taken advantage of when it comes to this new Medicare card release, be fallen victim to a scam or some form of a fee or anything like that. It’s on its way. That’s good news. Beware of the scam. That’s the not so great news.
Victor: With your eyes open and your ears perked up you can definitely stay on the right side of these things. No bank information, don’t give any of that around. Listen, when we come back I’m going to cover why this might, in fact, be the perfect storm for a Roth conversion.
In order to do that I’ve got to teach you a little bit about Roth’s and teach you about why this is the right time. Then I’ll leave you with the information that you need to know about whether or not this is the right time for you. Stick with us. We’ll be right back on Make It Last.
Victor: Welcome back to Make It Last. We’re talking today about Roth conversions. In order to do that I’ve got to lay out for you what a Roth IRA is for those people that don’t know, and then dispel some of the myths about Roth before we get to trying to figure out why this might be a perfect storm for you.
IRAs generally are just used to describe these retirement accounts where we’ve parked money away. For most people it might have started as a 401(k). Then that 401(k) it was an employer‑sponsored plan. They contributed money. Sometimes their employer gave some extra money on top of it, what we would call a matching fund.
Then you just let it grow. You invested it but you just kept contributing to it. When you separated from service, when you left that job, you had the option to roll that employer‑sponsored plan into an individual retirement account, an IRA.
Many people took advantage of doing that when they left the job because they thought that the investment options might be better moving away from the company‑sponsored plan. They wanted to control it. Maybe they didn’t leave on the best of terms and they [laughs] don’t want any of their money associated with their prior employer.
For whatever the reason, they took the opportunity to move that money over and continue to manage it on their own. The central tax characteristic of that account didn’t change.
You contributed pre‑tax dollars into the account and because they had never paid taxes on them, anytime you took money out to live on, to spend, you basically had to pay the tax on that like it was ordinary wage income. In other words, it was like your salary. When you had that money moving out of that account you knew that it was going to be taxable.
That’s the case for as long as you have this IRA. In fact, when you turn 70‑and‑a‑half, you have to start to take some of this money because the federal government isn’t going to allow you to leave this money tax free without paying taxes on it forever and ever and ever. They’re going to require you to take some of the money out.
There’s a little wrinkle, of course, which is that if you’re in a 401(k) and still working, whether or not you’re contributing but you’re still working, you don’t have to take money out of that account. Anyway, for the most part, you’ve got to start taking money out of an IRA. Then somewhere along the line we got these Roth IRA’s.
The Roth IRA’s essentially came with it, some of the benefits of a traditional IRA and then some things that were different. For instance, contributions into a Roth IRA are made on an after‑tax basis. You don’t contribute to a Roth IRA as a way to reduce your taxable income the way you do with a traditional IRA.
The amount that’s in there, while it grows tax free, is not subject to any required minimum distributions. That’s one of the nicer characteristics about a Roth is that, in fact, you don’t ever have to take money out. You might be sitting there feeling like, “Oh, jeez, what a benefit. I don’t have to take any money out.”
If you think about it, federal government doesn’t care whether or not you take any money out of that account because you’ve already paid the taxes on it. By definition, it went in as after‑tax money. Whether or not you take anything out, the federal government isn’t sitting there waiting for their tax funds on it.
You’re allowed to delay that Roth IRA distribution for as long as you want. You don’t ever have to take any money out during your lifetime. When you take the money out though, all of the growth on that money is tax free.
Not only are the distributions tax free but if you put a $100,000 into there over your lifetime and it grew to $300,000, you don’t have to pay any tax on that growth. That’s a tax‑free account. The Roth’s are really good and some people said, “Well, jeez, why can’t I just park all of my retirement money in here?”
The answer is because the federal government was a step ahead of you on that one. They’re going to allow you to contribute to a Roth but only to some certain limitations. For instance, for the most part people who are contributing to a Roth IRA are limited to a few thousand dollars a year from their income.
In fact, if they make too much income they can’t contribute at all. There are some income limitations on the Roth conversion. Just to give you the full picture there are some situations in which your employer can offer a Roth 401(k), which will allow you to contribute up to $18,000 a year.
Let’s just stick with what most people deal with which is the ability or the opportunity to contribute to a Roth IRA on their own. What you need to know is essentially that that’s limited. It’s limited by the amount that you can contribute and it’s limited by your income. If you make too much you can’t contribute to an IRA, a Roth IRA.
I, as a trained lawyer, have chosen my words very, very carefully in describing this to you. I said that you can’t contribute past certain limitations but there is a way for you to have a lot of money in a Roth. That is to convert it. You’re allowed to make a Roth conversion from your traditional IRA. Here’s the nice part about it.
You have no limitations on the amount that you can convert. It doesn’t matter what your income is and it doesn’t matter how much you want to convert. You’re allowed to convert all of your IRA into a Roth in any particular year if you choose to do that, which is a pretty good benefit.
It’s a way of getting money into a Roth IRA even though you may not have had the conditions, or the opportunity, to contribute to one. You might think, in fact, that the Roth IRA, with its tax‑free treatment, is better for you. Again, if we think about it from the federal government’s perspective they don’t care. Right?
If you convert this over because by definition when you move the money out of your traditional IRA, you’ve got to pay the taxes on that money. In fact, if you’re going to be super bold and convert a whole bunch of money, of course, that’s going to push you into a higher tax bracket. When it pushes you into a higher tax bracket, federal government’s happy about that.
They’re going to be getting more income tax money. It’s important to know where you are in the tax brackets. In other words, if a tax bracket for the 12 percent number for a married couple goes up to about $77,000 you need to know where you stand on that.
What’s your social security number might look like, any pensions, anything that’s a required minimum distribution, bond interest that might be coming out, dividends that are being declared. All of these things end up getting jumbled together so that you know where you stand on that.
If you start to want to convert some more money out of your traditional IRA into a Roth, you want to know what tax bracket either that’s going to be charged at or push you into, depending where you are with the rest of your income.
There’s just one more role before we get to figuring out whether or not now is the right time to be making a Roth conversion and that’s this. In order for you to take advantage of the tax‑free withdrawals off of the growth, your conversions into a Roth IRA have a five‑year holding period.
What that means is that when you make the conversion on a certain amount, you can’t make a withdrawal of that amount for the next five years without paying a penalty on it. If you might think about this, you can make multiple Roth conversions.
It’s a fairly simple thing to think about a five‑year mark when you do it once and be worried about whether or not that’s the right move for you.
If you’re making conversions on a regular basis, if essentially what you’re doing is you make one conversion this year and another conversion next year, each of them is running its own five‑year clock, so to speak, on the conversion before you can take it out.
Five years from now you can take some money out even though you can’t take it from next year’s conversion, kind of tracking with that.
Victor: There’s this five‑year holding period. Now, when we come back I’m going to talk to you about why today, now, might be the best time to take advantage of a Roth conversion given that today’s tax structure.
Now that you know everything that you need to know about what Roth’s are and why you might consider it. Stick with us. We’ll be right back on Make it Last talking about Roth IRA’s. We’ll be right back.
Victor: Welcome back to Make it Last. We’re talking about Roth IRAs. I have lectured for years about how wonderful Roth IRAs are. They are wonderful for, not only the reasons that we’ve discussed already, the tax‑free benefits, but they are a wonderful inheritance planning tool.
If you are somebody that is super concerned about what you leave behind, and want to make sure that what you’re leaving behind for your kids or grandkids is something in the best way for them, the most that you can leave behind, taking advantage of the Roth IRA is one of the strongest tools in your toolbox.
The reason for this is that, if you remember in the prior segment, I said to you that you don’t have to take any money out of a Roth IRA, the way you do with the traditional. There are no required minimum distributions on a Roth.
When you leave that account behind and it becomes an inherited account, the people who inherit that, in fact, do have to take money out. They’re called in that circumstance, life expectancy distributions. It’s sort of the technical term for it.
The amount that they have to take out is based entirely on their age. If they are a younger person, they’ll have to take less out than if they were an older person. You might think about it like your required minimum distributions. It’s very similar. It’s the same schedule of the percentage out.
It’s important that when it becomes an inherited IRA, you understand that you have to take that money out, whether it’s an inherited traditional IRA or an inherited Roth IRA. While you have to take some money out, you don’t have to take any more than what’s required.
Follow this through to its logical conclusion. If you leave behind a Roth IRA to somebody and they only have to take one or two percent out annually, but you keep it invested or they keep it invested, sorry, you died. [laughs]
You’re dead, but they keep it invested, and that grows six, seven percent on average basis over the long haul, in that circumstance, they have built quite a nesting of tax‑free money for the rest of their lives.
Leaving behind a Roth IRA sometimes, by the way, not only with children but to grandchildren, in that circumstance, jeez, the percentage that the grandchildren have to take out, since they’re so much younger, is so small that the compounding power of a Roth IRA properly invested is incredible.
We get to today. Unless you’re hiding under a rock, you know all about the new tax cuts in Jobs Act, which is the tax reform that was passed in December. They came with one negative change for Roth IRAs, but otherwise, Roth IRAs, they’re pretty attractive these days.
The one negative change has to do with something called characterization or re‑characterization. I won’t spend a lot of time on it because it went away. [laughs] It’s no longer the law. If you made a Roth conversion, there was a law before that said that you had until October 15 to re‑characterize and bring it back into your account in your traditional.
Why might you choose to do that? The investment performance wasn’t what you wanted, and so why pay the tax on something that didn’t grow? Anyway, for right now, trying to figure out why this is the best time centers on this new tax law.
The biggest way to get a whole bunch of money into a Roth IRA, as we talked about it, is in the form of a conversion. A conversion is treated as essentially a taxable distribution from your traditional IRA. It’s as though you made a payout from that account.
Basically, you will pay taxes on that as it goes into the Roth IRA. Why might this be the perfect time to think about a Roth IRA? The reason is because today’s federal income tax rates might be the lowest that you will see as a retiree for the rest of your life.
If you’re a younger person, maybe they’ll get down this low again. As a retiree, for the next nine years, we’re seeing tax rates like never before. Here’s what it looks like on the horizon. Right now, the tax brackets are at 10 percent, 12 percent, 22 and 24 percent.
There are more brackets, but for most retirees, that’s the place that you’ll be living. Before, they were 10, 15, 25 and 28. You see about a three or a four percent benefit over these new tax brackets. What you need to understand though is that after 2026, the old brackets are going to come back into play.
We’re going to go back to other numbers. The reason for that is because in order for this tax bill to be passed through reconciliation, you need it to limit the loss, the deficit, to $1.5 trillion over 10 years. After 10 years, there couldn’t be any loss whatsoever.
What was the easiest way to do that? Confer a tax benefit for nine years or so, and then roll the tax brackets back to what they were before, and then the deficit stops. If you weren’t paying attention, in fact, we do have a deficit based [laughs] on what we have on the new law, and it’s thankfully, only $1.5 trillion by definition. Then it stops.
The reason why it stops is because they increase the taxes again. They do that by a whole bunch of ways. The only thing that stays as a permanent tax bracket are all the corporate tax brackets benefits that have been in there.
If you’re trying to figure whether or not they’re looking out for you or a corporation, just survey and figure out, “Well, jeez, the corporate one goes forever and ever. It’s permanent, but my tax benefits, they sunset at some point in time.”
We know that these new tax brackets, by law, are only going to be around for the next nine or so years. Eight years if you’re starting in 2018. In fact, in 2026, within only seven years, we’re going to have the old tax brackets.
Depending on where you’re at, this might be the lowest tax situation that you’ll face in your lifetime. We know that these things are going to be going back again. For people who are considering this, I promise you that we would give you the factors to consider whether or not this is going to be right for you.
Thinking about a Roth conversion right now are best for people who believe that their tax rates during retirement are going to be the same or higher than their current ones. In other words, if you’re going to be in the 22 percent bracket, that number, those ranges, you believe that you’ll be in those ranges in the future.
If that’s the case, then thinking about a Roth conversion will be beneficial to you. If for no reason than seven years from now, that same bracket, for those same numbers, is going to jump up back to 25 percent. If you are in that situation, you might think about a Roth conversion.
You’re not going to convert everything over. That would be running against this idea about using the tax brackets to your advantage. You might think about a multi‑year, or what we call in our office, a laddered conversion strategy, a little bit in every year.
Do you remember, I talked about a couple that might make about $50,000 a year, where the top of the 12 percent bracket was $77,000? Those individuals might think about making a $27,000 conversion from their traditional IRA into their Roth IRA, and do that roughly every year, if their income is going to stay the same.
You can’t convert it back. Once you do that, you’re going to pay the taxes, and then those taxes are going to be paid forever and ever. Remember, there is a five‑year holding period. We don’t want to make conversion into money that we’re going to need right away.
This is going to be for further down the road. You might be thinking about it in terms of inheritance planning. Because of the tax brackets and where they are today, and knowing that they’re going to be converted back in future, look, play the political game.
Try to figure out, if power changes, do we think that a new tax law will be put in place? Likely the case. If this power doesn’t change and we stay in the same political climate, we know that the laws that this political structure put in place, is going to sunset in seven years.
There’s a lot of validity to thinking about this Roth conversion strategy now as being that perfect storm for doing it. What do you think about it? Let us know. If you’re interested in learning more, drop us a line.
You can always send an email to firstname.lastname@example.org. Let us know if you had any questions about what we’re doing. Certainly, if you want to explore this Roth conversion, you should do it with a competent financial advisor and somebody who’s well‑versed in tax. That’s something that we do.
If you’re interested in learning more about it from us, certainly reach out to The Medina Law Group, or me on my financial services site under Private Client Capital Group. We’re happy to talk to you about that.
Otherwise, if you like the show, share it with a friend. We are available on iTunes, Spotify, all the major channels. We even have a YouTube channel streaming the live video of this show, and you can go back and watch it any time and share it with a friend.
Other than that, I’m going to thank you for joining us here this Saturday on Make it Last…
Victor: …where we help you keep your legal ducks in a row and your financial nest egg secure. We will catch you next Saturday. Bye‑bye.
Announcer: The foregoing content reflects the opinions of Medina Law Group, LLC and Private Client Capital Group, LLC and is subject to change at any time without notice.
Content provided herein is for informational purposes only and should not be used or construed as investment or legal advice, or a recommendation regarding the purchase or sale of any security, or to follow any legal strategy.
There is no guarantee that the strategies, statements, opinions or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment.
Any investor who attempts to limit the performance of an index would incur fees and expenses, which would reduce returns. All investing involves risk, including the potential for loss of principal. There’s no guarantee that any investment plan or strategy will be successful.
We recommend that you consult with a professional dedicated to your needs.